-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, N7SQo8WpV/jF85TiMnKaF9L10Kx6+JNWYwfWwUrJqRyX1QxkPCh7ZFD+FnNxxYYG cUecN33SNPXbdGzTYPc6cg== 0000891618-99-002051.txt : 19990510 0000891618-99-002051.hdr.sgml : 19990510 ACCESSION NUMBER: 0000891618-99-002051 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19990328 FILED AS OF DATE: 19990507 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VERILINK CORP CENTRAL INDEX KEY: 0000774937 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 942857548 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-28562 FILM NUMBER: 99613985 BUSINESS ADDRESS: STREET 1: 145 BAYTECH DR CITY: SAN JOSE STATE: CA ZIP: 95134 BUSINESS PHONE: 4089451199 MAIL ADDRESS: STREET 1: 145 BAYTECH DR CITY: SAN JOSE STATE: CA ZIP: 95134 10-Q 1 FORM 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 28, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to _______ Commission file number 0-19360 VERILINK CORPORATION - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 94-2857548 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 145 BAYTECH DRIVE, SAN JOSE, CALIFORNIA 95134 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) 408-945-1199 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The number of shares outstanding of the issuer's common stock as of April 26, 1999 was 13,880,431. 2 INDEX VERILINK CORPORATION FORM 10-Q
PART I. FINANCIAL INFORMATION PAGE NO. - ------- --------------------- -------- Item 1. Financial Statements Condensed Consolidated Statements of Operations for the 3 three months and nine months ended March 28, 1999 and March 29, 1998 Condensed Consolidated Balance Sheets as of 4 March 28, 1999 and June 28, 1998 Condensed Consolidated Statements of Cash Flows for 5 the nine months ended March 28, 1999 and March 29, 1998 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of 9 Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 20 SIGNATURES 21
2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS VERILINK CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) (Unaudited)
Three Months Ended Nine Months Ended ---------------------- ---------------------- March 28, March 29, March 28, March 29, 1999 1998 1999 1998 -------- -------- -------- -------- Net sales $ 12,003 $ 14,081 $ 46,187 $ 33,612 Cost of sales 7,392 7,361 24,153 17,249 -------- -------- -------- -------- Gross profit 4,611 6,720 22,034 16,363 Operating expenses: Research and development 3,964 3,639 10,654 9,201 Selling, general and administrative 6,372 4,034 16,860 11,590 In-process research and development -- -- 3,330 -- Restructuring charge 3,200 -- 3,200 -- -------- -------- -------- -------- Total operating expenses 13,536 7,673 34,044 20,791 Loss from operations (8,925) (953) (12,010) (4,428) Interest and other income, net 275 483 1,242 1,565 -------- -------- -------- -------- Loss before provision for income taxes (8,650) (470) (10,768) (2,863) Provision for (benefit from) income taxes -- -- 389 (889) -------- -------- -------- -------- Net loss $ (8,650) $ (470) (11,157) $ (1,974) ======== ======== ======== ======== Net loss per share - Basic and diluted $ (0.62) $ (0.03) (0.80) (0.14) ======== ======== ======== ======== Shares used in per share computations - Basic and diluted 14,020 13,798 13,952 13,706 ======== ======== ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 4 VERILINK CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands)
March 28, June 28, --------- -------- 1999 1998 ------- ------- (unaudited) ASSETS Current assets: Cash and cash equivalents $20,988 $16,304 Short-term investments 6,317 26,111 Accounts receivable, net 6,002 5,992 Inventories 6,842 4,900 Deferred tax assets 1,532 1,532 Other current assets 293 342 ------- ------- Total current assets 41,974 55,181 Property and equipment, net 8,248 7,047 Deferred tax assets 436 436 Intangible assets, net 5,877 -- Other assets 3,013 1,164 ------- ------- Total assets $59,548 $63,828 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,695 $ 2,527 Accrued expenses 12,976 6,747 Income taxes payable 624 744 ------- ------- Total liabilities 16,295 10,018 Stockholders' equity 43,253 53,810 ------- ------- Total liabilities and stockholders' equity $59,548 $63,828 ======= =======
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 5 VERILINK CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, unaudited)
Nine Months Ended March 28, March 29, -------- -------- 1999 1998 -------- -------- Cash flows from operating activities: Net loss $(11,157) $ (1,974) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 2,270 1,705 In-process research and development 3,330 -- Deferred compensation related to stock options 122 121 Deferred income taxes -- (883) Accrued interest on notes receivable from (11) (166) Non-cash restructuring related costs 264 -- Changes in assets and liabilities: Accounts receivable 2,622 288 Inventories (232) (1,259) Other assets (1,780) (619) Accounts payable (785) 326 Accrued expenses 2,162 766 Income tax payable (120) 363 -------- -------- Net cash used in operating activities (3,315) (1,332) -------- -------- Cash flows from investing activities: Purchases of property and equipment (2,274) (1,580) Purchases of short-term investments -- (22,753) Maturities of short-term investments 19,794 9,884 Purchase of TxPort, Inc. (10,000) -- -------- -------- Net cash provided by (used in) investing activities 7,520 (14,449) -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock, net 801 848 Purchases of treasury stock (322) -- -------- -------- Net cash provided by financing activities 479 848 -------- -------- Net increase (decrease) in cash and cash equivalents 4,684 (14,933) Cash and cash equivalents at beginning of period 16,304 36,596 -------- -------- Cash and cash equivalents at end of period $ 20,988 $ 21,663 ======== ======== Supplemental disclosures: Cash paid for (refund from) income taxes $ 495 $ (363) ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) NOTE 1. Interim Financial Statements The accompanying unaudited interim condensed consolidated financial statements of Verilink Corporation (the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, these statements include all adjustments, consisting of normal and recurring adjustments, considered necessary for a fair presentation of the results for the periods presented. The results of operations for the periods presented are not necessarily indicative of results which may be achieved for the entire fiscal year ending June 27, 1999. The unaudited interim condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the fiscal year ended June 28, 1998 as filed with the Securities and Exchange Commission. NOTE 2. Inventories Inventories are stated at the lower of cost, determined using the first-in, first-out method, or market. Inventories consisted of the following (in thousands):
March 28, June 28, -------- ------- 1999 1998 ------ ------ Raw materials $2,663 $2,313 Work in process 1,077 926 Finished goods 3,102 1,661 ------ ------ $6,842 $4,900 ====== ======
NOTE 3. Earnings Per Share Basic earnings per share (EPS) is computed by dividing net income available to common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during a period. In computing diluted EPS, the average price for the period is used in determining the number of shares assumed to be purchased from exercise of stock options. Earnings per share for all periods presented have been restated to conform to the SFAS 128 requirements. Options to purchase 2,675,242 shares of common stock at prices ranging from $0.50 to $10.38 per share were outstanding at March 28, 1999 but were not included in the computation of diluted EPS because inclusion of such options would have been antidilutive. 6 7 NOTE 4. Recent Accounting Pronouncements In June, 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income". SFAS 130 establishes standards for reporting comprehensive income and its components in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income, as defined, includes all changes in equity (net assets) during a period from non-owner sources. Examples of items to be included in comprehensive income, which are excluded from net income, include foreign currency translation adjustments and unrealized gain/loss on available-for-sale securities. No comprehensive income information has been presented as the impact of the disclosure required by SFAS 130 is immaterial to the financial statements of the Company. In June, 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information". This statement establishes standards for the way companies report information about operating segments in annual financial statements. