Form 10-Q

-----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, JbaigYmYP7eDVjNTpmhP2Y2SQSDXYZjKueqMFz5SUuXpeUxpyAp/EOVYvSUrgHsm Qv7WokoHdROzPolI7o9DyA== 0001206774-03-000041.txt : 20030207 0001206774-03-000041.hdr.sgml : 20030207 20030207101615 ACCESSION NUMBER: 0001206774-03-000041 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20021227 FILED AS OF DATE: 20030207 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: 1934 Act SEC FILE NUMBER: 000-28562 FILM NUMBER: 03543592 BUSINESS ADDRESS: STREET 1: 127 JETPLEX CIR CITY: MADISON STATE: AL ZIP: 35758-8989 BUSINESS PHONE: 256-327-2001 MAIL ADDRESS: STREET 1: 127 JETPLEX CIR CITY: MADISON STATE: AL ZIP: 35758-8989 10-Q 1 d11881.htm Form 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 27, 2002

Commission file number: 0-28562

VERILINK CORPORATION
(Exact name of registrant as specified in its charter)

Delaware		94-2857548
(State of incorporation)		(I.R.S. Employer Identification No.)

127 Jetplex Circle, Madison, Alabama 35758
(Address of principal executive offices, including zip code)

(256) 327-2001
(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 |_|

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|

The number of shares outstanding of the issuer’s common stock as of January 24, 2003 was 15,003,034.

INDEX
VERILINK CORPORATION
FORM 10-Q

PART I.	FINANCIAL INFORMATION	Page

Item 1.	Financial Statements (unaudited):

	Condensed Consolidated Statements of Operations for the three months and six months
	ended December 27, 2002 and December 28, 2001	3

	Condensed Consolidated Balance Sheets as of December 27, 2002 and June 28, 2002	4

	Condensed Consolidated Statements of Cash Flows for the six months ended
	December 27, 2002 and December 28, 2001	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21

Item 4.	Controls and Procedures	21

PART II.	OTHER INFORMATION

Item 4.	Submission of Matters to a Vote of Security Holders	21

Item 5.	Other Information	22

Item 6.	Exhibits and Reports on Form 8-K	22

SIGNATURE		23

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 27, 2002				December 28, 2001				December 27, 2002				December 28, 2001

Net sales		$	6,145			$	6,187			$	14,858			$	11,708
Cost of sales			2,953				4,352				7,151				7,937

Gross profit			3,192				1,835				7,707				3,771

Operating expenses:
Research and development			706				1,607				1,554				3,728
Selling, general and administrative			1,956				3,992				4,189				7,677
Asset impairment loss			—				550				—				550

Total operating expenses			2,662				6,149				5,743				11,955

Income (loss) from operations			530				(4,314	)			1,964				(8,184	)
Interest and other income, net			122				103				224				304
Interest expense			(47	)			(71	)			(100	)			(157	)

Income (loss) before provision for income taxes			605				(4,282	)			2,088				(8,037	)
Provision for income taxes			—				—				—				—

Net income (loss) before cumulative change in
accounting principle, relating to goodwill			605				(4,282	)			2,088				(8,037	)
Cumulative effect of change in accounting principle,
relating to goodwill			—				—				(1,233	)			—

Net income (loss)		$	605			$	(4,282	)		$	855			$	(8,037	)


Net income (loss) per share, basic and diluted:
Net income (loss) before cumulative change in
accounting principle, relating to goodwill		$	0.04			$	(0.27	)		$	0.14			$	(0.51	)

Cumulative effect of change in accounting principle,
relating to goodwill		$	—			$	—			$	(0.08	)		$	—

Net income (loss)		$	0.04			$	(0.27	)		$	0.06			$	(0.51	)


Weighted average shares outstanding:
Basic			14,999				15,945				14,998				15,845

Diluted			15,411				15,945				15,266				15,845

The accompanying notes are an integral part of these condensed consolidated financial statements.

VERILINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

	December 27,
	2002	June 28,
	(unaudited)	2002

ASSETS
Current assets:

Cash and cash equivalents	$	9,689		$	5,630
Short-term investments		101			598
Accounts receivable, net		1,579			4,045
Inventories, net		1,873			1,246
Other current assets		222			354

Total current assets		13,464			11,873
Property held for lease, net		6,520			6,456
Property, plant and equipment, net		826			832
Restricted cash		1,000			1,000
Goodwill, net		-			1,233
Other intangible assets, net		275			426
Other assets		500			360

	$	22,585		$	22,180

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt and capital lease obligations	$	727		$	711
Accounts payable		563			1,445
Accrued expenses		3,666			3,427

Total current liabilities		4,956			5,583
Long-term debt and capital lease obligations		4,115			4,480

Total liabilities		9,071			10,063

Stockholders’ equity:
Preferred Stock, $0.01 par value, 1,000,000 shares
authorized; no shares issued and outstanding		—			—
Common Stock, $0.01 par value; 40,000,000 shares authorized;
15,003,034 and 14,996,534 shares issued		150			150
Additional paid-in capital		51,486			51,483
Treasury Stock		(49	)		-
Notes receivable from stockholder		(2,643	)		(3,230	)
Accumulated other comprehensive loss		(24	)		(25	)
Accumulated deficit		(35,406	)		(36,261	)

Total stockholders’ equity		13,514			12,117

	$	22,585		$	22,180

The accompanying notes are an integral part of these condensed consolidated financial statements.

VERILINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

	Six Months Ended

	December 27,				December 28,
	2002				2001

Cash flows from operating activities:
Net income (loss)		$	855			$	(8,037	)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization			562				1,629
Impairment of long-lived assets			—				550
Research and development expenses related to Beacon Telco agreements, net			—				(583	)
Loss on retirement of property, plant and equipment			—				15
Accrued interest on notes receivable from stockholders, net of reserve			(88	)			139
Cumulative effect of change in accounting principle, relating to goodwill			1,233				—
Changes in assets and liabilities:
Accounts receivable, net			2,466				971
Inventories, net			(627	)			1,020
Other assets			(8	)			250
Accounts payable			(882	)			(1,364	)
Accrued expenses			101				(813	)

Net cash provided by (used in) operating activities			3,612				(6,223	)

Cash flows from investing activities:
Purchases of property, plant and equipment			(469	)			(97	)
Sale (purchase) of short-term investments			497				(72	)
Proceeds from repayment of notes receivable			150				—

Net cash provided by (used in) investing activities			178				(169	)

Cash flows from financing activities:
Payments on long-term debt obligations			(361	)			(358	)
Repurchase of common stock			(49	)			—
Proceeds from issuance of Common Stock			3				11
Proceeds from repayments of notes receivable from stockholder			675				—
Change in other comprehensive income (loss)			1				(4	)

Net cash provided by (used in) financing activities			269				(351	)

Net increase (decrease) in cash and cash equivalents			4,059				(6,743	)
Cash and cash equivalents at beginning of period			5,630				15,219

Cash and cash equivalents at end of period		$	9,689			$	8,476

Supplemental disclosures:
Cash paid for interest		$	99			$	156
Cash paid for income taxes		$	17			$	6

The accompanying notes are an integral part of these condensed consolidated financial statements.

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 27, 2003. 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, 2002 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 and presents it as accumulated other comprehensive income (loss) in the accompanying condensed consolidated balance sheets. For the three and six months ended December 27, 2002 comprehensive income amounted to $607,000 and $856,000 respectively, while comprehensive loss for the three and six months ended December 28, 2001 amounted to $4,278,000 and $8,041,000, respectively.

Note 3 – Inventories

Inventories are stated at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis. Inventories consisted of the following (in thousands):

	December 27,				June 28,
	2002				2002

Inventories:
Raw materials		$	2,740			$	2,102
Work in process			47				18
Finished goods			1,556				2,336

			4,343				4,456
Less: Inventory reserves			(2,470	)			(3,210	)

Inventories, net		$	1,873			$	1,246

Note 4 – Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share gives effect to all dilutive potential common shares outstanding during a period. In computing diluted earnings (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 exercise of stock options and stock warrants. The following table sets forth the computation of basic and diluted earnings (loss) per share for the three and six months ended December 27, 2002 and December 28, 2001 (in thousands, except per share amounts):

	Three months ended							Six months ended

	December 27,			December 28,				December 27,			December 28,
	2002			2001				2002			2001

Net income (loss)		$	605		$	(4,282	)		$	855		$	(8,037	)

Weighted average shares outstanding:
Basic			14,999			15,945				14,998			15,845
Effect of potential common stock from the exercise of
stock options			412			—				268			—

Diluted			15,411			15,945				15,266			15,845

Basic earnings (loss) per share		$	0.04		$	(0.27	)		$	0.06		$	(0.51	)

Diluted earnings (loss) per share		$	0.04		$	(0.27	)		$	0.06		$	(0.51	)

Options to purchase 2,395,894 and 3,349,952 shares of Common Stock were outstanding at December 27, 2002 and December 28, 2001, respectively, but were not included in the computation of diluted earnings (loss) per share for the six months ended December 27, 2002 and December 28, 2001, respectively, because inclusion of such options would have been antidilutive.

Note 5 –Goodwill and Other Intangible Assets – Adoption of Statement No. 142

In June 2001, the Financial Accounting Standards Board issued SFAS No. 142, Goodwill and Other Intangible Assets, which establishes the financial accounting and reporting for acquired goodwill and other intangible assets, and supercedes APB Opinion No. 17, Intangible Assets. This statement addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Goodwill will cease to be amortized upon the implementation of the statement and companies must test goodwill at least annually for impairment. The Company adopted SFAS No. 142 effective June 29, 2002 and ceased amortizing goodwill of $1,232,900 (including $117,800 of goodwill previously classified as other intangible assets).

This statement requires that goodwill be tested for impairment annually. In the year of adoption, this statement requires the completion of a transitional goodwill impairment evaluation, which is a two-step process. The first step, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired, and the second step of the impairment test is not required. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss. The second step compares the implied fair value of goodwill with the carrying amount of the goodwill. If the carrying amount of the goodwill exceeds the implied fair value of the goodwill, an impairment loss shall be recognized in an amount equal to that excess. As of June 29, 2002, the Company completed this impairment test for all of its goodwill and intangible assets, and recorded a transitional impairment loss of $1,232,900 during the three months ended September 27, 2002 as a cumulative change in accounting principle in its condensed consolidated statement of operations.

