-----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, ASIa2IPoR19bBeETK+t+BOlmIffXERD9k9ijvKXisuYW+LOMhIv2ujU+rsw2bsiS 0qHFeuw1luDJKbM8QLGPZQ== 0000950144-01-002240.txt : 20010214 0000950144-01-002240.hdr.sgml : 20010214 ACCESSION NUMBER: 0000950144-01-002240 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20001229 FILED AS OF DATE: 20010213 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: 0627 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-28562 FILM NUMBER: 1535335 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 g66908e10-q.txt VERILINK CORPORATION 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 December 29, 2000 [ ] 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 of incorporation) (I.R.S. Employer Identification No.) 950 EXPLORER BOULEVARD, HUNTSVILLE, ALABAMA 35806 - -------------------------------------------------------------------------------- (Address of principal executive offices, including zip code) (256) 327-2001 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) 127 JETPLEX CIRCLE, MADISON, ALABAMA 35758 - -------------------------------------------------------------------------------- (Former Address) 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 January 26, 2001 was 14,811,371. 2 INDEX VERILINK CORPORATION FORM 10-Q
PART I. FINANCIAL INFORMATION Page No. - ------- --------------------- -------- Item 1. Financial Statements (unaudited): Condensed Consolidated Statements of Operations for the 3 three months and six months ended December 29, 2000 and December 31, 1999 Condensed Consolidated Balance Sheets as of 4 December 29, 2000 and June 30, 2000 Condensed Consolidated Statements of Cash Flows for 5 the six months ended December 29, 2000 and December 31, 1999 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of 9 Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk 20 PART II. OTHER INFORMATION - -------- ----------------- Item 2. Changes in Securities 21 Item 4. Submission of Matters to a Vote of Security Holders 21 Item 6. Exhibits and Reports on Form 8-K 22 SIGNATURE 22 - ---------
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 Six Months Ended ------------------------------- ------------------------------- December 29, December 31, December 29, December 31, 2000 1999 2000 1999 -------------- --------------- -------------- --------------- Net sales............................................. $ 9,036 $ 16,183 $ 20,865 $ 31,035 Cost of sales......................................... 5,704 8,114 11,086 16,811 -------- -------- -------- -------- Gross profit...................................... 3,332 8,069 9,779 14,224 -------- -------- -------- -------- Operating expenses: Research and development.......................... 10,984 2,170 13,090 5,335 Selling, general and administrative............... 4,992 5,498 10,168 11,096 Restructuring and other non-recurring charges.......................................... -- 1,400 -- 8,300 -------- -------- -------- -------- Total operating expenses....................... 15,976 9,068 23,258 24,731 -------- -------- -------- -------- Loss from operations.................................. (12,644) (999) (13,479) (10,507) Interest and other income, net........................ 311 222 621 393 -------- -------- -------- -------- Loss before provision for income taxes................ (12,333) (777) (12,858) (10,114) Provision for income taxes............................ -- -- 6,311 -- -------- -------- -------- -------- Net loss.............................................. $(12,333) $ (777) $(19,169) $(10,114) ======== ======== ======== ======== Net loss per share - Basic............................ $ (0.84) $ (0.06) $ (1.30) $ (0.72) ======== ======== ======== ======== Net loss per share - Diluted.......................... $ (0.84) $ (0.06) $ (1.30) $ (0.72) ======== ======== ======== ======== Shares used in per share computations - Basic......... 14,719 13,971 14,717 13,960 ======== ======== ======== ======== Shares used in per share computations - Diluted....... 14,719 13,971 14,717 13,960 ======== ======== ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 4 VERILINK CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
December 29, 2000 June 30, (Unaudited) 2000 --------------- ------------- ASSETS Current assets: Cash and cash equivalents.................................................. $ 11,156 $ 6,617 Restricted cash............................................................ 500 500 Short-term investments..................................................... 2,200 4,079 Accounts receivable, net................................................... 5,564 15,233 Inventories................................................................ 6,404 4,840 Notes receivable........................................................... 1,423 1,440 Other receivable........................................................... 417 515 Deferred tax assets........................................................ -- 2,638 Other current assets....................................................... 333 575 -------- -------- Total current assets.................................................... 27,997 36,437 Property, plant and equipment, net............................................. 13,373 10,790 Restricted cash, long-term..................................................... 500 500 Notes receivable, long-term.................................................... 2,091 2,276 Goodwill and other intangible assets, net...................................... 3,503 3,203 Deferred tax assets............................................................ -- 4,828 Other assets................................................................... 902 686 -------- -------- Total assets............................................................ $ 48,366 $ 58,720 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt.......................................... $ 600 $ 600 Accounts payable........................................................... 2,708 3,601 Accrued expenses........................................................... 4,788 5,884 -------- -------- Total current liabilities............................................... 8,096 10,085 Long-term debt, less current portion above..................................... 5,558 3,521 -------- -------- Total liabilities....................................................... 13,654 13,606 -------- -------- Stockholders' equity: Common stock, $0.01 par value; 40,000,000 shares authorized; 14,719,258 and 18,307,751 shares issued...................... 147 183 Additional paid-in capital................................................. 50,942 50,696 Treasury stock; 3,662,523 shares of common stock at cost................... -- (8,335) Other stockholders' equity................................................. (16,377) 2,570 -------- -------- Total stockholders' equity.............................................. 34,712 45,114 -------- -------- Total liabilities and stockholders' equity.............................. $ 48,366 $ 58,720 ======== ========
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)
Six Months Ended -------------------------------------- December 29, December 31, 2000 1999 ------------- -------------- Cash flows from operating activities: Net loss........................................................................ $(19,169) $(10,114) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization................................................ 1,707 2,150 Deferred income taxes........................................................ 6,311 -- Research and development expenses related to warrants........................ 8,335 -- Deferred compensation related to stock options............................... -- 91 Net book value of assets charged against restructuring reserve............... -- 1,461 Accrued interest on notes receivable from stockholders....................... (149) (31) Changes in assets and liabilities: Accounts receivable....................................................... 9,669 (3,114) Other receivable.......................................................... 98 (3,558) Inventories............................................................... (1,564) 3,377 Other assets.............................................................. 26 807 Accounts payable.......................................................... (893) 866 Accrued expenses.......................................................... (1,096) 1,204 -------- -------- Net cash provided by (used in) operating activities................... 3,275 (6,861) -------- -------- Cash flows from investing activities: Purchases of property, plant and equipment...................................... (3,810) (182) Proceeds from sale of short-term investments.................................... 1,879 8,017 Decrease (increase) in goodwill................................................. 375 (375) Repayments of notes receivable, net of advances................................. 322 -- -------- -------- Net cash provided by (used in) investing activities................... (1,234) 7,460 -------- -------- Cash flows from financing activities: Proceeds from long term debt, net of payments................................... 2,037 -- Proceeds from issuance of common stock, net..................................... 210 382 Repurchase of common stock...................................................... -- (78) Proceeds from repayment of notes receivable from stockholders................... 281 55 Change in other comprehensive income............................................ (30) -- -------- -------- Net cash provided by financing activities............................. 2,498 359 -------- -------- Net increase in cash and cash equivalents........................................... 4,539 958 Cash and cash equivalents at beginning of period.................................... 