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The disclosures prescribed by SFAS 131 are effective for the fiscal year ending June 27, 1999 but are not required for interim financial statements in 1999. The Company does not anticipate to have segments during the current fiscal year. NOTE 5. Related Party Transactions In September 1998, the Company began occupying an additional 16,000 square feet of space at 161 Nortech Drive leased from Baytech Associates ("Baytech") in accordance with an agreement currently under negotiation. Baytech is owned by two stockholders who are Directors of the Company. The Company has agreed to loan Baytech funds for leasehold improvements and rent obligations at 161 Nortech Drive in consideration of certain lease concessions made by Baytech to the Company. As of April 26, 1999, $349,000 was borrowed by Baytech against this facility. The loan to Baytech is evidenced by a promissory note bearing interest at 8% and will be payable out of the net lease proceeds received by Baytech from leasing a portion of the Nortech building. In September 1998, the Company provided a Director with a loan facility not to exceed $1,000,000 at an interest rate of 6% per annum. As of April 26, 1999, $986,000 was borrowed against that facility. All loans made pursuant to this facility are due on or before December 31, 1999. In October 1998, the Company guaranteed $500,000 in borrowings made by one of its Directors by pledging as collateral $500,000 on deposit with the lending institution (CivicBank of Commerce) and agreed to provide that Director with a loan facility not to exceed $3,000,000, including the guaranty. As of April 26, 1999, $1,005,000 was borrowed against that facility. All loans made pursuant to this loan facility will be due on or before December 31, 1999. This loan facility is currently secured by a pledge of the Director's general partnership interest in Baytech Associates. 7 8 NOTE 6. Acquisitions Effective November 16, 1998, the Company completed its acquisition of TxPort, Inc. ("TxPort") from Acme-Cleveland Corporation, by purchasing all the outstanding shares of TxPort at a cost of $10,500,000. TxPort is a manufacturer of high speed voice and data communications products. The transaction was accounted for using the purchase method, and the purchase price was allocated to the assets acquired and liabilities assumed based on the estimated fair market values at the date of acquisition. The in-process research and development, which was expensed at the acquisition date, represented the estimated current fair market value of specified technologies which had not reached technological feasibility and had no future uses at the date of acquisition. The results of the operations acquired were included with those of the Company from the date of acquisition. Intangible assets have been recorded as other assets, and are amortized over estimated useful lives between three and ten years. The allocation of the purchase price was as follows (in thousands):
In-process research and development $ 3,330 Intangible assets 6,233 Receivables 2,632 Inventory 1,710 Other assets 10 Property and equipment 841 Liabilities assumed (4,256) ------- Total $10,500 ======= The total purchase price is as follows: Cash payment $10,000 Other expenses 500 ------- Total $10,500 =======
The following unaudited pro forma financial information is presented to give effect to the purchase as if the transaction had occurred as of the beginning of each of the periods presented. The pro forma information gives effect of certain adjustments, including amortization of goodwill and other intangibles, based on the value allocated to assets acquired in the purchase. In-process research and development costs of $3,300,000, which were written off immediately after the purchase was completed, and all non-recurring and related party transactions are excluded from the results of both periods presented. The pro forma information is presented for illustrative purposes only and does not purport to be indicative of the operating results that would have occurred had the acquisition been effected for the periods indicated nor is it indicative of the future operating results of the Company.
(in thousands, except per share amounts) ---------------------------------------- Nine months ended ---------------------------------------- March 28, 1999 March 29, 1998 -------------- -------------- Pro forma net sales $ 54,047 $ 51,944 Pro forma net loss $ (5,686) $ (2,731) Pro forma loss per share - Basic and diluted $ (0.41) $ (0.20) Shares used in per share computation - 13,952 13,706 Basic and diluted
8 9 [S] NOTE 7. Restructuring Charge During the current quarter, the Company announced and began implementing its plans to streamline operations and eliminate redundant functions by consolidating manufacturing, combining sales and marketing functions, and restructuring research and development activities. This will result in a reduction in workforce of approximately 52 employees, or 13% of the Company's total workforce. As of March 28, 1999, approximately 37 employees were separated from the Company. As a result, the Company incurred a pretax restructuring charge of $3,200,000 during March, 1999. The components of the restructuring reserve and charges to the reserve during the current quarter are as follows: Restructuring Reserve (Unaudited)
Reduction in Workforce Other Costs Total --------------------------------------------- Beginning reserve balance $ 2,916,000 $ 284,000 $ 3,200,000 Current quarter charges (304,132) (264,000) (568,132) --------------------------------------------- Ending reserve balance $ 2,611,868 $20,000 2,631,868 ---------------------------------------------
The reserve for reduction in workforce includes severance, related medical benefits and other termination benefits or obligations to employees. The workforce reductions were in the sales, marketing, engineering and operations functions and impacted employees in California and Alabama. The reserve for other restructuring costs primarily relates to the write-off of employee loans who were part of the reduction in workforce plan. The Company expects the restructuring activities to be substantially complete by the end of the current fiscal year. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. This Report on Form 10-Q 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, including statements regarding the Company's beliefs, expectations, intentions, hopes, plans and goals regarding the future and statements regarding the Company's research and development expenditures, selling, general and administrative expenditures, restructuring activities and charges, reductions in operating, spending, anticipated capital expenditures, future capital requirements, adequacy of facilities, and Year 2000 planning, assessment and remediation efforts. Actual results could differ from those projected in any forward-looking statements for the reasons detailed below and in the Sections entitled "Factors Affecting Future Results" and other sections of this Report on Form 10-Q. The forward-looking statements included on this Form 10-Q are based on information available to the Company as of the date of this Report on Form 10-Q, and the Company assumes no obligation to update the forward-looking statements, or to update the reasons why actual results could differ from those projected in the forward-looking statements. Investors should also consult the risk factors listed from time to time in the Company's Reports on Form 10-K and Annual Report to Stockholders. RESULTS OF OPERATIONS During the second quarter of fiscal 1999, the Company acquired TxPort, a manufacturer of high speed voice and data communications products, based in Huntsville, Alabama for $10,000,000 in cash, paid out of the Company's working capital. Accordingly, the results of operations of TxPort, commencing from November 16, 1998, the date of acquisition, are consolidated in the Company's operating results for fiscal 1999. The following table presents the percentages of total sales represented by certain line items from the Condensed Consolidated Statements of Operations for the periods indicated.