The following table represents the impact on net income (loss) and basic and diluted earnings (loss) per share amounts from the reduction of amortization of goodwill as if SFAS No. 142 was adopted in the first quarter of fiscal 2002 (in thousands, except per share amounts):

	Three months ended							Six months ended

	December 27,			December 28,				December 27,			December 28,
	2002			2001				2002			2001

Reported net income (loss)		$	605		$	(4,282	)		$	855		$	(8,037	)
Add back: goodwill and assembled work force
amortization			—			116				—			233

Adjusted net income (loss)			605			(4,166	)			855			(7,804	)

Reported basic and diluted earnings (loss) per share		$	0.04		$	(0.27	)		$	0.06		$	(0.51	)
Add back: goodwill and assembled work force
amortization per share			—			.01				—			.02

Adjusted earnings (loss) per basic and diluted share		$	0.04		$	(0.26	)		$	0.06		$	(0.49	)

Note 6 – Recently Issued Accounting Pronouncements

In August 2001, the Financial Accounting Standards Board issued SFAS No.143, Accounting for Asset Retirement Obligations (“ARO”), which has an effective date for financial statements for fiscal years beginning after June 15, 2002. This statement addresses the diversity in practice for recognizing asset retirement obligations and requires that obligations associated with the retirement of a tangible long-lived asset be recorded as a liability when those obligations are incurred, with the amount of the liability initially measured at fair value. Upon initially recognizing a liability for an ARO, an entity must capitalize the cost by recognizing an increase in the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The impact of SFAS No. 143 is not expected to be material to the Company’s financial statements.

In October 2001, the Financial Accounting Standards Board issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which has an effective date for financial statements for fiscal years beginning after December 15, 2001. This statement, which supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, this statement expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. The impact of SFAS No. 144 is not expected to be material to the Company’s financial statements.

In April 2002, the Financial Accounting Standards Board issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, which has an effective date for transactions occurring after May 15, 2002. This statement rescinds or amends several existing statements related to the extinguishment of debt, intangible assets of motor carriers, certain lease transactions and several other technical corrections to existing pronouncements. The impact of SFAS No. 145 is not expected to be material to the Company’s financial statements.

In July 2002, the Financial Accounting Standards Board issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which has an effective date for exit or disposal activities that are initiated after December 31, 2002. This statement provides that cost associated with an exit or disposal activity must be recognized when the liability is incurred. The impact of SFAS No. 146 is not expected to be material to the Company’s financial statements.

In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure – an Amendment of FAS 123, which is effective for financial statements for fiscal years ending after December 15, 2002. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.

Note 7 – Property Held for Lease

The Company owns a facility in Huntsville, Alabama located at 950 Explorer Boulevard. In August 2002, the Company entered into an agreement with The Boeing Company (“Boeing”) to lease this facility through November 2007. The lease allows Boeing the option of terminating the lease at the end of the 40th month, but also provides an option for Boeing to extend the lease term for five additional two-year periods. Rental income for the three and six months ended December 27, 2002 totaled $196,000 and $327,000 respectively.

Property held for lease consists of the following at December 27, 2002 and June 28, 2002:

	December 27,				June 28,
	2002				2002

Land		$	1,400			$	1,400
Building			5,317				5,317
Project in progress			152				—

			6,869				6,717
Less: Accumulated depreciation			(349	)			(261	)

Property held for lease, net		$	6,520			$	6,456

Future minimum rental income on this operating lease over the non-cancelable period as of December 27, 2002 is as follows:

Fiscal years ending June:
2003	$	393
2004		785
2005		785
2006		327

	$	2,290

Note 8 – Treasury Stock

On October 23, 2002, the Company’s Board of Directors approved a program to repurchase up to $1,000,000 of its Common Stock. The program, which is open ended, allows the Company to repurchase shares on the open market based on market conditions, availability of cash consistent with the Company’s operating plan, and in accordance with the requirements of the Securities and Exchange Commission. Under this program, the Company re-purchased 50,000 shares of its Common Stock in the three months ended December 27, 2002, at a total cost of $49,000.

Note 9 – Related Party Transactions

In September 2002, the company approved providing its President and Chief Executive Officer with additional relocation benefits of approximately $300,000 in connection with the sale of his California residence. In November 2002, the President made a payment of $675,000 against his outstanding notes receivable to the Company.

Note 10 – Subsequent Event

The acquisition will be recorded under the purchase method of accounting, and the purchase price will be allocated based on the fair value of the assets and liabilities acquired. In accordance with generally accepted accounting principles, purchased research and development costs allocated to developed technology will be capitalized and amortized over the respective estimated useful lives. The remaining amounts of purchased research and development will be expensed upon the closing of the transaction. Any goodwill resulting from the acquisition will not be amortized but will be included in the Company’s annual review of goodwill and other intangible assets for impairment. The Company expects to complete the preliminary allocation of the purchase price during the third quarter of fiscal 2003.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The Company provides voice and data network access solutions to service providers and enterprise customers for DDS, T1/E1, NxT1, T3 and G.SHDSL communication services. The Company develops, manufactures and markets customer premise equipment (“CPE”) and central site solutions for data and telecommunication centers. The Company offers a variety of application-specific solutions for time-division multiplexing, inverse multiplexing, digital cross-connect and IP bridging and routing, as well as converged solutions for access to Frame Relay, ATM and IP-based networks. The Company’s customers include equipment integrators, network service providers (“NSPs”) consisting of wireline and wireless providers, inter-exchange carriers (“IXCs”), local exchange carriers (“LECs”), Internet service providers (“ISPs”), enterprise customers, Fortune 500 companies and various local, state and federal government agencies. The Company was founded in California in 1982 and is a Delaware corporation currently headquartered in Madison, Alabama.