6,617 6,880 -------- -------- Cash and cash equivalents at end of period.......................................... $ 11,156 $ 7,838 ======== ======== Supplemental disclosures: Cash paid for interest.......................................................... $ 189 $ -- ======== ======== Refund from income taxes........................................................ $ 23 $ 500 ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1. Basis of Presentation The accompanying unaudited interim condensed consolidated financial statements of Verilink Corporation (the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, these statements include all adjustments, consisting of normal and recurring adjustments, considered necessary for a fair presentation of the results for the periods presented. The results of operations for the periods presented are not necessarily indicative of results which may be achieved for the entire fiscal year ending June 29, 2001. The unaudited interim condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2000 as filed with the Securities and Exchange Commission. NOTE 2. Comprehensive Income (Loss) The Company records gains or losses on the Company's foreign currency translation adjustments and unrealized gains or losses on the Company's available-for-sale investments as accumulated other comprehensive income and presents it in other stockholders' equity in the accompanying condensed consolidated balance sheets. For the three months ended December 29, 2000 and December 31, 1999, comprehensive loss amounted to $12,348,000 and $777,000, respectively. For the six months ended December 29, 2000 and December 31, 1999, comprehensive loss was $19,199,000 and $10,114,000, respectively. NOTE 3. Restructuring Charge During the first quarter of fiscal 2000, the Company announced its plans to consolidate its San Jose operations with its facilities in Huntsville, Alabama, and outsource its San Jose-based manufacturing operations. The Company recorded charges (credits) of $6.9 million, $1.4 million, and ($0.3) million in the first, second and fourth quarters of fiscal 2000, respectively, in connection with the restructuring activities that included 1) severance and other termination benefits for the approximately 135 San Jose-based employees who were involuntarily terminated, 2) the termination of certain facility leases, 3) the write-down of certain impaired assets and 4) the pro-rata portion of the non-recurring retention bonuses offered to the involuntarily terminated employees to support the transition from California to Alabama. All amounts accrued for the restructuring have been paid or charged against the restructuring reserve. NOTE 4. Inventories Inventories are stated at the lower of cost, determined using the first-in, first-out method, or market. Inventories consisted of the following (in thousands):
December 29, June 30, 2000 2000 ------------ --------- Raw materials $1,642 $1,517 Work in process 213 -- Finished goods 4,549 3,323 ------ ------ $6,404 $4,840 ====== ======
6 7 NOTE 5. Earnings Per Share Basic net income (loss) per share is computed by dividing net income (loss) available to common stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Diluted net income (loss) per share gives effect to all dilutive potential common shares outstanding during a period. In computing diluted net income (loss) per share, the average price of the Company's Common Stock for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options under the treasury stock method. Following is a reconciliation of the numerators and denominators of the basic and diluted net income (loss) per share for the three and six months ended December 29, 2000 and December 31, 1999, respectively:
(in thousands, except per share amounts) ------------------------------------------------------------------- Three Months Ended Six Months Ended --------------------------------- ----------------------------- Dec. 29, 2000 Dec. 31, 1999 Dec. 29, 2000 Dec. 31, 1999 -------------- --------------- ------------- ------------- Net loss [numerator] $ (12,333) $ (777) $ (19,169) $(10,114) ========== ========== ========== ======== Shares calculation [denominator]: Weighted shares outstanding - Basic 14,719 13,971 14,717 13,960 Effect of dilutive securities: Potential common stock relating to stock options and warrants (a) -- -- -- -- ---------- ---------- ---------- -------- Weighted shares outstanding - Diluted 14,719 13,971 14,717 13,960 ========== ========== ========== ======== Net loss per share - Basic $ (0.84) $ (0.06) $ (1.30) $ (0.72) ========== ========== ========== ======== Net loss per share - Diluted $ (0.84) $ (0.06) $ (1.30) $ (0.72) ========== ========== ========== ========
(a) Options to purchase 4,282,431 and 3,453,964 shares of common stock at prices ranging from $0.50 to $19.75 per share were outstanding at December 29, 2000 and December 31, 1999, respectively, and stock warrants to purchase 2,249,900 shares at $4.75 were outstanding at December 29, 2000, but were not included in the computation of diluted net loss per share because inclusion of such options would have been antidilutive. NOTE 6. Recently Issued Accounting Pronouncements In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities Deferral of the Effective Date of FASB No. 133", which deferred the effective date provisions of SFAS No. 133 for the Company until fiscal 2001. SFAS 133 establishes new standards of accounting and reporting for derivative instruments and hedging activities. SFAS 133 requires that all derivatives be recognized at fair value in the statement of financial position, and that the corresponding gains or losses be reported either in the statement of operations or as a component of other comprehensive income, depending on the type of hedging relationship that exists. The Company currently does not hold derivative instruments or engage in hedging activities. In December 1999, the Securities and Exchange Commission released Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements". This pronouncement summarizes certain of the SEC staff's views on applying generally accepted accounting principles to revenue recognition. The Company has reviewed the requirements of SAB 101 and believes that its existing accounting policies are in accordance with the guidance provided in the SAB. 7 8 NOTE 7. Stock Warrants and Related Agreements In October 2000, the Company entered into agreements with Beacon Telco, L.P. ("Beacon Telco") and the Boston University Photonics Center to establish a product development center at the Photonics Center to develop new optical networking products. As part of the agreements, the Company issued Beacon Telco warrants for 2,249,900 shares of the Company's common stock at an exercise price of $4.75 per share that will become exercisable at various dates, and will expire on October 13, 2003. The exercise dates of the warrants may be accelerated based upon meeting development milestones and certain other events, including the market price of the Company's common stock exceeding a certain price. The issuance of these warrants dilutes the Company's earnings per share by approximately 15%. The agreements provide Beacon Telco the opportunity to receive two bonus payments based in part on meeting certain milestones and the market price of the Company's common stock. The first bonus payment of $3,562,500 was earned on October 13, 2000 and paid on February 9, 2001 in the form of a note that Beacon Telco used in conjunction with the exercise of warrants for 749,900 shares of the Company's common stock. The second bonus payment of up to $7.1 million, if earned, may be paid at the option of the Company in cash, common stock, or a five-year note (payable in either cash or common stock). The Company recorded a charge to research and development expenses in the second quarter of fiscal 2001 of $8.3 million for the warrants and the first bonus payment to be used in the exercise of the warrants. The second bonus payment will be charged to research and development expenses in future periods as the optical networking products are developed to achieve the related milestones. Management expects research and development expenses, excluding the $8.3 million charge for the warrants and bonus, to increase significantly during calendar 2001 in support of ongoing optical product development at the Photonics Center. NOTE 8. Treasury Stock In November 2000, the Company retired all 3,662,523 shares of its treasury stock by charging the original cost against common stock and additional paid in capital. NOTE 9. Income Taxes As a result of losses currently expected to arise from the increased research and development expenses for the optical networking products, the Company established a full valuation allowance against its deferred tax assets at September 29, 2000. Management believes that due to the net loss expected for the current fiscal year and the existing net loss carryforwards from prior years, it is more likely than not that the Company's deferred tax assets will not be realized. The valuation allowance includes $1,155,000 related to the deferred tax assets of an acquired business for which uncertainty now exists surrounding the realization of such assets. This amount was recorded as an increase in costs in excess of net assets of the acquired company (goodwill). The valuation allowance will be used to reduce goodwill in the future when any portion of the related deferred tax assets is recognized. 8 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information in this Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements, including, without limitation, statements relating to the Company's revenues, expenses, margins, liquidity and capital needs. Such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed elsewhere herein under the caption "Factors Affecting Future Results". RESULTS OF OPERATIONS The following table presents the percentages of total sales represented by certain line items from the Condensed Consolidated Statements of Operations for the periods indicated.