Three Months Ended Nine Months Ended ---------------------- ---------------------- March 28, March 29, March 28, March 29, --------- --------- --------- --------- 1999 1998 1999 1998 ----- ----- ----- ----- Sales 100.0% 100.0% 100.0% 100.0% Cost of sales 61.6 52.3 52.3 51.3 ----- ----- ----- ----- Gross margin 38.4 47.7 47.7 48.7 ----- ----- ----- ----- Operating expenses: Research and development 33.0 25.8 23.1 27.4 Selling, general and administrative 53.1 28.6 36.5 34.5 In-process research and development -- -- 7.2 Restructuring charge 26.7 -- 6.9 -- ----- ----- ----- ----- Total operating expenses 112.8 54.4 73.7 61.9 ----- ----- ----- ----- Loss from operations (74.4) (6.8) (26.0) (13.2) Interest and other income, net 2.3 3.4 2.7 4.7 ----- ----- ----- ----- Loss before provision for income taxes (72.1) (3.3) (23.3) (8.5) Provision for (benefit from) income taxes -- -- 0.8 (2.6) ----- ----- ----- ----- Net loss (72.1)% (3.3)% (24.2)% (5.9)% ----- ----- ----- -----
9 10 Sales. Net sales for the three months ended March 28, 1999 decreased approximately 15% to $12 million from $14 million in the comparable period of the prior fiscal year. This decrease is a result of the decline in demand by the Company's wireless customers, as well as to a lesser extent, its carrier customers. Sales to the Company's other major customers also decreased, which appears to be a result of a major customer focusing its efforts on their network integration and Year 2000 compliance issues. Sales to the Company's five largest customers during the three months ended March 28, 1999 accounted for 30% of net sales as compared to 66% of net sales in the comparable period of the prior fiscal year. Net sales for the nine months ended March 28, 1999 increased 37% to $46.2 million from $33.6 million in the comparable period of the prior fiscal year. Approximately $7.6 million of the current year's sales is attributed to the former TxPort product lines. Sales to the Company's four largest customers for the nine months ended March 28, 1999 accounted for 51% of net sales as compared to 53% of net sales in the comparable period of the prior fiscal year. Gross Margin. Gross margin decreased to 38.4% of net sales for the three months ended March 28, 1999 as compared to 47.7% for the three months ended March 29, 1998. The decrease in gross margin is primarily due to factory under utilization and changes in channel and product mix. Gross margin remained relatively constant at approximately 47.7% and 48.7% for the nine months ended March 28, 1999 and March 29, 1998, respectively. Research and Development. Research and development expenditures for the three months ended March 28, 1999 increased 9% to $4 million from $3.6 million in the comparable period of the prior fiscal year and increased as a percentage of sales to 33% from 25.8%. Research and development expenditures for the nine months ended March 28, 1999 increased 16% to $10.6 million from $9.2 million in the comparable period in the prior fiscal year and as a percentage of net sales, decreased to approximately 23% from 27%. The increase in both periods in absolute dollars is due to an increase in headcount and personnel-related costs as a result of the TxPort acquisition. Since the Company's reduction in workforce occurred late in the quarter, it did not impact current quarter spending. The increase as a percentage of net sales for the three month period comparison is a result of an increase in personnel related expenses spread over a lower sales volume. The decrease as a percentage of sales for the nine month period is a result of a small increase in absolute dollars of research and development expenses spread over a larger revenue base. The Company believes that a significant level of investment in product development is required to remain competitive and that such expenses will vary over time as a percentage of sales. Selling, general and administrative. Selling, general and administrative expenses for the three months ended March 28, 1999 increased 58% to $6.4 million from $4.0 million in the comparable period of the prior fiscal year and increased as a percentage of sales to 53.1% from 28.6%. Selling, general and administrative expenses for the nine months ended March 28, 1999 increased 45.5% to $16.9 million from $11.6 million in the comparable period of the prior fiscal year. The increase in spending over the corresponding periods in the prior year is primarily due to an increase in expenses as a result of the TxPort acquisition and an increase in costs to support the enterprise resource planning implementation. The Company expects selling, general and administrative expenses to increase in the future as a result of increased administrative expenses for information technology as well as expenses associated with the acquisition. The Company expects such expenses will vary over time as a percentage of sales. Restructuring charge. The Company announced and began implementing during the current quarter, its plans to streamline operations and eliminate redundant functions by consolidating manufacturing, 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 pretax restructuring charge of $3,200,000. See Note 7 in the Notes to Condensed Consolidated Financial Statements for further details of the restructuring charge and the restructuring reserve activity during the current quarter. Approximately $2,930,000 of the restructuring charge is cash in nature and will be paid out of the Company's working capital. The Company's restructuring plans will result in a reduction in workforce of approximately 52 employees, or 13% of the Company's total workforce. As of March 28, 1999, approximately 37 employees were separated from the Company. As a result of this reduction in workforce, the Company expects to reduce operating spending by approximately $1 million for each of the next two quarters. The Company expects the restructuring activities to be substantially completed by the end of the current fiscal year. 10 11 In-process research and development. During the nine months ended March 28, 1999, the Company acquired TxPort. As a result of this acquisition, the Company incurred a one time charge of $3.3 million related to in-process research and development for which technological feasibility was not achieved at the time of acquisition. Interest and Other Income. Net interest and other income was approximately $1.2 million for the nine month period ended March 28, 1999 as compared to $1.6 million in the comparable period of the prior fiscal year. The decrease was a result of a lower cash and cash equivalents balance as a result of the TxPort acquisition for which the Company paid $10 million in cash. Provision for Income Taxes. Based on the estimated taxable income for fiscal 1999, the Company elected not to record a tax benefit or provision for income taxes for the quarter ended March 28, 1999. For the nine month period ended March 29, 1998, the Company recorded a 31% benefit from income taxes reflecting available net operating loss carry-back capacity and expected tax credits. LIQUIDITY AND CAPITAL RESOURCES On March 28, 1999, the Company's principal sources of liquidity included $27.3 million of cash and cash equivalents, and short-term investments. During the nine month period ended March 28, 1999, the Company used approximately $3.3 million for operating activities, compared to the $1.3 million used during the nine month period ended March 29, 1998. Net cash used in operating activities was primarily due to the loss of $11.2 million incurred through the nine months ended March 28, 1999, partially offset by the non-cash depreciation and amortization and in-process research and development charge totaling $5.6 million, a reduction in accounts receivable of $2.6 million and an increase in accrued expenses of $2.2 million. Cash provided by investing activities was approximately $7.5 million for the nine month period ended March 28, 1999, as compared to approximately $14 million used in investing activities for the nine month period ended March 29, 1998. The increase in funds provided by investing activities is primarily a result of the maturity of short-term investments being reinvested in cash and cash equivalents of $19.8 million, offset by the purchase of TxPort for $10.0 million. The Company also invested approximately $2.3 million in property and equipment during the first nine months of fiscal 1999, which is an increase of approximately $700,000 from the comparable period in the prior year. The Company anticipates significant capital expenditures for the fourth quarter of fiscal 1999 which are anticipated to be used for ERP software applications and implementation. In mid-September, the Company began occupying an additional 16,000 square feet of office space. The Company expects its current facilities to be adequate for its needs through fiscal 2000. Cash provided by financing activities was approximately $479,000 for the nine month period ended March 28, 1999, as compared to approximately $848,000 provided for the nine month period ended March 29, 1998. The decrease in funds provided by financing activities of $369,000 is primarily due to the repurchase of 89,000 shares at an average price of $3.62 per share. On February 18, 1999, the Board of Directors authorized the Company's management to systematically repurchase up to 1,000,000 shares of the Company's stock. As of April 26, 1999, the Company repurchased a total of 192,500 shares at an average price of $3.23 per share. The Company believes that its existing cash and cash equivalents, short-term investments and anticipated cash flows from operations will satisfy the Company's near-term cash needs. 