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 net sales represented by certain line items from the Condensed Consolidated Statements of Operations for the periods indicated.

	Three months ended						Six months ended

	December 27,			December 28,			December 27,			December 28,
	2002			2001			2002			2001

Net sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales		48.1			70.3			48.1			67.8

Gross profit		51.9			29.7			51.9			32.2

Operating expenses:
Research and development		11.5			26.0			10.5			31.8
Selling, general and administrative		31.8			64.5			28.2			65.6
Asset impairment loss		—			8.9			—			4.7

Total operating expenses		43.3			99.4			38.7			102.1

Income (loss) from operations		8.6			(69.7	)		13.2			(69.9	)
Interest and other income, net		2.0			1.7			1.5			2.6
Interest expense		(0.8	)		(1.2	)		(0.6	)		(1.3	)

Income (loss) before provision for income taxes		9.8			(69.2	)		14.1			(68.6	)
Provision for income taxes		—			—			—			—

Net income (loss) before cumulative change in
accounting principle, relating to goodwill		9.8			(69.2	)		14.1			(68.6	)
Cumulative effect of change in accounting
principle, relating to goodwill		—			—			(8.3	)		—

Net income (loss)		9.8	%		(69.2	)%		5.8	%		(68.6	)%

Sales. Net sales for the three months ended December 27, 2002 decreased slightly to $6,145,000 from $6,187,000 in the comparable period of the prior fiscal year. Net sales of carrier and carrier access products, primarily AS2000 products, increased 37% to $3,650,000 in the three months ended December 27, 2002 from $2,665,000 in the comparable prior year period due to an increase in sales to the Company’s largest customer, which can fluctuate between quarters based upon the timing of its projects. Net sales of enterprise access products declined by 29.1% in the three months ended December 27, 2002 to $2,496,000 from $3,521,000 for the same period last year. This decrease was primarily a result of decreased

spending by our customers, which we believe to be a result of both economic and industry-wide factors, including financial constraints affecting our customers and over-capacity in our customers’ markets. Additionally, this decline also reflects an overall decline in legacy product sales, which has not been offset by an increase in sales of the newer WANsuite products.

Net sales for the six months ended December 27, 2002 increased 26.9% to $14,858,000 from $11,708,000 for the first six months of the prior fiscal year. This increase in net sales for the six-month period ended December 27, 2002 primarily resulted from an increase in sales volume of the Company’s carrier and carrier access product lines, which increased 75.8% to $9,998,000 in the six months ended December 27, 2002 from $5,688,000 in the comparable prior year period. As noted above, this increase in carrier and carrier access product sales is due to an increase in sales to the Company’s largest customer. Net sales of enterprise access products declined by 19.3% in the six months ended December 27, 2002 to $4,861,000 from $6,020,000 for the same period last year. Also as noted above, this decrease reflects decreased spending by our customers due to both economic and industry-wide factors, as well as the overall decline in legacy product sales. The Company anticipates that reduced capital spending by our customers and the decline in legacy product sales will continue to affect sales until an overall recovery in the telecommunications market begins and the sales of WANsuite products gain wider market acceptance. An overall recovery in the telecommunications market is not expected until at least 2004. In any event, it is challenging to forecast future revenue trends in the current environment.

The Company’s business continues to be characterized by a concentration of sales to a limited number of key customers. Net sales to the Company’s top five customers increased 20.8% to $5,184,000 in the three months ended December 27, 2002 from $4,291,000 in the comparable period in the prior year, and increased 71% to $12,658,000 for the six months ended December 27, 2002 from $7,401,000 in the comparable period of the prior year. Net sales to all other customers declined by 49.3% in the three-month period and 48.9% in the six-month period ended December 27, 2002 from the comparable periods in the prior fiscal year. The Company’s top five customers did not remain the same over these periods.

Gross Profit. Gross profit increased to 51.9% of net sales for the three months ended December 27, 2002 as compared to 29.7% for the three months ended December 28, 2001, and increased to 51.9% of sales for the six months ended December 27, 2002 as compared to 32.2% for the same period in the prior year. These increases are primarily attributable to the increased sales volume and the benefit from cost reduction measures enacted during the last two years, including productivity gains and lower fixed manufacturing costs, particularly facilities costs, as well as the impact of provision for inventory reserves. The provision for excess & obsolete inventories decreased to $8,000 for the three months ended December 27, 2002 as compared to $751,000 for the three months ended December 28, 2001, and decreased to $180,000 for the six months ended December 27, 2002 as compared to $899,000 for the same period in the prior year.