Three Months Ended Six Months Ended ------------------------- ------------------------- Dec. 29, Dec. 31, Dec. 29, Dec. 31, 2000 1999 2000 1999 --------- --------- --------- ---------- Sales 100.0% 100.0% 100.0% 100.0% Cost of sales 63.1 50.1 53.1 54.2 ------ ------ ------ ------ Gross margin 36.9 49.9 46.9 45.8 ------ ------ ------ ------ Operating expenses: Research and development 121.6 13.4 62.8 17.2 Selling, general and administrative 55.2 34.0 48.7 35.8 Restructuring and other non-recurring charges -- 8.7 -- 26.7 ------ ------ ------ ------ Total operating expenses 176.8 56.1 111.5 79.7 ------ ------ ------ Loss from operations (139.9) (6.2) (64.6) (33.9) Interest and other income, net 3.4 1.4 3.0 1.3 ------ ------ ------ ------ Loss before provision for income taxes (136.5) (4.8) (61.6) (32.6) Provision for income taxes -- -- 30.2 -- ------ ------ ------ ------ Net loss (136.5)% (4.8)% (91.9)% (32.6)% ====== ====== ====== ======
Sales. Net sales decreased approximately 44% to $9 million for the three months ended December 29, 2000 from $16.2 million in the comparable period of the prior fiscal year. Net sales decreased 33% to $20.9 million for the six months ended December 29, 2000 from $31 million during the comparable period in the prior year. The decrease in net sales resulted from a decrease in sales volume to most of the Company's product markets. Carrier and carrier access products net sales decreased from $10.6 million in the three months ended December 31, 1999 to $5.2 million in the three months ended December 29, 2000 and decreased from $19.1 million in the six months ended December 31, 1999 to $12.7 million in the six months ended December 29, 2000. These decreases were primarily a result of reduced spending by the large telecommunication infrastructure companies that have traditionally contributed to more than half of the Company's revenue base. Net sales to the Company's top five customers decreased approximately 52% in the three months ended December 29, 2000 to $5 million from $10.3 million in the three months ended December 31, 1999, and decreased 26% to $13.3 million for the six months ended December 29, 2000 from $18 million for the six months ended December 31, 1999. Net sales to all other customers declined by approximately 31% and 58%, respectively, in the three- and six-month periods ended December 29, 2000 from the comparable periods in the prior fiscal year due in part to the impact of the reorganization of the sales force from a geographical focus to a market focus and the implementation of a two-tier distribution channel. See "Factors Affecting Future Results -- Reorganization of Sales Force". The Company's top five customers did not remain the same over the periods. Gross Margin. Gross margin decreased to 36.9% of net sales for the three months ended December 29, 2000 as compared to 49.9% for the three months ended December 31, 1999. This decrease is attributable to a number of factors, including the product sales mix, a high level of unabsorbed manufacturing overhead and other costs 9 10 associated with the lower sales volume this year, and additional excess inventory reserves provided against certain product lines. Gross margin improved to 46.9 % of net sales for the six months ended December 29, 2000 from 45.8% for the six months ended December 31, 1999, again due to a number of factors including, higher gross margins in the first quarter of fiscal 2001 due to that quarter's product sales mix, the duplication of costs in both San Jose and Huntsville in fiscal 2000 prior to the Company's move to Huntsville in December 1999, a high level of warranty expense in the first two quarters of fiscal 2000, and a high level of non-warranty repairs that carry a lower than average gross margin in the first quarter of fiscal 2000. Research and Development. Research and development expenditures increased 406% to $11 million for the three months ended December 29, 2000 from $2.2 million for the three months ended December 31, 1999 and increased 145% to $13.1 million for the six months ended December 29, 2000 from $5.3 million for the six months ended December 31, 1999. As a percentage of sales, research and development expenses increased from 13.4% for the three months ended December 31, 1999 to 121.6% for the three months ended December 29, 2000 and increased from 17.2% for the six months ended December 31, 1999 to 62.8% for the six months ended December 29, 2000. These increases were due to the agreements announced in October 2000 with Beacon Telco and the Boston University Photonics Center to establish a product development center to develop new optical networking products. In connection with these agreements, the Company recorded a non-cash charge to research and development expenses for $8.3 million in the second quarter of fiscal 2001. Research and development expenses, excluding the $8.3 million charge for the warrants and bonus, are expected to increase during the next five to six quarters in connection with the development of optical networking products. See "Optical Networking Project and Related Warrants" and "Factors Affecting Future Results - Optical Networking Product Development". The Company believes that a significant level of investment in product development is required to remain competitive and that such expenses will vary over time as a percentage of net sales. Selling, General and Administrative. Selling, general and administrative expenses decreased 9% to $5 million for the three months ended December 29, 2000 from $5.5 million for the three months ended December 31, 1999 and decreased 8% to $10.2 million for the six months ended December 29, 2000 from $11.1 million for the six months ended December 31, 1999. The decrease in absolute dollars over the same periods in the prior year is due to a decrease in variable selling expenses on the lower sales volume, cost reduction programs implemented during the second quarter of fiscal 2001, and to the completion of the restructuring and consolidation plan during fiscal 2000. Selling, general and administrative expenses increased as a percentage of sales from 34.0% for the three months ended December 31, 1999 to 55.2% for the three months ended December 29, 2000 and increased from 35.8% for the six months ended December 31, 1999 to 48.7% for the six months ended December 29, 2000 due to the lower sales levels. The Company expects the dollar amount of selling, general and administrative expenses will remain flat to slightly increasing in the future and that such expenses will vary over time as a percentage of sales. Restructuring and Other Non-recurring Charges. During the first quarter of fiscal 2000, the Company announced and began implementing its plans to consolidate its operations into its existing operations located in Huntsville, Alabama, and to outsource its San Jose based manufacturing activities. The Company incurred pretax charges of $1.4 million and $8.3 million, respectively, in the three- and six-month periods ended December 31, 1999 for restructuring and other related non-recurring activities. See Note 3 in the Notes to Condensed Consolidated Financial Statements for further details of the restructuring and other non-recurring charges. Interest and Other Income, Net. Net interest and other income increased 40% from $222,000 for the three months ended December 31, 1999 to $311,000 for the three months ended December 29, 2000 and increased 58% from $393,000 for the six months ended December 31, 1999 to $621,000 for the six months ended December 29, 2000. These increases are a result of higher cash and cash equivalents, restricted cash and short-term investment balances and higher market interest rates. Provision for Income Taxes. With the full valuation allowance established against its deferred tax assets at September 29, 2000, the Company did not record a tax benefit for income taxes for the three months ended December 29, 2000. The Company did not record a tax benefit or provision for income taxes in the three- and six-month periods ended December 31, 1999. 10 11 OPTICAL NETWORKING PROJECT AND RELATED WARRANTS In October 2000, the Company entered into agreements with Beacon Telco, L.P. ("Beacon Telco") and the Boston University Photonics Center to establish a product development center at the Photonics Center to develop new optical networking products. The goal of this project is to accelerate the development of optics-based products to expand the Company's current product offerings and market positioning, and to build in-house R&D expertise in optics technology to support potential future development of a broad variety of optics-based products. The arrangement provides the Company with access to the Photonics Center's state-of-the-art optics laboratories and specialized technical expertise, which, together with the Company's own engineering and strategic marketing resources, may accelerate the development of new optics-based products. As part of the agreements, the Company issued Beacon Telco warrants to purchase up to 2,249,900 shares of the Company's common stock (representing approximately 15% of the current outstanding common stock of the Company) at an exercise price of $4.75 per share, subject to customary anti-dilution adjustments. The warrants become exercisable over time, subject to acceleration based upon meeting development milestones and certain other events, including the market price of the Company's common stock exceeding a certain price, and will expire on October 13, 2003. The Company has agreed to appoint one designee of Beacon Telco to the Board of Directors of the Company. Until the earlier of October 13, 2005 or the date that Beacon Telco beneficially owns less than 10% of Company's common stock, including the common stock issuable upon exercise of its warrants, the Company has agreed to recommend that its stockholders elect the designee of Beacon Telco at each meeting of stockholders at which the Beacon