11 12 YEAR 2000 The year 2000 presents concerns which are widespread and complex. If computer, information or telecommunication systems do not correctly recognize date information when the year changes to 2000, there could be an adverse impact on the Company's operations. The Company is evaluating its year 2000 risk as it exists in four areas: Information technology infrastructure, including reviewing what actions are necessary to bring all software tools used internally to year 2000 compliance, information systems used by the Company's suppliers, potential warranty and year 2000 claims from the Company's customers, and the potential impact of reduced spending by customers or potential customers on telecommunication network solutions as a result of devoting a substantial portion of their information system spending to resolve year 2000 compliance issues. The Company continues to evaluate its information technology infrastructure for year 2000 compliance, which includes reviewing what actions are required to make all software systems used internally year 2000 compliant. For example, the Company has purchased an enterprise resource planning solution which has been determined to be year 2000 compliant. The implementation of this ERP solution requires a material investment by the Company in internal and external resources. The ERP system began operating on March 29, 1999 and is performing the daily business operations of the Company. It is the Company's intent for all software systems and tools that are identified as non-compliant to be either upgraded or replaced. For the non-compliant systems identified to date, the cost to bring the systems to year 2000 compliance is not expected to be material to the Company's operating results. However, if implementation of replacement systems and tools is delayed, or if significant new non-compliance issues are identified, the Company's results of operations, business and financial condition could be materially affected. The Company is in the process of contacting its key suppliers to determine that the suppliers operations and the products and services they provide are year 2000 compliant. The Company anticipates this assessment to be completed by June, 1999. In the event that any of the Company's key suppliers does not successfully and timely achieve year 2000 compliance, the Company's business, financial condition and results of operations could be adversely affected. All of the Company's products are currently being reviewed for compliance to year 2000 guidelines. This process includes complete and thorough testing of current products as well as inclusion of year 2000 requirements in specifications for future product releases. Based on this review, the Company believes its current product shipments are year 2000 compliant and that neither performance nor functionality are affected by dates prior to, during, and after the year 2000 and that the year 2000 is recognized as a leap year. However, as all customer events cannot be anticipated, the Company may see an increase in product warranty and other claims. In the event that any of the Company's products ultimately are not year 2000 compliant, or there are customer claims made against the Company, the Company's business, financial condition and results of operations could be adversely affected. The Company has not developed a contingency plan to address every potential year 2000 non-compliance situation that may be present when the year changes to 2000. However, it is the Company's intention to formulate contingency plans in those areas where year 2000 non-compliance could have a material adverse effect on the Company's business, financial condition and results of operation. That plan is currently being developed. 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. Customer Concentration. A small number of customers continue to account for a majority of the Company's sales. For the nine month period ended March 28, 1999, sales to MCI, Nortel, Compuserve and Qualcomm accounted for 20%, 19%, 9% and 6% of the Company's sales respectively and sales to the Company's top five customers accounted for 59% of the Company's sales. In fiscal 1998, Nortel, MCI, Qualcomm and CompuServe accounted for 20%, 16%, 12% and 11% of the Company's sales, respectively, and sales to the Company's top five customers accounted for 64% of the Company's sales. In fiscal 1997, Nortel, MCI, Qualcomm and CompuServe accounted for 22%, 20%, 9% and 11% 12 13 of the Company's sales, respectively, and the Company's top five customers accounted for 67% of the Company's sales. In fiscal 1996, MCI and CompuServe accounted for 29% and 18% of the Company's sales, respectively, and the Company's top five customers accounted for 64% of sales. Other than Nortel, MCI, Qualcomm and CompuServe, no customer accounted for more than 10% of the Company's sales in fiscal years 1998, 1997, or 1996. There can be no assurance that the Company's current customers will continue to place orders with the Company, that orders by existing customers will continue at the levels of previous periods, or that the Company will be able to obtain orders from new customers. Certain of the Company's customers have delayed orders in the past as a result of a diversion of their resources to network integration and the Year 2000 issues. This trend may continue or worsen and result in additional order delays or cancellations. In addition, certain customers of the Company have been or may be acquired by other existing customers. The impact of such acquisitions on sales to such customers is uncertain, but there can be no assurance that such acquisitions will not result in a reduction in sales to those customers. In addition, such acquisitions could result in further concentration of the Company's customers. The Company has in the past experienced significant declines in 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 future merger and acquisition activity among the customers will not have a similar adverse affect on the Company's 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 has materially adversely affected the Company's business, financial condition and results of operations in the past and may do so in the future. See "Competition" and "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 MCI, Nortel, Qualcomm and CompuServe have varied between quarters by as much as $4.0 million and were the major contributor to the variability of quarterly sales in fiscal years 1998 and 1999. Most of the Company's sales are in the form of large orders with short delivery times. The Company's ability to affect and judge the timing of individual customer orders is limited. The Company has experienced large fluctuations in sales from quarter-to-quarter due to a wide variety of factors, such as delay, cancellation or acceleration of customer projects, and other factors discussed below. The Company's sales for a given quarter may depend to a significant degree upon planned product shipments to a single customer, often related to specific equipment deployment projects. The Company has experienced both acceleration and slowdown in orders related to such projects, causing changes in the sales level of a given quarter relative to both the preceding and subsequent quarters. Delays or lost sales can be caused by other factors beyond the Company's control, including late deliveries by other vendors of components in a customer's system, changes in implementation priorities, slower than anticipated growth in demand for the services that the Company's products support and delays in obtaining regulatory approvals for new services. Delays and lost sales have occurred in the past and may occur in the future. Operating results in recent periods have been adversely affected by delays in receipt of significant purchase orders from customers. Certain of the Company's customers have delayed orders in the past as a result of a diversion of their resources to network integration and the Year 2000 issues. This trend may continue or worsen and result in additional order delays or cancellations. In addition, the Company has in the past experienced delays as a result of the need to modify its products to comply with unique customer specifications. These and similar delays or lost sales could materially adversely affect the Company's business, financial condition and results of operations. See "Customer Concentration" and "Dependence on Component Availability and Key Suppliers". The Company's backlog at the beginning of each quarter typically is not sufficient to achieve expected sales for that quarter. To achieve its sales objectives, the Company is dependent upon obtaining orders in a quarter for shipment in that quarter. Furthermore, the Company's agreements with its customers typically provide that they may change delivery schedules and cancel orders within specified timeframes, typically up to 30 days prior to the scheduled shipment date, without significant penalty. The Company's customers have in the past built, and may in the future build, significant inventory in order to facilitate more rapid deployment of anticipated major projects or for other reasons. Decisions by such customers to reduce their inventory levels could lead to reductions in purchases from the Company. These reductions, in turn, could cause fluctuations in the Company's operating results and could have an adverse effect on the Company's business, financial condition and results of operations in the periods in which the inventory is reduced. The Company's industry is characterized by declining prices of existing products, and therefore continual improvement of manufacturing efficiencies and introduction of new products and enhancements to existing products are required to maintain gross margins. In response to customer demands or competitive pressures, or to pursue new 13 14 product or market opportunities, the