Research and Development. Research and development expenditures for the three months ended December 27, 2002 decreased 56.1% to $706,000 from $1,607,000 for the same period in the prior year, and decreased as a percentage of sales from 26.0% to 11.5%. Research and development expenditures for the six months ended December 27, 2002 decreased 58.3% to $1,554,000 from $3,728,000 for the same period in the prior year and decreased as a percentage of sales from 31.8% to 10.5%. These decreases were the result of the suspension of the Company’s optical network access project in October 2001, staff reductions and other cost reduction measures. 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. However, the Company will continue to monitor the level of its investment in research and development activities and adjust spending levels, either upward or downward, based upon anticipated sales volume. The Company currently expects research and development spending to increase in the three months ending March 28, 2003 over the amounts spent in the three months ended December 27, 2002 due primarily to the NAP acquisition discussed below under “Subsequent Event – NAP Acquisition”.

Selling, General and Administrative. Selling, general and administrative expenses for the three months ended December 27, 2002 decreased 51% to $1,956,000 from $3,992,000 in the comparable period in the prior fiscal year and decreased as a percentage of sales from 64.5% to 31.8%. Selling, general and administrative expenses for the six months ended December 27, 2002 decreased 45.4% to $4,189,000 from $7,677,000 in the comparable period in the prior fiscal year and decreased as a percentage of sales from 65.6% to 28.2%. The decrease in absolute dollars over the same period in the prior year is primarily due to reduced headcount between the two periods and other cost reduction measures implemented by the Company in fiscal 2002 and 2003. The significant decrease as a percentage of sales is due to lower spending on increased sales dollars. The Company expects that selling, general and administrative expenses will vary over time as a percentage of sales, and expects total spending to increase in the three months ending March 28, 2003 with the NAP acquisition mentioned above.

Amortization of goodwill and other intangible assets in the three months ended December 27, 2002 and December 28, 2001 was $75,600 and $232,000, respectively. Amortization of goodwill and other intangible assets in the six months ended December 27, 2002 and December 28, 2001 was $151,200 and $484,000, respectively. Amortization for the three and six months ended December 28, 2001 included $116,400 and $233,800 related to goodwill and assembled work force. As of June 29, 2002, the Company adopted SFAS No. 142 and completed the transitional impairment test of its goodwill. As a result, the Company determined that its goodwill was impaired and recorded a charge of $1,232,900 in the quarter ended September 27, 2002. This charge is presented in the condensed consolidated statement of operations as a cumulative effect of change in accounting principle, relating to goodwill.

Interest and Other Income, Net, and Interest Expense. Interest and other income, net, increased 18.4% to $122,000 for the three months ended December 27, 2002 from $103,000 in the comparable period in the prior fiscal year. Interest and other income, net, decreased 26.3% to $224,000 for the six months ended December 27, 2002 from $304,000 in the comparable period in the prior fiscal year. This decline was a result of lower interest rates and lower average interest bearing assets. Rental income, net of expenses, of $138,000 and $179,000 for the three and six months ended December 27, 2002, respectively, is included in interest and other income, net, as a result of the lease agreement signed with Boeing. See Note 7 of Notes to Condensed Consolidated Financial Statements for additional information on the Boeing lease.

Interest expense declined 33.8% to $47,000 for the three months ended December 27, 2002 from $71,000 in the same period in the prior fiscal year and declined 36.3% to $100,000 from $157,000 for the six months ended December 27, 2002. These decreases are a result of lower interest rates and the lower principal balance on the Company’s debt obligations.

Provision for Income Taxes. No tax provision or tax benefits were provided in the three or six months ended December 27, 2002 or December 28, 2001 due to the valuation allowance provided against the net change in deferred tax assets. During fiscal 2001, the Company established a full valuation allowance against its deferred tax assets due to the net operating loss carryforwards from prior years and the operating loss incurred in fiscal 2001. The Company does not expect to recognize a provision for income taxes in the current year due to its net operating loss carryforwards that totaled approximately $34,500,000 at June 28, 2002.

LIQUIDITY AND CAPITAL RESOURCES

On December 27, 2002, the Company’s principal sources of liquidity included $9,790,000 of unrestricted cash, cash equivalents and short-term investments.

During the six months ended December 27, 2002, cash provided by operating activities was $3,612,000 compared to $6,223,000 used in operating activities during the six months ended December 28, 2001. Net cash provided by operating activities this period was due to income before depreciation, amortization and the cumulative effect of change in accounting principle, which totaled $2,650,000. The decrease in accounts receivable provided cash of $2,466,000 in the six months ended December 27, 2002 compared to $971,000 provided in the comparable period in the prior fiscal year. The increase in inventories for the six months ended December 27, 2002 used $627,000 of cash compared to $1,020,000 of cash provided in the same period last year. Inventories increased during the six months ended December 27, 2002 due to inventory purchases related to the transfer of manufacturing of its AS2000 products from an outside electronics manufacturing services provider to the Company’s facility in Madison, Alabama, which the Company completed during the quarter ended December 27, 2002. Accounts payable and accrued expenses decreased $781,000 in the six-month period ended December 27, 2002 compared to a decrease of $2,177,000 in the comparable period in the prior fiscal year. The changes in accounts payable and accrued expenses for the six months ended December 27, 2002 and the comparable prior year period were primarily due to the timing of inventory purchases and the resulting payments to vendors.