Designee is up for election. Beacon Telco has agreed to vote shares of Common Stock issued upon exercise of its warrants in accordance with the recommendation of the Board of Directors of the Company. In addition, Beacon Telco has agreed to certain "standstill" provisions and the Company has agreed to register Beacon Telco's resale of the common stock issuable upon exercise of the warrants under the Securities Act of 1933. The agreements provide Beacon Telco the opportunity to receive two bonus payments based in part on meeting certain milestones and the market price of the Company's common stock. The first bonus payment of $3,562,500 was earned on October 13, 2000 and paid on February 9, 2001 in the form of a note that Beacon Telco used in conjunction with the exercise of warrants for 749,900 shares of the Company's common stock. The second bonus payment of up to $7.1 million, if earned, may be paid at the option of the Company in cash, common stock, or a five-year non-interest bearing note (payable in either cash or common stock). The Company recorded a charge to research and development expenses in the second quarter of fiscal 2001 of $8.3 million for the warrants and the first bonus payment to be used in the exercise of the warrants. The second bonus payment will be charged to research and development expenses in future periods as the optical networking products are developed to achieve the related milestones. Management expects research and development expenses, excluding the $8.3 million charge for the warrants and bonus, to increase significantly during calendar 2001 in support of ongoing optical product development at the Photonics Center. The foregoing description is qualified by reference to the definitive documents that were filed as exhibits to Form 10-Q for the quarterly period ended September 29, 2000 filed on November 13, 2000. LIQUIDITY AND CAPITAL RESOURCES On December 29, 2000, the Company's principal sources of liquidity included $13.9 million of cash and cash equivalents, restricted cash, and short-term investments. During the six months ended December 29, 2000, cash flow provided by operating activities was approximately $3.3 million compared to $6.9 million used in operating activities during the six months ended December 31, 1999. Net cash provided by operating activities this quarter was due primarily to better asset management, with accounts receivable decreasing $9.7 million from better collection efforts and lower sales volume, offset by the cash loss from operations of $2.8 million, the increase in inventories of $1.6 million, and the decrease in current liabilities of $2 million. Overall, the reduced sales volume impacted the changes in accounts receivable, inventories, and current liabilities during this six-month period. 11 12 Cash used in investing activities was approximately $1.2 million for the six months ended December 29, 2000, as compared to approximately $7.5 million provided for the six months ended December 31, 1999. Capital expenditures of $3.8 million for the six months ended December 29, 2000 were used primarily for renovation to the new headquarters facility acquired by the Company on June 30, 2000 and completion of the Oracle implementation project in July 2000. The maturity of short-term investments provided $1.9 million in cash during the first six months of fiscal 2001. The Company is committed to spend approximately $1.1 million to complete the renovation of the new headquarters facility, with an expected completion date in February 2001. Cash provided by financing activities was $2.5 million for the six months ended December 29, 2000 compared to $359,000 for the six months ended December 31, 1999. Proceeds of $2 million were provided during the six months ended December 29, 2000 from the loan agreement, as amended during the second quarter of fiscal 2001. Under the terms of the amended loan agreement, the Company can borrow up to $6.5 million to finance the purchase of the new headquarters property and make improvements thereon. As of December 29, 2000, the Company had approximately $42,000 of borrowings that are available under this loan agreement. The Company believes that its cash and investment balances, along with anticipated cash flows from operations according to our current operating forecast, and the remaining funds available under the multi-year mortgage will be adequate to finance current operations, anticipated investments, research and development expenses, and capital expenditures for at least the next twelve months. The Company continues to investigate the possibility of generating financial resources through committed credit agreements, technology or manufacturing partnerships, equipment financing, and offerings of debt and equity securities. FACTORS AFFECTING FUTURE RESULTS As described by the following factors, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. This Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements using terminology such as "may", "will", "expects", "plans", "anticipates", "estimates", "potential", or "continue", or the negative thereof or other comparable terminology regarding beliefs, plans, expectations or intentions regarding the future. Forward-looking statements include statements regarding the Company's consolidation of its operations and outsourcing of its manufacturing operations (the "Restructuring"); the goals, intended benefits and success of the Restructuring, particularly the goal of reducing expenses; expected changes in selling, general and administrative expenses; total budgeted capital expenditures; expected research and development expenses; results and anticipated benefits of the optical networking project; and the adequacy of the Company's cash position for the near-term. These forward-looking statements involve risks and uncertainties, and it is important to note that the Company's actual results could differ materially from those in such forward-looking statements. Among the factors that could cause actual results to differ materially are the factors detailed below as well as the other factors set forth in Item 2 hereof. All forward-looking statements and risk factors included in this document are made as of the date hereof, based on information available to the Company as of the date hereof, and the Company assumes no obligation to update any forward-looking statement or risk factor. You should consult the risk factors listed from time to time in the Company's Reports on Forms 10-Q and 10-K. Customer Concentration. A small number of customers continue to account for a majority of the Company's sales. In fiscal 2000, net sales to Nortel, WorldCom, and Ericsson accounted for 30%, 19%, and 3% of the Company's net sales, respectively, and the Company's top five customers accounted for 61% of the Company's net sales. In fiscal 1999, net sales to Nortel, WorldCom, and Ericsson accounted for 17%, 27%, and 5% of the Company's net sales, respectively, and net sales to the Company's top five customers accounted for 57% of the Company's net sales. Percentages of total revenue have been restated for prior periods as if Ericsson's May 1999 acquisition of Qualcomm's terrestrial Code Division Multiple Access (CDMA) wireless infrastructure business had been in effect for all periods presented. Other than Nortel, WorldCom, and Ericsson, no customer accounted for more than 10% of the Company's net sales in fiscal years 2000 or 1999. There can be no assurance that the 12 13 Company's current customers will continue to place orders with the Company, that orders by existing customers will continue at the levels of previous periods, or that the Company will be able to obtain orders from new customers. Certain customers of the Company have been or may be acquired by other existing customers. The impact of such acquisitions on net sales to such customers is uncertain, but there can be no assurance that such acquisitions will not result in a reduction in net sales to those customers. In addition, such acquisitions could have in the past, and could in the future, result in further concentration of the Company's customers. The Company has in the past experienced significant declines in net sales it believes were in part related to orders being delayed or cancelled as a result of pending acquisitions relating to its customers. There can be no assurance that future merger and acquisition activity among the Company's customers will not have a similar adverse affect on the Company's net sales and results of operations. The Company's customers are typically not contractually obligated to purchase any quantity of products in any particular period. Product sales to major customers have varied widely from period to period. In some cases, major customers have abruptly terminated purchases of the Company's products. Loss of, or a material reduction in orders by, one or more of the Company's major customers would materially adversely affect the Company's business, financial condition, and results of operations. See "Competition" and "Fluctuations in Quarterly Operating Results". Dependence on Outside Contractors. In September 1999, the Company entered into an agreement with a single outside contractor to outsource substantially all of the manufacturing operations previously located in San Jose, including its procurement, assembly, and system integration operations. The products manufactured by the outside contractor located in California generated a majority of the Company's revenues. There can be no assurance that this contractor will continue to meet the Company's future requirements for manufactured products, or that the contractor will not experience quality problems in manufacturing the Company's products. The inability of the Company's contractor to provide the Company with adequate supplies of high quality products could have a material adverse effect on the Company's business, financial condition, and results of operations. The loss of any