Company may take certain pricing or marketing actions, such as price reductions, volume discounts, or provision of services at below-market rates. These actions could materially and adversely affect the Company's operating results. Operating results may also fluctuate due to factors such as the timing of new product announcements and introductions by the Company, its major customers or its competitors, delays in new product introductions by the Company, market acceptance of new or enhanced versions of the Company's products, changes in the product or customer mix of sales, changes in the level of operating expenses, competitive pricing pressures, the gain or loss of significant customers, increased research and development and sales and marketing expenses associated with new product introductions, and general economic conditions. All of the above factors are difficult for the Company to forecast, and these or other factors can materially adversely affect the Company's business, financial condition and results of operations for one quarter or a series of quarters. The Company's expense levels are based in part on its expectations regarding future sales and are fixed in the short term to a large extent. Therefore, the Company may be unable to adjust spending in a timely manner to compensate for any unexpected shortfall in sales. Any significant decline in demand relative to the Company's expectations or any material delay of customer orders could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to sustain profitability on a quarterly or annual basis. In addition, the Company has had, and in some future quarter may have operating results below the expectations of public market analysts and investors. In such event, the price of the Company's common stock would likely be materially and adversely affected. See "Potential Volatility of Stock Price". The Company's products are covered by warranties and the Company is subject to contractual commitments concerning its products. If unexpected circumstances arise such that the product does not perform as intended and the Company is not successful in resolving product quality or performance issues, there could be an adverse effect on the Company's business, financial condition and results of operations. 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 since its initial public offering in June 1996. There is no assurance that such fluctuations will not continue. Dependence on Current and Recently Introduced Products, and Products Under Development. The Company's future results of operations are highly dependent on market acceptance of existing and future applications for both the Company's Access System 2000 and the Access System 3000 product lines. The Access System 2000 product line represented approximately 86% of sales in fiscal 1998 and 80% of sales in fiscal 1997. 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. Failure to introduce new products in a timely manner could cause companies to purchase products from competitors and have a material adverse effect on the Company's business, financial condition and results of operations. Due to a variety of factors, the Company may experience delays in developing its planned products. New products may require additional development work, enhancement, testing or further refinement before 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. Although the Company does not believe that such delays have had a material adverse effect on its customer relationships, such delays have deferred the receipt of revenue from the products involved. If the Company's 14 15 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. Risks Associated with the Acquisition of TxPort. In addition to risks described under "Risks Associated With Potential Acquisitions," the Company faces significant risks associated with its recent acquisition of TxPort. There can be no assurance that the Company will realize the desired benefits of this acquisition. In order to successfully integrate TxPort, the Company must, among other things, continue to attract and retain key personnel, integrate the acquired products and technology from engineering, sales and marketing perspectives, and consolidate functions and facilities. Difficulties encountered in the integration may have a material adverse effect on the Company's business, financial condition and results of operations. The Company used purchase accounting in connection with the acquisition of TxPort, resulting in a charge to be taken in each of the next three to ten years for the amortization of intangible assets. As a result, the Company expects that the acquisition will be dilutive to earnings in fiscal 1999. Risks Associated With Potential Acquisitions. An important element of the Company's strategy is to review acquisition prospects that would compliment its existing product offerings, augment its market coverage, enhance its technological capabilities or offer growth opportunities. Future acquisitions 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. The Company's management has limited prior experience in assimilating acquired organizations. 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, and the failure of the Company to do so could have a material adverse effect on the Company's business and operating results. Enterprise Resource Planning. The Company is currently engaged in a major project to upgrade its enterprise-wide database and information management systems, based principally on software from Oracle. The Company anticipates the project completion date to be in the fourth quarter of the current fiscal year. However, there can be no assurance that the Company will not experience significant disruption as a result of unexpected delays in the implementation process, or that the Company will not complete the project within the planned time frame or budget. Significant delays may have a material adverse impact on the Company's business, financial condition and results of operations. Need to Expand Marketing Organization and Channels of Distribution. Currently the Company sells its products to a small number of customers through a relatively small sales force. The Company's strategy is to distribute and market its products to a broader customer base, which will require the Company to significantly expand its channels of distribution. There can be no assurance that the Company will be able to recruit, train, motivate and manage additional qualified marketing personnel with the requisite experience and knowledge, or attract additional qualified distributors. Availability of qualified product marketing personnel is limited, and competition for experienced personnel in the network access and telecommunications equipment industries is intense. The failure to timely expand its channels of distribution and product marketing organization could have a material adverse effect on the Company's business, financial condition and results of operations. See "Customer Concentration", "Management of Growth" and "Dependence on Key Personnel". Dependence on Component Availability and Key Suppliers. On-time delivery of the Company's products depends upon the availability of components and subsystems used in its products. The Company depends in part upon suppliers to manufacture, assemble and deliver components in a timely and satisfactory manner. The Company obtains several components and licenses certain embedded software from single or limited sources. There can be no assurance that these suppliers will continue to be able and willing to meet the Company's requirements for any such components. The Company generally does not have any long-term contracts with such suppliers, other than software vendors. Any significant interruption in the supply of, or degradation in the quality of, any such item could have a material adverse effect on the Company's results of operations. The Company has no current plans to significantly expand its supplier base. 15 16 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. From time to time, the Company has experienced shortages and allocations of certain components, resulting in delays in fulfillment of customer orders. Such shortages and allocations could have a material adverse effect on the Company's business, financial condition and results of operations. See "Fluctuations in Quarterly Operating Results". Competition. The market for telecommunications network access equipment is highly competitive, and the Company expects competition to increase in the future. This market is subject to rapid technological change, regulatory developments, and new entrants. The market for integrated access devices such as the Company's Access System product line is subject to rapid change. The Company believes that the primary competitive factors in this market are the development and rapid introduction of new product features, price and performance, support for multiple types of communications services, network management, reliability, and quality of customer support. There can be no assurance that the Company's current products and future products under development will be able to compete successfully with respect to these or other factors. The Company's principal competition to date for its Access System product line has been from Digital Link Corporation, Kentrox, a division of ADC Telecommunications and Larscom, Inc., a subsidiary of Axel Johnson. In addition, the Company expects substantial competition from companies in the computer networking market and other related markets such as Newbridge Networks Corporation, Telco Systems, Inc., a division of World Access, Inc., Visual Networks Inc., and Adtran, Inc. To the extent that current or potential competitors can expand their current offerings to include products that have functionality