Cash provided by investing activities was $178,000 for the six months ended December 27, 2002 compared to $169,000 used for the six months ended December 28, 2001. The funds provided by investing activities during the six months ended December 27, 2002 are a result of the maturity of short-term investments of $497,000 and proceeds from the repayment of notes receivable of $150,000 reduced by capital expenditures of $469,000. For the six months ended December 28, 2001, cash was used to purchase short-term investments of $72,000 and property, plant and equipment of $97,000.

Cash provided by financing activities was $269,000 for the six months ended December 27, 2002 as compared to cash used in financing activities of $351,000 for the six months ended December 28, 2001. Payments on long-term debt obligations were $361,000 and $358,000 for the six months ended December 27, 2002 and December 28, 2001, respectively. Proceeds from the issuance of Common Stock under the Company’s stock plans provided $3,000 of cash in the current year and $11,000 in the prior fiscal year. Repayment of notes from stockholders provided $675,000 in the six months ended December 27, 2002 (See Note 9 of Notes to Condensed Consolidated Financial Statements).

In October 2002, the Company’s Board of Directors approved a program to repurchase up to $1,000,000 of its Common Stock. The program, which is open ended, allows the Company to repurchase shares on the open market based on market conditions, availability of cash consistent with the Company’s operating plan, and in accordance with the requirements of the Securities and Exchange Commission. Under this program, the Company re-purchased 50,000 shares of its Common Stock in the three months ended December 27, 2002, at a total cost of $49,000.

The Company believes that its cash and investment balances, along with anticipated cash flows from operations based upon current operating plans will be adequate to finance the Company’s operations, capital expenditures, research and development programs and stock repurchase program for at least the next twelve months. The Company’s future capital needs will depend on the Company’s ability to meet its current operating forecast, market demand for the Company’s products and the overall economic condition of our customers in the telecommunication sector. In the event that results of operations do not substantially meet the Company’s current operating forecast, the Company may evaluate further cost containment measures, reduce investments or delay R&D, which could adversely affect the Company’s ability to bring new products to market. The Company from time to time investigates the possibility of generating financial resources through committed credit agreements, technology or manufacturing partnerships, joint ventures, equipment financing and offerings of debt and equity securities.

SUBSEQUENT EVENT – NAP ACQUISITION

On January 29, 2003, the Company announced that it signed a purchase agreement to acquire the net assets used in and directly relating to Polycom, Inc.’s network access product line (“NAP”) for up to $3 million in cash. The NAP product line consists of the NetEngine family of IADs (integrated access devices) and routers that enable enterprise customers to access broadband and voice over broadband (“VoB”) services. NAP products support a wide range of broadband transmission standards and end user requirements, and are interoperable with the products of a variety of leading broadband equipment vendors. Verilink paid Polycom $1 million at the closing of the agreement and will pay an additional $250,000 upon the one-year anniversary of the closing and up to $1.75 million in quarterly installments based upon 10 percent of the sales of NetEngine products. In addition, Verilink has agreed to purchase Polycom’s NetEngine related inventories on an as-needed basis. The value of such inventory as of the closing date is approximately $1.9 million. Acquisition-related costs are expected to impact results and cash flow in the near term, and the Company’s overall gross margins in future periods can be expected to decline as a result of the acquisition.

Critical Accounting Policies

The Company’s financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States of America. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods might be based upon amounts that differ from those estimates. The following represent what the Company believes are among the critical accounting policies most affected by significant management estimates and judgments:

Impairment of Long-Lived Assets and Goodwill. The Company assesses the impairment of long-lived assets and goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable under the guidance prescribed by SFAS No. 144. The Company’s long-lived assets include, but are not limited to, the facility located at 950 Explorer Boulevard, related furniture and equipment, software licenses, goodwill and intangible assets related to an acquisition.

In assessing the recoverability of the Company’s long-lived assets, the Company obtained a third-party appraisal during fiscal 2002 for its facility located at 950 Explorer Boulevard, and made assumptions regarding future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, the Company may be required to record impairment charges for these assets not previously recorded. On June 29, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, and completed the analysis of its goodwill for impairment. The Company recorded an impairment charge of $1,232,900 during the three months ended September 27, 2002 related to goodwill.

Inventories. The Company values inventory at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis. Inventory quantities on hand are reviewed on a quarterly basis and a provision for excess and obsolete inventory is recorded based primarily on our estimated forecast of product demand for the next twelve months. Management’s estimates of future product demand may prove to be inaccurate, in which case the Company may increase or decrease the provision required for excess and obsolete inventory in future periods.

Revenue Recognition. The Company recognizes a sale when the product has been shipped, no material vendor or post-contract support obligations remain outstanding, except as provided by a separate service agreement, and collection of the resulting receivable is probable. A reserve for future product returns is established at the time of the sale based on historical return rates and return policies, including stock rotation for sales to distributors that stock the Company’s products.

Warranty Provision. The Company records a warranty provision at the time of the sale based on our best estimate of the amounts necessary to settle future claims on products sold. While we believe that our warranty reserve is adequate and that the judgment applied is appropriate, actual product failure rates, material usage or other rework costs could differ from our estimates, which could result in revisions to our warranty liability.