of the Company's outside contractors could cause a delay in the Company's ability to fulfill orders while the Company identifies a replacement contractor. Because the establishment of new manufacturing relationships involves numerous uncertainties, including those relating to payment terms, cost of manufacturing, adequacy of manufacturing capacity, quality control and timeliness of delivery, the Company is unable to predict whether such relationships would be on terms that the Company regards as satisfactory. Any significant disruption in the Company's relationships with its manufacturing sources would have a material adverse effect on the Company's business, financial condition, and results of operations. Dependence on Key Personnel. The Company's future success will depend to a large extent on the continued contributions of its executive officers and key management, sales, and technical personnel. The Company is a party to agreements with certain of its executive officers to help ensure the officers' continued service to the Company in the event of a change-in-control. Each of the Company's executive officers, and key management, sales and technical personnel would be difficult to replace. Several members of the senior management team recently joined the Company and have had only a limited time to work together. The loss of the services of one or more of the Company's executive officers or key personnel, the inability of the management team to work effectively together, or the inability to continue to attract qualified personnel would delay product development cycles or otherwise would have a material adverse effect on the Company's business, financial condition and results of operations. Management of Growth. To manage potential future growth effectively, the Company must improve its operational, financial and management information systems and must hire, train, motivate and manage its employees. The future success of the Company also will depend on its ability to increase its customer support capability and to attract and retain qualified technical, marketing and management personnel, for whom competition is intense. In particular, the current availability of qualified personnel may be limited and competition among companies for such personnel is intense. The Company is currently attempting to hire a number of engineering personnel and has experienced some delays in filling such positions. There can be no assurance that the Company will be able to effectively achieve or manage any such growth, and failure to do so could delay product development and introduction cycles or otherwise have a material adverse effect on the Company's business, financial condition and results of operations. See "Dependence on Key Personnel". Dependence on Component Availability and Key Suppliers. The Company generally relies upon a contract manufacturer to buy component parts that are incorporated into board assemblies used in its products. On-time 13 14 delivery of the Company's products depends upon the availability of components and subsystems used in its products. Currently, the Company and third party sub-contractors depend upon suppliers to manufacture, assemble and deliver components in a timely and satisfactory manner. The Company has historically obtained several components and licenses for certain embedded software from single or limited sources. There can be no assurance that these suppliers will continue to be able and willing to meet the Company's and third party sub-contractors' requirements for any such components. The Company and third party sub-contractors generally do not have any long-term contracts with such suppliers, other than software vendors. Any significant interruption in the supply of, or degradation in the quality of, any such item could have a material adverse effect on the Company's results of operations. Any loss in a key supplier, increase in required lead times, increase in prices of component parts, interruption in the supply of any of these components, or the inability of the Company or its third party sub-contractor to procure these components from alternative sources at acceptable prices and within a reasonable time, could have a material adverse effect upon the Company's business, financial condition and results of operations. Purchase orders from the Company's customers frequently require delivery quickly after placement of the order. As the Company does not maintain significant component inventories, delay in shipment by a supplier could lead to lost sales. The Company uses internal forecasts to determine its general materials and components requirements. Lead times for materials and components may vary significantly, and depend on factors such as specific supplier performance, contract terms, and general market demand for components. If orders vary from forecasts, the Company may experience excess or inadequate inventory of certain materials and components, and suppliers may demand longer lead times, higher prices, or termination of contracts. From time to time, the Company has experienced shortages and allocations of certain components, resulting in delays in fulfillment of customer orders. Such shortages and allocations may occur in the future, and could have a material adverse effect on the Company's business, financial condition, and results of operations. See "Fluctuations in Quarterly Operating Results". Fluctuations in Quarterly Operating Results. The Company's sales are subject to quarterly and annual fluctuations due to a number of factors resulting in more variability and less predictability in the Company's quarter-to-quarter sales and operating results. For example, sales to Nortel, WorldCom, and Ericsson have varied between quarters by as much as $4.0 million, and orders delayed by these customers had a significant negative impact on the Company's first and second quarter results of fiscal 2001 as well as the third and fourth quarter results in fiscal 1999. Most of the Company's sales are in the form of large orders with short delivery times. The Company's ability to affect and judge the timing of individual customer orders is limited. The Company has experienced large fluctuations in sales from quarter-to-quarter due to a wide variety of factors, such as delay, cancellation or acceleration of customer projects, and other factors discussed below. The Company's sales for a given quarter may depend to a significant degree upon planned product shipments to a single customer, often related to specific equipment deployment projects. The Company has experienced both acceleration and slowdown in orders related to such projects, causing changes in the sales level of a given quarter relative to both the preceding and subsequent quarters. Delays or lost sales can be caused by other factors beyond the Company's control, including late deliveries by the third party subcontractors the Company is using to outsource its manufacturing operations as well as by other vendors of components used in a customer's system, changes in implementation priorities, slower than anticipated growth in demand for the services that the Company's products support and delays in obtaining regulatory approvals for new services and products. Delays and lost sales have occurred in the past and may occur in the future. Operating results in recent periods have been adversely affected by delays in receipt of significant purchase orders from customers. The Company believes that sales in prior periods have been adversely impacted by merger activities by some of its top customers. In addition, the Company has in the past experienced delays as a result of the need to modify its products to comply with unique customer specifications. These and similar delays or lost sales could materially adversely affect the Company's business, financial condition and results of operations. See "Customer Concentration" and "Dependence on Component Availability and Key Suppliers". The Company's backlog at the beginning of each quarter typically is not sufficient to achieve expected sales for that quarter. To achieve its sales objectives, the Company is dependent upon obtaining orders in a quarter for shipment in that quarter. Furthermore, the Company's agreements with its customers typically provide that they may change delivery schedules and cancel orders within specified timeframes, typically up to 30 days prior to the scheduled shipment date, without significant penalty. The Company's customers have in the past built, and may in 14 15 the future build, significant inventory in order to facilitate more rapid deployment of anticipated major projects or for other reasons. Decisions by such customers to reduce their inventory levels could lead to reductions in purchases from the Company. These reductions, in turn, could cause fluctuations in the Company's operating results and could have an adverse effect on the Company's business, financial condition, and results of operations in the periods in which the inventory is reduced. The Company's industry is characterized by declining prices of existing products, and therefore continual improvement of manufacturing efficiencies and introduction of new products and enhancements to existing products are required to maintain gross margins. In response to customer demands or competitive pressures, or to pursue new product or market opportunities, the Company may take certain pricing or marketing actions, such as price reductions, volume discounts, or provision of services at below-market rates. These actions could materially and adversely affect the Company's operating results. Operating results may also fluctuate due to a variety of factors, particularly: - delays in new product introductions by the Company; - market acceptance of new or enhanced versions of the Company's products; - changes in the product or customer mix of sales; - changes in the level of operating expenses; - changes in the level of research and