similar to the Company's products and planned products, the Company's business, financial condition and results of operations could be materially adversely affected. The Company believes that the market for basic network termination products is mature and that the principal competitive factors in this market are price, installed base and quality of customer support. In this market, the Company primarily competes with Adtran, Digital Link, Kentrox, Paradyne and Larscom. There can be no assurance that such companies or other competitors will not introduce new products that provide greater functionality and/or at a lower price than the Company's like products. In addition, advanced termination products are emerging which represent both new market opportunities as well as a threat to current products. Furthermore, basic line termination functions are increasingly being integrated by competitors into other equipment such as routers and switches, which include direct WAN interfaces in certain products, eroding the addressable market for separate network termination products. Many of the Company's current and potential competitors have substantially greater technical, financial, manufacturing and marketing resources than the Company. In addition, many of the Company's competitors have long-established relationships with network service providers. There can be no assurance that the Company will have the financial resources, technical expertise, manufacturing, marketing, distribution and support capabilities to compete successfully in the future. Rapid Technological Change. The network access and telecommunications equipment markets are characterized by rapidly changing technologies and frequent new product introductions. The rapid development of new technologies increases the risk that current or new competitors could develop products that would reduce the competitiveness of the Company's products. The Company's success will depend to a substantial degree upon its ability to respond to changes in technology and customer requirements. This will require the timely selection, development and marketing of new products and enhancements on a cost-effective basis. The development of new, technologically advanced products is a complex and uncertain process, requiring high levels of innovation. The development of new products for the 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 which meet industry standards for safety, emissions and network interconnection. With new and emerging technologies and service offerings from network service providers, such standards are often changing or unavailable. As a result, there is a potential for product development 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 16 17 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 Products under Development". Management of Growth. The Company has recently experienced growth in the number of its employees and the scope of its operations as a result of its recent acquisition. To manage potential future growth effectively, the Company must improve its operational, financial and management information systems and must hire, train, motivate and manage a growing number of employees. The future success of the Company also will depend on its ability to increase its customer support capability and to attract and retain qualified technical, marketing and management personnel, for whom competition is intense. In particular, the current availability of qualified personnel is quite limited, and competition among companies for such personnel is intense. The Company is currently attempting to hire a number of product marketing and engineering personnel and has experienced delays in filling such positions and expects to experience continued difficulty in filling its needs for qualified personnel. There can be no assurance that the Company will be able to effectively achieve or manage any such growth, and failure to do so could delay product development and introduction cycles or otherwise have a material adverse effect on the Company's business, financial condition and results of operations. See "Need to Expand Sales and Marketing Organizations and Channels of Distribution" and "Dependence on Key Personnel". Compliance with Regulations and Evolving Industry Standards. The market for the Company's products is characterized by the need to meet a significant number of communications regulations and standards, some of which are evolving as new technologies are deployed. In the United States, the Company's products must comply with various regulations defined by the Federal Communications Commission and standards established by Underwriters Laboratories and Bell Communications Research. For some public carrier services, installed equipment does not fully comply with current industry standards, and this noncompliance must be addressed in the design of the Company's products. Standards for new services such as frame relay, performance monitoring services and ATM are still evolving. As these standards evolve, the Company will be required to modify its products or develop and support new versions of its products. The failure of the Company's products to comply, or delays in compliance, with the various existing and evolving industry standards could delay introduction of the Company's products, which could have a material adverse effect on the Company's business, financial condition and results of operations. Government regulatory policies are likely to continue to have a major impact on the pricing of existing as well as new public network services and therefore are expected to affect demand for such services and the telecommunications products that support such services. Tariff rates, whether determined by network service providers or in response to regulatory directives, may affect the cost effectiveness of deploying communication services. Such policies also affect demand for telecommunications equipment, including the Company's products. Risks Associated With 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. 17 18 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 has received and may receive in the future communications from third parties asserting that the Company's products infringe or may infringe the proprietary rights of third parties. In its sales and 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 would be materially adversely affected. Limited Protection of Intellectual Property. The Company relies upon a combination of patent, trade secret, copyright and trademark laws and contractual restrictions to establish and protect proprietary rights in its products and technologies. The Company has been issued certain U.S. and Canadian patents with respect to limited aspects of its single purpose network access technology. The Company has not obtained significant patent protection for its Access System technology. There can be no assurance that third parties have not or will not develop equivalent technologies or products without infringing the Company's patents or that the Company's patents would be held valid and enforceable by a court having jurisdiction over a dispute involving such patents. The Company has also entered into confidentiality and invention assignment agreements with its employees and 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. Dependence on Key Personnel. The Company's future success will depend to a large extent on the continued contributions of its executive officers and key management, sales and technical personnel. The Company is a party to agreements with certain of its executive officers to help ensure the officer's continual service to the Company in the event of a change-in-control. Each of the Company's executive officers, and key management, sales and technical personnel would be difficult to replace. The loss of the services of one or more of the Company's executive officers or key personnel, or the inability to continue to attract qualified personnel could delay product development cycles or otherwise have a material adverse effect on the Company's business, financial condition and results of operations. See "Management of Growth". Antitakeover Effects of Certain Charter Provisions. The Company's Board of Directors has the authority to issue up to 1,000,000 shares of Preferred Stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The 18 19 issuance of shares of Preferred Stock, while potentially providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company. The Company has no present intention to issue shares of Preferred Stock. In addition, the Company is subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which will prohibit the Company from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. The application of Section 203 also could have the effect of delaying or preventing a change of control of the Company. Furthermore, certain provisions of the Company's Amended and Restated Certificate of Incorporation, including provisions that provide for the Board of Directors to be divided into three classes to serve for staggered three-year terms, may have the effect of delaying or preventing a change of control of the Company, which could adversely affect the market price of the Company's common stock. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable. 19 20 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Index:
Exhibit Number Description of Exhibit -------------- ---------------------- 10.28 Employment Agreement between Registrant and Graham Pattison dated March 22, 1999. 10.29 Retirement Agreement between Registrant and Leigh S. Belden dated April 9, 1999. 10.30 Retirement Agreement between Registrant and Steve S. Taylor dated April 9, 1999. 10.31 Severance Agreement between Registrant and Stephen M. Tennis dated April 9, 1999 27.1 Financial Data Schedule