Allowance for Doubtful Accounts. The Company estimates losses resulted from the inability of our customers to make payments for amounts billed. The collectability of outstanding invoices is continually assessed. Assumptions are made regarding the customer’s ability and intent to pay, and are based on historical trends, general economic conditions and current customer data. Should our actual experience with respect to collections differ from these assessments, there could be adjustments to our allowance for doubtful accounts.

Valuation of Notes Receivable. The Company continually assesses the collectability of assets classified as outstanding notes receivable. Assumptions are made regarding the counter party’s ability and intent to pay and are based on historical trends and general economic conditions, and current data. Should our actual experience with respect to collections differ from our initial assessment, adjustments in the reserves may be needed.

Deferred Tax Assets. The Company has provided a full valuation reserve related to its deferred tax assets. In the future, if sufficient evidence of the Company’s ability to generate sufficient future taxable income in certain tax jurisdictions becomes apparent, the Company may be required to reduce its valuation allowances, resulting in income tax benefits in the Company’s consolidated statement of operations. Management evaluates the realizability of the deferred tax assets and assesses the need for the valuation allowance each quarter.

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 anticipated reduced capital spending by the Company’s customers; the expected increase in research and development expenses; a significant level of investment in product development; 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 the Company’s Annual Report on Form 10-K.

Dependence on Legacy Products, 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 WANsuite family of integrated access devices and new integrated access system products in development. The majority of sales continue to be provided by the Company’s legacy products, primarily the AS2000 product line which represented approximately 53% of net sales in fiscal 2002, 61% of net sales in fiscal 2001 and 58% of net sales in fiscal 2000. Sales of WANsuite products represented approximately 8% and 2% of net sales in fiscal 2002 and 2001, respectively. The Company anticipates that net sales of its legacy products will continue to shrink as newly introduced products by the Company and its competitors capture market share.

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 and systems in general, the availability and price of competing products and technologies, and the success of the Company’s sales and marketing 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.

Risks Associated With Acquisitions, Potential Acquisitions and Joint Ventures. An important element of the Company’s historical strategy has been to review acquisition prospects and joint venture opportunities that would complement its existing product offerings, augment its market coverage, enhance its technological capabilities or offer growth opportunities. As noted above, on January 29, 2003, the Company announced that it signed a purchase agreement to acquire the net assets used in and directly relating to Polycom, Inc.’s network access product line (“NAP”) for up to $3 million in cash. Transactions of this nature by the Company could result in potentially dilutive issuance of equity securities, use of cash and/or the incurring of debt and the assumption of contingent liabilities, any of which could have a material adverse effect on the Company’s business and operating results and/or the price of the Company’s Common Stock. Acquisitions entail numerous risks, including difficulties in the assimilation of acquired operations, technologies and products, diversion of management’s attention from other business concerns, risks of entering markets in which the Company has limited or no prior experience and potential loss of key employees of acquired organizations. Joint ventures entail risks such as potential conflicts of interest and disputes among the participants, difficulties in integrating technologies and personnel, and risks of entering new markets. The Company’s management has limited prior experience in assimilating such transactions. No assurance can be given as to the ability of the Company to successfully integrate the businesses, products, technologies or personnel acquired in the NAP acquisition or those of other entities that may 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. The failure of the Company to integrate the NAP acquisition or to integrate future potential acquisitions could have a material adverse effect on the Company’s business, financial condition and results of operations.

Customer Concentration. A small number of customers continue to account for a majority of the Company’s sales. In fiscal 2002, net sales to Nortel Networks and Interlink Communications Systems accounted for 36% and 15% of the

Company’s net sales, respectively, and the Company’s top five customers accounted for 71% of the Company’s net sales. In fiscal 2001, net sales to Nortel Networks accounted for 37% of the Company’s net sales, and net sales to the Company’s top five customers accounted for 66% of the Company’s net sales. In fiscal 2000, net sales to Nortel Networks and WorldCom accounted for 30% and 19% of the Company’s net sales, respectively, and net sales to the Company’s top five customers accounted for 61% of the Company’s net sales. Other than Nortel Networks, Interlink Communications Systems and WorldCom, no customer accounted for more than 10% of the Company’s net sales in fiscal years 2002, 2001 or 2000. On a quarterly basis in fiscal 2002, net sales to Nortel Networks of legacy products has accounted for as much as 64% of the Company’s net sales that quarter. There can be no assurance that the Company’s current customers will continue to place orders with the Company, that orders by existing customers will continue at the levels of previous periods, or that the Company will be able to obtain orders from new customers. The economic climate and conditions in the telecommunication equipment industry are expected to remain unpredictable in fiscal 2003 and 2004. WorldCom filed a bankruptcy petition under Chapter 11 of the Bankruptcy Code in July 2002. A bankruptcy filing by one or more of the Company’s other major customers would materially adversely affect the Company’s business, financial condition and results of operations.