development expenses; - competitive pricing pressures; - the gain or loss of significant customers; - increased research and development and sales and marketing expenses associated with new product introductions; and - general economic conditions. All of the above factors are difficult for the Company to forecast, and these or other factors can materially and adversely affect the Company's business, financial condition and results of operations for one quarter or a series of quarters. The Company's expense levels are based in part on its expectations regarding future sales and are fixed in the short term to a large extent. Therefore, the Company may be unable to adjust spending in a timely manner to compensate for any unexpected shortfall in sales. Any significant decline in demand relative to the Company's expectations or any material delay of customer orders could have a material adverse effect on the Company's business, financial condition, and results of operations. There can be no assurance that the Company will be 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 could likely be materially and adversely affected. See "Potential Volatility of Stock Price". The Company's products are covered by warranties and the Company is subject to contractual commitments concerning its products. If unexpected circumstances arise such that the product does not perform as intended and the Company is not successful in resolving product quality or performance issues, there could be an adverse effect on the Company's business, financial condition, and results of operations. For example, during the fourth quarter of fiscal 1999, the Company was notified by one of its major customers of an intermittent problem involving one of the Company's products installed in the field. Although the Company identified a firmware fix for this problem and negotiated an agreement with the customer to share in the expense associated with the upgrade, this or similar problems in the future could increase expenses or reduce product acceptance. 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 15 16 market fluctuations may materially adversely affect the market price of the Company's common stock. The Company has experienced significant fluctuations in its stock price and share trading volume in the past and may continue to do so. Dependence on Recently Introduced Products and New Product Development. The Company's future results of operations are highly dependent on market acceptance of existing and future applications for both the Company's AS2000 product line, and the WANsuite(TM) family of integrated access devices introduced during the third quarter of fiscal 2000. The AS2000 product line represented approximately 58% of net sales in fiscal 2000, 67% of net sales in fiscal 1999 and 86% of net sales in fiscal 1998. Sales of WANsuite(TM) products began during the last quarter of fiscal 2000. Market acceptance of both the Company's current and future product lines is dependent on a number of factors, not all of which are in the Company's control, including the continued growth in the use of bandwidth intensive applications, continued deployment of new telecommunications services, market acceptance of integrated access devices in general, the availability and price of competing products and technologies, and the success of the Company's sales efforts. Failure of the Company's products to achieve market acceptance would have a material adverse effect on the Company's business, financial condition, and results of operations. The market for the Company's products are characterized by rapidly changing technology, evolving industry standards, continuing improvements in telecommunication service offerings, and changing demands of the Company's customer base. Failure to introduce new products in a timely manner could cause companies to purchase products from competitors and have a material adverse effect on the Company's business, financial condition and results of operations. Due to a variety of factors, the Company may experience delays in developing its planned products. New products may require additional development work, enhancement, and testing or further refinement before the Company can make them commercially available. The Company has in the past experienced delays in the introduction of new products, product applications and enhancements due to a variety of internal factors, such as reallocation of priorities, difficulty in hiring sufficient qualified personnel and unforeseen technical obstacles, as well as changes in customer requirements. Such delays have deferred the receipt of revenue from the products involved. If the Company's products have performance, reliability or quality shortcomings, then the Company may experience reduced orders, higher manufacturing costs, delays in collecting accounts receivable and additional warranty and service expenses. See "Optical Networking Product Development". Optical Networking Product Development. The Company's future results and operations are highly dependent on the success of the Company's optical product development project, the Company's cooperative research agreement with Beacon Telco (the "Cooperative Research Agreement"), and its related Premises Access and Services Agreement with the Boston University Photonics Center (the "Facility Access Agreement"). The Cooperative Research Agreement and the Facility Access Agreement are hereinafter collectively referred to as the "Research Agreements". The Company has committed to pay the expenses related to the Research Agreements and therefore anticipates significant increases in research and development expenses in addition to increases in the ongoing development and marketing costs necessary to bring a potential optical networking product to market. Either of these expenses may exceed the budget that the Company has established and could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has also agreed both to license from Beacon Telco and/or the Boston University Photonics Center or their affiliates, for additional license fees yet to be determined any background intellectual property necessary to commercialize the optical networking product and to certain limitations on the Company's ownership and use of intellectual property generated in the course of the performance of the Research Agreements. The parties may be unable to agree on the proper fees to be charged for such license of background intellectual property necessary to commercialize the optical networking product, or, if agreed, the costs of licensing background or other intellectual property could be substantial and may limit the ability of the Company to develop and market the optical networking product on a profitable basis. The success of the project may depend on the ability of the Company to effectively utilize certain resources of the Photonics Center, which are to be provided on an as-available basis at the discretion of the Trustees of Boston University. If critical resources are not made available to the Company on a timely basis, the project may be unsuccessful or may require significantly higher costs than expected. 16 17 The Company's ongoing effort to develop and market an optical networking product will require high levels of innovation and may not be successful. Even if the Company does succeed in developing an optical networking product, it may have difficulty marketing and selling the product. Moreover, there can be no assurance that any product developed by the Company will gain and hold market acceptance in the rapidly growing optical networking market which is characterized by rapid innovation, numerous competing products and technologies, as well as strong competition. Failure of the Company to develop an optical networking product or to gain market acceptance for such a product would have a material adverse effect on the Company's business, financial condition and results of operations. Furthermore, the development of an optical networking product may take longer or be less successful than anticipated, which, in either event, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Rapid Technological Change", "Dependence on Recently Introduced Products and New Product Development", and "Risks Associated with Potential Acquisitions and Joint Ventures". Competition. The market for telecommunications network access equipment is highly competitive, and the Company expects competition to increase in the future. This market is subject to rapid technological change, regulatory developments, and new entrants. The market for integrated access devices such as the Access System product line and WANSuite(TM), and for enterprise devices such as the PRISM, FrameStart(TM), and Lite product lines is subject to rapid change. The Company believes that the primary competitive factors in this market are the development and rapid introduction of new product features, price and performance, support for multiple types of communications services, network management, reliability, and quality of customer support. There can be no assurance that the Company's current products and future products under development will be able to compete successfully with respect to these or other factors. The Company's principal competition to date for its current AS2000 and AS4000 products has been from Quick Eagle Networks (formerly Digital Link Corporation), ADC Kentrox, a division of ADC Telecommunications, and Larscom, Inc., a subsidiary of Axel Johnson. In addition, the Company experiences substantial competition with its enterprise access and network termination products from companies in the computer networking market and other related markets. These competitors include Premisys Communications, Inc. (now a part of Zhone Technologies), Newbridge Networks Corporation, Visual Networks, Adtran, Inc., and Paradyne Inc. To the extent that current or potential competitors can expand their current offerings to include