(b) The Company filed no reports on Form 8-K during the quarter ended March 28, 1999. 20 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. VERILINK CORPORATION May 7, 1999 By: /s/ John C. Batty ------------------------- John C. Batty, Vice President, Finance and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) 21 22 EXHIBIT INDEX
Exhibit Number Description of Exhibit -------------- ---------------------- 10.28 Employment Agreement between Registrant and Graham Pattison dated March 22, 1999. 10.29 Retirement Agreement between Registrant and Leigh S. Belden dated April 9, 1999. 10.30 Retirement Agreement between Registrant and Steve S. Taylor dated April 9, 1999. 10.31 Severance Agreement between Registrant and Stephen M. Tennis dated April 9, 1999 27.1 Financial Data Schedule
EX-10.28 2 EMPLOYMENT AGREEMENT DATED 3/2/99 1 EXHIBIT 10.28 March 22, 1999 Graham Pattison 80 Comstock Drive Wrentham, MA 02093 Dear Graham: I am pleased to extend to you an offer of employment for the position of President and CEO of Verilink Corporation. The terms and conditions of your employment will be as follows: 1. Your employment will commence not later than April 12, 1999. You will report to the Company's Board of Directors. 2. Your base compensation will initially be $11,538.47 paid bi-weekly (annualized salary of $300,000.00). Executive compensation is reviewed annually after the end of Verilink's June 30 fiscal year end. Any increase in salary is at the sole discretion of the Board of Directors. 3. You will receive such benefits as are customarily granted to officers of Verilink. Attachment 1 sets forth the benefits currently available to Verilink employees generally and to Verilink executive officers, except that your automobile allowance will be $1,000.00 per month. Please note that officers do not participate in the profit sharing plan. These benefits are subject to review from time-to-time by the Compensation Committee of the Board of Directors. 4. Contingent upon your acceptance of this offer of employment, and subject to the Board of Directors' approval, Verilink will grant you a Non-Qualified Stock Option which gives you the right to purchase, under terms stated in your Stock Option Agreement, 400,000 shares of Verilink Common Stock at the fair market value as determined by the Board of Directors on the date of the grant. Vesting will occur over 4 years at the rate of 2.08% (1/48th) at the end of each month, assuming continuous employment. 5. You will be eligible for participation in Verilink's Management Incentive Plan for fiscal 2000 (July 1, 1999 - June 30, 2000) and thereafter. The Plan will provide for a target potential payout to you of 50% of your base salary upon achievement of 2 Graham Pattison March 22, 1999 Page 2 your objectives under the Plan, but in no event less than a guaranteed payment to you for fiscal 2000 of one-half of your target bonus (25% of base salary), which guaranteed payment is subject to completion and approval by the Board of a corporate business plan prior to the end of fiscal 1999 and to your still being employed by Verilink at the end of fiscal 2000. 6. During the first year of employment, if your employment is terminated by Verilink other than for cause, whether or not a change of control has occurred, you will receive two years' base salary, including applicable benefits, with vested options available to execute for up to a period of twelve additional months. If your employment is terminated by Verilink other than for cause during the second year of employment, you will receive one year's base salary, including applicable benefits, with vested options available to execute for up to a period of twelve additional months. If such termination occurs after a change in control, you will also receive such additional benefits as are provided in the Verilink Change of Control Severance Benefits Agreement (Attachment 2). At Verilink's option, the foregoing severance may be paid as salary continuation or as a lump sum. After two years of employment, any severance benefits will be subject to the Change of Control Severance Benefits Agreement and other then existing practices applicable to Verilink's executive officers. For purposes of this paragraph, "cause" shall be defined as any act or failure to act involving dishonesty towards Verilink; unethical business practices; embezzlement or misappropriation of corporate funds, property or proprietary information; unreasonable and willful refusal to perform the duties required by Verilink; willful breach of this Agreement or habitual neglect of duties and responsibilities, other than due to illness or disability; aiding and abetting a competitor; or participation in any fraud or any criminal activities. 7. For a period of up to 180 days after the commencement of your employment, Verilink will provide you with temporary housing. In addition, Verilink shall reimburse you for your moving costs, travel associated with your move, and other relocation costs. Attachment 3 sets forth Verilink's standard relocation policies. You and Verilink's Human - Resources Department will mutually agree upon the application of those policies to your situation. The total relocation assistance shall not exceed $125,000. If you voluntarily terminate your employment within 12 months after commencement of employment, you will repay Verilink the amount of the foregoing relocation payments. If you voluntarily terminate your employment between 12 months and 18 months after commencement of employment, you will repay Verilink a pro-rata portion of the relocation payment based upon the number of months remaining to 18 months divided by six. Please understand this offer of relocation is a confidential, one-time offer for you only. It is not Verilink's intention for this relocation package to become permanent policy. 3 Graham Pattison March 22, 1999 Page 3 8. If you do not sell your existing home within 90 days of commencement of employment and you make a written offer that is accepted to purchase a new home in California, which purchase is scheduled to close prior to the sale of your existing home, Verilink shall loan you an amount equal to the "equity" in your existing home (fair market value less encumbrances). That loan will be interest-free and shall be repaid by you on the earlier of the closing sale of your existing home or twelve months after the commencement of your employment. You agree to use your best efforts to sell your existing home as soon as possible. During the first six months of your employment, Verilink will also reimburse you for any mortgage payments upon your existing home made by you after you purchase a new home in California. 9. Verilink shall provide you with a housing assistance loan of $600,000.00 in accordance with Attachment 4. This Note will be secured by a second deed of trust on your California property. 10. Subject to any severance benefits described in this letter, your employment with Verilink is voluntarily entered into and is for no specific period. As a result, you are free to resign at any time, for any reason or for no reason. Similarly, Verilink is free to conclude its at-will employment relationship with you at any time, with or without cause. 11. In the event of any dispute or claims relating to or arising out of our employment relationship, you and Verilink agree that all such disputes shall be fully and finally resolved by binding arbitration conducted by the American Arbitration Association in San Jose, California. However, we agree that this arbitration provision shall not --- apply to any dispute or claims relating to or arising out of the misuse or misappropriation of the Company's trade secrets or proprietary or confidential information or to enforcement of your rights under the Change of Control Severance Benefits Agreement. 12. This offer of employment is contingent upon the following: (a) A completed employment application. (b) Full compliance with the Immigration Reform and Control Act of 1986, which requires new employees to provide documentation/identification to establish both identity and work authorization within three (3) days of your employment. (c) On your date of hire, you will be required to sign a Verilink Confidentiality Agreement (Attachment 5) as part of your total employment package. 4 Graham Pattison March 22, 1999 Page 4 (d) If you will be driving your personal automobile for company business on a regular basis, you will be required to provide proof of personal auto insurance. If you have any questions regarding the nature of any of this documentation, please contact the Human Resources Department. 13. This letter, together with all attachments hereto, set forth the terms of your employment with Verilink and supersede any prior representations or agreements, whether written or oral. This letter may not be modified or amended except by an instrument in writing, signed by Verilink and by you. Verilink has grown to be a well respected company in the telecommunications industry. We are pleased to have you join the Verilink team, and we look forward to your participation in our continued success. This offer remains effective until March 21, 1999. Please acknowledge your acceptance by signing this letter and returning it to me at your earliest convenience. Sincerely, VERILINK CORPORATION /s/ LEIGH S. BELDEN Leigh S. Belden President and CEO I accept the foregoing offer: /s/ GRAHAM PATTISON - ------------------------------ Graham Pattison Date: MARCH '99 ------------------------- EX-10.29 3 RETIREMENT AGREEMENT DATED 4/9/99 1 EXHIBIT 10.29 April 9, 1999 Leigh S. Belden President and CEO Verilink Corporation 145 Baytech Drive San Jose, CA 95134 Dear Leigh: Leigh S. Belden April 9, 1999 Page 2 This letter shall set forth the terms and conditions of your retirement as an active employee of Verilink Corporation. Those terms and conditions are: 1. You shall receive a lump sum payment in an amount equal to two years' current salary, less applicable withholdings. 