products that have functionality similar to the Company's products and planned products, the Company's business, financial condition and results of operations could be materially adversely affected. The Company believes that the market for basic network termination products is mature, but that the market for feature-enhanced network termination and network access products continues to grow and expand, as more "capability" and "intelligence" moves outward from the central office to the enterprise. The Company believes that the principal competitive factors in this market are price, feature sets, installed base, and quality of customer support. In this market, the Company primarily competes with Adtran, Quick Eagle Networks, ADC Kentrox, Paradyne, Visual Networks, and Larscom. There can be no assurance that such companies or other competitors will not introduce new products that provide greater functionality and/or at a lower price than the Company's like products. In addition, advanced termination products are emerging which represent both new market opportunities as well as a threat to the Company's current products. Furthermore, basic line termination functions are increasingly being integrated by competitors, such as Cisco and Nortel Networks, into other equipment such as routers and switches. These include direct WAN interfaces in certain products, which may erode the addressable market for separate network termination products. Many of the Company's current and potential competitors have substantially greater technical, financial, manufacturing and marketing resources than the Company. In addition, many of the Company's competitors have long-established relationships with network service providers. There can be no assurance that the Company will have the financial resources, technical expertise, manufacturing, marketing, distribution and support capabilities to compete successfully in the future. See "Competition". Reorganization of Sales Force. In July 2000, the Company restructured its sales force from a sales force organized by geographical region to one focused on sales to particular markets and through particular distribution channels. This reorganization appeared to be disruptive in the first half of fiscal 2001 and may continue to be disruptive to the Company's sales in future quarters and involves numerous uncertainties, including, but not limited to, the increased costs to retrain the sales force in the methods and techniques needed to effectively approach the different markets and distribution channels available for the Company's products, the ability to retain current 17 18 members of the sales force, the effectiveness of the sales force in closing sales, and the re-allocation of relationships that the sales force may have previously developed with customers in the geographic regions. As a result, the Company expects that the reorganization may continue to have a short-term negative impact on the Company's sales and results of operations. The transition to a market and distribution channel based sales force may take longer or be less successful than anticipated, which, in either event, could have a material adverse effect on the Company's business, financial condition, and results of operations. Rapid Technological Change. The network access and telecommunications equipment markets are characterized by rapidly changing technologies and frequent new product introductions. The rapid development of new technologies increases the risk that current or new competitors could develop products that would reduce the competitiveness of the Company's products. The Company's success will depend to a substantial degree upon its ability to respond to changes in technology and customer requirements. This will require the timely selection, development and marketing of new products and enhancements on a cost-effective basis. The development of new, technologically advanced products is a complex and uncertain process, requiring high levels of innovation. The Company may need to supplement its internal expertise and resources with specialized expertise or intellectual property from third parties to develop new products. The development of new products for the WAN access market requires competence in the general areas of telephony, data networking, network management and wireless telephony as well as specific technologies such as Digital Subscriber Lines (DSL), Integrated Services Digital Networks (ISDN), Frame Relay, Asynchronous Transfer Mode (ATM), and Internet Protocols (IP). Furthermore, the communications industry is characterized by the need to design products that meet industry standards for safety, emissions, and network interconnection. With new and emerging technologies and service offerings from network service providers, such standards are often changing or unavailable. As a result, there is a potential for product development delays due to the need for compliance with new or modified standards. The introduction of new and enhanced products also requires that the Company manage transitions from older products in order to minimize disruptions in customer orders, avoid excess inventory of old products, and ensure that adequate supplies of new products can be delivered to meet customer orders. There can be no assurance that the Company will be successful in developing, introducing or managing the transition to new or enhanced products, or that any such products will be responsive to technological changes or will gain market acceptance. The Company's business, financial condition and results of operations would be materially adversely affected if the Company were to be unsuccessful, or to incur significant delays in developing and introducing such new products or enhancements. See "Dependence on Recently Introduced Products and New Product Development" and "Optical Networking Product Development". Compliance with Regulations and Evolving Industry Standards. The market for the Company's products is characterized by the need to meet a significant number of communications regulations and standards, some of which are evolving as new technologies are deployed. In the United States, the Company's products must comply with various regulations defined by the Federal Communications Commission and standards established by Underwriters Laboratories and Bell Communications Research. For some public carrier services, installed equipment does not fully comply with current industry standards, and this noncompliance must be addressed in the design of the Company's products. Standards for new services such as frame relay, performance monitoring services and Digital Subscriber Lines (DSL) are still evolving. As these standards evolve, the Company will be required to modify its products or develop and support new versions of its products. The failure of the Company's products to comply, or delays in compliance, with the various existing and evolving industry standards could delay introduction of the Company's products, which could have a material adverse effect on the Company's business, financial condition and results of operations. Government regulatory policies are likely to continue to have a major impact on the pricing of existing as well as new public network services and therefore are expected to affect demand for such services and the telecommunications products that support such services. Tariff rates, whether determined by network service providers or in response to regulatory directives, may affect the cost effectiveness of deploying communication services. Such policies also affect demand for telecommunications equipment, including the Company's products. Risks Associated With Potential Acquisitions and Joint Ventures. An important element of the Company's strategy is to review acquisition prospects and joint venture opportunities that would compliment its existing product offerings, augment its market coverage, enhance its technological capabilities or offer growth opportunities. Transactions of this nature by the Company could result in potentially dilutive issuance of equity securities, use of 18 19 cash and/or the incurring of debt and the assumption of contingent liabilities, any of which could have a material adverse effect on the Company's business and operating results and/or the price of the Company's common stock. Acquisitions entail numerous risks, including difficulties in the assimilation of acquired operations, technologies and products, diversion of management's attention from other business concerns, risks of entering markets in which the Company has limited or no prior experience and potential loss of key employees of acquired organizations. Joint ventures entail risks such as potential conflicts of interest and disputes among the participants, difficulties in integrating technologies and personnel, and risks of entering new markets. The Company's management has limited prior experience in assimilating such transactions. No assurance can be given as to the ability of the Company to successfully integrate any businesses, products, technologies or personnel that might be acquired in the future or to successfully develop any products or technologies that might be contemplated by any future joint venture or similar arrangement, and the failure of the Company to do so could have a material adverse effect on the Company's business, financial condition and results of operations. See "Optical Networking Product Development". Risks Associated With Entry into International Markets. The Company to date has had minimal direct sales to customers outside of North America. The Company has little experience in the European and Far Eastern markets, but intends to expand sales of its products outside of North America and to enter certain international markets, which will require significant management attention and financial resources. Conducting business outside of North America is subject to certain risks, including longer payment cycles, unexpected changes in regulatory requirements and tariffs, difficulties in staffing and managing foreign operations, greater difficulty in accounts receivable collection and potentially adverse tax consequences. To the extent any Company sales are denominated in foreign currency, the Company's sales and results of operations may also be directly affected by fluctuations in foreign currency exchange rates. In order to sell its products internationally, the Company must meet standards established by telecommunications authorities in various countries, as well as recommendations of the Consultative Committee on International Telegraph and Telephony. A delay in obtaining, or the failure to obtain, certification of its products in countries outside the United States could delay or preclude the Company's marketing and sales efforts in such countries, which could have a material adverse effect on the Company's business, financial condition and results of operations. Risk of Third Party Claims of Infringement. The network access and telecommunications equipment industries are characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. From time to time, third parties may assert exclusive patent, copyright, trademark, and other intellectual property rights to technologies that are important to the Company. The Company has not conducted a formal patent search relating to the technology used in its products, due in part to the high cost and limited benefits of a formal search. In addition, since patent applications in the United States are not publicly disclosed until the related patent is issued and foreign patent applications generally are not publicly disclosed for at least a portion of the time that they are pending, applications may have been filed which, if issued as patents, could relate to the Company's products. Software comprises a substantial portion of the technology in the Company's products. The scope of protection accorded to patents covering software-related inventions is evolving and is subject to a degree of uncertainty which may increase the risk and cost to the Company if the Company discovers third party patents related to its software products or if such patents are asserted against the Company in the future. Patents have been granted recently on fundamental technologies in software, and patents may be issued which relate to fundamental technologies incorporated into the Company's products. The Company may receive communications from third parties asserting that the Company's products infringe or may infringe the proprietary rights of third parties. In its distribution agreements, the Company typically agrees to indemnify its customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties. In the event of litigation to determine the validity of any third-party claims, such litigation, whether or not determined in favor of the Company, could result in significant expense to the Company and divert the efforts of the Company's technical and management personnel from productive tasks. In the event of an adverse ruling in such litigation, the Company 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. 19 20 Limited Protection of Intellectual Property. The Company relies upon a combination of patent, trade secret, copyright, and trademark laws and contractual restrictions to establish and protect proprietary rights in its products and technologies. The Company has been issued certain U.S. and Canadian patents with respect to limited aspects of its single purpose network access technology. The Company has not obtained significant patent protection for its Access System technology. There can be no assurance that third parties have not or will not develop equivalent technologies or products without infringing the Company's patents or that a court having jurisdiction over a dispute involving such patents would hold the Company's patents valid and enforceable. The Company has also entered into confidentiality and invention assignment agreements with its employees and independent contractors, and enters into non-disclosure agreements with its suppliers, distributors and appropriate customers so as to limit access to and disclosure of its proprietary information. There can be no assurance that these statutory and contractual arrangements will deter misappropriation of the Company's technologies or discourage independent third-party development of similar technologies. In the event such arrangements are insufficient, the Company's business, financial condition and results of operations could be materially adversely affected. The laws of certain foreign countries in which the Company's products are or may be developed, manufactured or sold may not protect the Company's products or intellectual property rights to the same extent as do the laws of the United States and thus, make the possibility of misappropriation of the Company's technology and products more likely. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. At December 29, 2000, the Company's investment portfolio consisted of fixed income securities of $2.2 million. 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 December 29, 2000, 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 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. 20 21 PART II. OTHER INFORMATION ITEM 2: CHANGES IN SECURITIES On October 13, 2000, and in consideration of the execution of the agreements described under "Optical Networking Project and Related Warrants" above, the Company issued Beacon Telco warrants to purchase 2,249,900 shares of the Company's common stock at an exercise price of $4.75 per share. The warrants were issued in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended, for transactions by an issuer not involving a public offering. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The Annual Meeting of Stockholders of the Company was held on November 15, 2000 (the "Annual Meeting"). The voting of holders of record of 14,717,591 shares of the Company's Common Stock outstanding at the close of business on October 2, 2000 was solicited by proxy pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. (b) The following individuals were elected as Class I Directors of the Company at the Annual Meeting:
VOTES WITHHOLDING CLASS I DIRECTOR VOTES FOR AUTHORITY ------------------ ----------- ------------- Graham G. Pattison 11,768,947 868,534 John E. Major 11,757,808 879,673
The following Directors' terms of office as Director continued after the meeting: Leigh S. Belden, John A. McGuire, Howard Oringer, and Steven C. Taylor. (c) The amendments to the Company's Amended and Restated 1993 Stock Option Plan to increase the number of shares available for issuance thereunder from 6,050,000 to 8,800,000 shares of common stock were ratified. The stockholders' vote was 5,833,977 shares FOR; 1,503,746 shares AGAINST; 31,187 shares ABSTAINED from voting; and 5,268,571 shares NO VOTE. (d) The amendments to the Company's 1996 Employee Stock Purchase Plan to increase the number of shares available for issuance thereunder from 500,000 to 750,000 shares of common stock were ratified. The stockholders' vote was 7,176,299 shares FOR; 158,241 shares AGAINST; 31,868 shares ABSTAINED from voting; and 5,271,073 shares NO VOTE. (e) The appointment of PricewaterhouseCoopers LLP as the Company's independent certified public accountants for fiscal year 2001 was ratified. The stockholders' vote on such appointment was 12,566,651 shares FOR; 21,450 shares AGAINST; 46,878 shares ABSTAINED from voting; and 2,502 shares NO VOTE. 21 22 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Index:
Exhibit Number Description of Exhibit -------------- ---------------------- 10.56 Lease Cancellation Agreement and Business Terms of Lease Cancellation Agreement between Registrant and Industrial Properties of the South dated January 19, 2001 (b) No reports on Form 8-K were filed during the quarter ended December 29, 2000.
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 February 12, 2000 By: /s/ Ronald G. Sibold ------------------------------------------ Ronald G. Sibold, Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) 22 EX-10.56 2 g66908ex10-56.txt LEASE CANCELLATION AGREEMENT 1 EXHIBIT 10.56 January 19, 2001 Lease Cancellation Agreement Verilink Corporation (as Successor to TxPort, Inc.) as Lessee and Industrial Properties of the South as Lessor have a lease agreement dated June 1993, as amended (the "Lease") in which Verilink's space on the top, third floor, and first floor space expire as of February 28, 2001; but Verilink's lease on the second floor space runs through March 31, 2002. Lessee and Lessor hereby agree that the Lease is cancelled, terminated and no longer in effect as of February 28, 2001 and that Lessee will surrender the space empty in broom clean condition as of the same date. Other business terms regarding this cancellation are covered in a separate letter agreement of this same date. /s/ Charlene B. Graham 1/19/01 /s/ C. W. Smith 1/19/01 - -------------------------------------- -------------------------------- by: Lessor Date by: Lessee Date Industrial Properties of the South Verilink Corporation VP & Corporate Controller 2 January 19, 2001 Business Terms of Lease Cancellation Agreement Verilink agrees to pay Industrial Properties of the South rent on the second floor for March, April, and May of 2001 in order to receive a cancellation of rent due for the remaining ten (10) months of the lease. At $13,968.39 per month, this is a savings of $139,683.90 to Verilink. This consideration is necessary to recoup the discounted rate Verilink has had for the past two (2) years of $6.40 rather than $6.90 for the longer term lease. /s/ Charlene B. Graham 1/19/01 - ------------------------------------- Charlene B. Graham date /s/ C. W. Smith 1/19/01 --------------------------------------- by: Verilink Corporation date VP & Corporate Controller -----END PRIVACY-ENHANCED MESSAGE-----