2. You shall receive the sum of $95,000, which approximates twice the average annual amount paid to you for your automobile allowance and reimbursement of auto, legal, financial planning, health club and fitness expenses. You acknowledge that Verilink intends to terminate any automobile insurance covering your automobiles and that you will be responsible for obtaining your own automobile insurance coverage. 3. You shall receive the sum of $90,000, which is intended to reimburse you for the cost of office space, furnishings and equipment, and administrative assistance for a period of two years. 4. Verilink shall maintain for you and your family until you reach the age of 65 health, dental and vision insurance comparable to that provided to Verilink's officers. Verilink shall pay the cost of such insurance for two years. Thereafter, you shall reimburse Verilink for such costs; provided, however, that your responsibility shall not exceed the amount of the average premium paid by Verilink for its officers. In addition, consistent with existing practice, Verilink will pay unreimbursed medical costs for you and your family for a period of two years. 2 Leigh S. Belden April 9, 1999 Page 2 5. Verilink shall pay the reasonable and necessary expenses incurred by you in connection with TIA and EIA activities, including, but not limited to, first class air travel for you and your spouse. 6. Upon termination of your employment, you shall be entitled to retain your cellular telephone, two computers, Palm Pilot, miscellaneous equipment and office furniture currently used by you. 7. You will be granted a nonqualified stock option to acquire 15,625 shares of Verilink common stock at a price equal to the fair market value of such stock on the date of grant. 8. The payments described in paragraphs 1, 2 and 3 shall be made to you on or before April 13, 1999. 9. You shall continue to serve as a member of Verilink's Board of Directors. Upon your retirement, you shall be granted a non-employee director stock option pursuant to Verilink's 1993 Amended and Restated Stock Option Plan. Please indicate your agreement with the foregoing by signing and returning this letter. Very truly yours, VERILINK CORPORATION /s/ HOWARD ORINGER Howard Oringer Chairman of the Board Agreed: /s/ LEIGH S. BELDEN - --------------------------- Leigh S. Belden Date: 4-13-99 ---------------------- EX-10.30 4 RETIREMENT AGREEMENT DATED 4/9/99 1 EXHIBIT 10.30 April 9, 1999 Steven C. Taylor Chief Technology Officer Verilink Corporation 145 Baytech Drive San Jose, CA 95134 Dear Steve: This letter shall set forth the terms and conditions of your retirement as an active employee of Verilink Corporation. Those terms and conditions are: 1. You shall receive a lump sum payment in an amount equal to two years' current salary, less applicable withholdings. 2. You shall receive the sum of $95,000, which approximates twice the average annual amount paid to you for your automobile allowance and reimbursement of auto, legal, financial planning, health club and fitness expenses. You will be responsible for making all payments required under the lease for the automobile currently provided by Verilink. You acknowledge that Verilink intends to terminate any automobile insurance covering your automobiles and that you will be responsible for obtaining your own automobile insurance coverage. 3. You shall receive the sum of $90,000, which is intended to reimburse you for the cost of office space, furnishings and equipment, and administrative assistance for a period of two years. 4. Verilink shall maintain for you and your family until you reach the age of 65 health, dental and vision insurance comparable to that provided to Verilink's officers. Verilink shall pay the cost of such insurance for two years. Thereafter, you shall reimburse Verilink for such costs; provided, however, that your responsibility shall not exceed the amount of the average premium paid by Verilink for its officers. In addition, consistent with existing practice, Verilink will pay unreimbursed medical costs for you and your family for a period of two years. 2 Steven C. Taylor April 9, 1999 Page 2 5. Upon termination of your employment, you shall be entitled to retain your cellular telephone, computer, Palm Pilot, miscellaneous equipment and office furniture currently used by you. 6. You will be granted a nonqualified stock option to acquire 15,625 shares of Verilink common stock at a price equal to the fair market value of such stock on the date of grant. 7. The payments described in paragraphs 1, 2 and 3 shall be made to you on or before April 13, 1999. 8. You shall continue to serve as a member of Verilink's Board of Directors. Upon your retirement, you shall be granted a non-employee director stock option pursuant to Verilink's 1993 Amended and Restated Stock Option Plan. Please indicate your agreement with the foregoing by signing and returning this letter. Very truly yours, VERILINK CORPORATION /s/ HOWARD ORINGER - -------------------------- Howard Oringer Chairman of the Board Agreed: /s/ STEVEN C. TAYLOR - -------------------------- Steven C. Taylor Date: 4/15/99 --------------------- EX-10.31 5 SEVERENCE AGREEMENT DATED 4/9/99 1 EXHIBIT 10.31 April 9, 1999 Stephen M. Tennis Vice President, General Counsel Verilink Corporation 145 Baytech Drive San Jose, CA 95134 Dear Steve: This letter will set forth the terms and conditions applicable to the termination of your employment with Verilink Corporation. 1. You shall remain employed by Verilink until June 30, 1999. While employed, your current salary and benefits shall continue. 2. Upon termination of your employment, you will receive a lump sum payment equal to six months' then existing salary, less applicable withholdings. In addition, you will receive the sum of $20,000, which approximates the amount which would be paid to you for automobile allowance, miscellaneous benefits and reimbursement of automobile expenses, health club and fitness expenses, and unreimbursed medical expenses for six months. 3. Upon termination of your employment, you will receive a payment intended to reimburse you for COBRA premiums for a period of six months. You will be responsible for payment of your own COBRA premiums. 4. At the termination of your employment with Verilink, you shall continue to provide services to Verilink as an independent contractor for a period of one year. On the date of this letter, you shall receive a non-refundable payment of $85,000. During that one-year period you agree to provide Verilink a minimum of one-half of your normal billable hours, or approximately 200 hours per quarter. Such services shall be provided at such times and places as shall be determined by you. In addition to the retainer, Verilink shall pay you the sum of $100,000 for such services, payable quarterly in advance commencing on the date of your termination of employment. You shall provide Verilink with a quarterly accounting of the services rendered to Verilink, including a description of services and the number of hours worked by you. If you render services for less than 180 hours during a quarter, the sum of 2 Stephen M. Tennis April 9, 1999 Page 2 $125.00 per hour of such deficiency shall be deducted from the payment due for the next quarter. If you render services in excess of 200 hours during a quarter, you shall be compensated for such services at a rate per hour which represents a 20% discount from the hourly rate you charge third parties for your services; provided, however, that if you render between 180 and 200 hours for any prior quarter, hours in excess of 200 hours shall first be offset against such deficiency. Such excess hours shall be accounted for quarterly and shall be paid by Verilink upon receipt of a statement. At the end of one year, Verilink may continue the consulting arrangement on such terms and conditions as are mutually agreeable to you and Verilink. Verilink may terminate your services at any time after the first quarter; provided, however, that in the event of any such termination, Verilink shall pay you a sum equal to one-half of the quarterly payments due for the remainder of the twelve-month period. 5. Upon termination of your employment, you shall be entitled to retain your cellular telephone, Palm Pilot, other miscellaneous equipment and office furniture currently used by you. 6. Your existing options to acquire 100,000 shares of Verilink common stock (granted December 2, 1997, December 18, 1997, January 4, 1999, and April 13, 1999) shall be immediately vested and exercisable in full for a period commencing on the date of this letter and ending twelve months from the date of your termination of employment. Please indicate your agreement with the foregoing by signing and returning this letter. Very truly yours, VERILINK CORPORATION /s/ HOWARD ORINGER - ----------------------------- Howard Oringer Chairman of the Board Agreed: /s/ STEPHEN M. TENNIS - ----------------------------- Stephen M. Tennis Date: 4/13/99 ------------------------ EX-27.1 6 FINANCIAL DATA SCHEDULE
5 THIS FINANCIAL SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS CONTAINED IN THE FORM 10-Q OF VERILINK CORPORATION FOR THE SECOND FISCAL QUARTER ENDED DECEMBER 28, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS JUN-27-1999 JUL-29-1998 MAR-28-1999 20,988 6,317 6,216 214 6,842 41,974 19,204 10,956 59,548 16,295 0 0 0 140 43,113 59,548 12,003 12,003 7,392 7,392 13,536 0 0 (8,650) 0 (8,650) 0 0 0 (8,650) (0.62) (0.62) "For Purposes of this Exhibit, Primary Means Basic"
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