Certain customers of the Company have been or may be acquired by other existing customers. The impact of such acquisitions on net sales to such customers is uncertain, but there can be no assurance that such acquisitions will not result in a reduction in net sales to those customers. In addition, such acquisitions could have in the past and could in the future, result in further concentration of the Company’s customers. The Company has in the past experienced significant declines in net sales it believes were in part related to orders being delayed or cancelled as a result of pending acquisitions relating to its customers. There can be no assurance that future merger and acquisition activity among the Company’s customers will not have a similar adverse affect on the Company’s net sales and results of operations. The Company’s customers are typically not contractually obligated to purchase any quantity of products in any particular period. Product sales to major customers have varied widely from period to period. In some cases, major customers have abruptly terminated purchases of the Company’s products. Loss of, or a material reduction in orders by, one or more of the Company’s major customers would materially adversely affect the Company’s business, financial condition and results of operations. See “Competition” and “Fluctuations in Quarterly Operating Results”.

Dependence on Key Personnel. The Company’s future success will depend to a large extent on the continued contributions of its executive officers and key management, sales, and technical personnel. The Company is a party to agreements with its executive officers to help ensure the officer’s continual service to the Company in the event of a change-in-control. Each of the Company’s executive officers, and key management, sales and technical personnel would be difficult to replace. The Company implemented significant cost and staff reductions during fiscal 2002, which may make it more difficult to attract and retain key personnel. The loss of the services of one or more of the Company’s executive officers or key personnel, or the inability to attract qualified personnel could delay product development cycles or otherwise could have a material adverse effect on the Company’s business, financial condition and results of operations.

Dependence on Key Suppliers and Component Availability. The Company generally relies upon contract manufacturers to buy finished goods for certain product families and component parts that are incorporated into board assemblies used in its products. On-time delivery of the Company’s products depends upon the availability of components and subsystems used in its products. Currently, the Company and third party sub-contractors depend upon suppliers to manufacture, assemble and deliver components in a timely and satisfactory manner. The Company has historically obtained several components and licenses for certain embedded software from single or limited sources. There can be no assurance that these suppliers will continue to be able and willing to meet the Company and third party sub-contractors requirements for any such components. The Company and third party sub-contractors generally do not have any long-term contracts with such suppliers, other than software vendors. Any significant interruption in the supply of, or degradation in the quality of, any such item could have a material adverse effect on the Company’s results of operations. Any loss in a key supplier, increase in required lead times, increase in prices of component parts, interruption in the supply of any of these components, or the inability of the Company or its third party sub-contractor to procure these components from alternative sources at acceptable prices and within a reasonable time, could have a material adverse effect upon the Company’s business, financial condition and results of operations.

The loss of any of the Company’s outside contractors could cause a delay in the Company’s ability to fulfill orders while the Company identifies a replacement contractor. Because the establishment of new manufacturing relationships involves numerous uncertainties, including those relating to payment terms, cost of manufacturing, adequacy of manufacturing capacity, quality control, and timeliness of delivery, the Company is unable to predict whether such relationships would be on

terms that the Company regards as satisfactory. Any significant disruption in the Company’s relationships with its manufacturing sources would have a material adverse effect on the Company’s business, financial condition, and results of operations.

Purchase orders from the Company’s customers frequently require delivery quickly after placement of the order. As the Company does not maintain significant component inventories, delay in shipment by a supplier could lead to lost sales. The Company uses internal forecasts to manage its general materials and components requirements. Lead times for materials and components may vary significantly, and depend on factors such as specific supplier performance, contract terms, and general market demand for components. If orders vary from forecasts, the Company may experience excess or inadequate inventory of certain materials and components, and suppliers may demand longer lead times, higher prices or termination of contracts. From time to time, the Company has experienced shortages and allocations of certain components, resulting in delays in fulfillment of customer orders. Such shortages and allocations may occur in the future, and could have a material adverse effect on the Company’s business, financial condition and results of operations. See “Fluctuations in Quarterly Operating Results”.

Fluctuations in Quarterly Operating Results. The Company’s sales are subject to quarterly and annual fluctuations due to a number of factors resulting in more variability and less predictability in the Company’s quarter-to-quarter sales and operating results. For example, sales to Nortel Networks during fiscal 2002 and 2001 have varied between quarters by as much as $6.2 million, and order volatility by this customer had a significant impact on the Company in fiscal 2002. 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. The Company believes that sales in the past have been adversely impacted by merger activities by some of its top customers. In addition, the Company has experienced delays as a result of the need to modify its products to comply with unique customer specifications. These and similar delays or lost sales could materially adversely affect the Company’s business, financial condition and results of operations. See “Customer Concentration” and “Dependence on Key Suppliers and Component Availability”.

The Company’s backlog at the beginning of each quarter typically is not sufficient to achieve expected sales for that quarter. To achieve its sales objectives, the Company is dependent upon obtaining orders in a quarter for shipment in that quarter. Furthermore, the Company’s agreements with certain of 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 in certain periods. These reductions, in turn, could cause fluctuations in the Company’s operating results and could have an adverse effect on the Company’s business, financial condition and results of operations in the periods in which the inventory is reduced.

The Company’s industry is characterized by declining prices of existing products, and therefore continual improvement of manufacturing efficiencies and introduction of new products and enhancements to existing products are required to maintain gross margins. In response to customer demands or competitive pressures, or to pursue new product or market opportunities, the Company may take certain pricing or marketing actions, such as price reductions, volume discounts, or provision of services at below-market rates. These actions could materially and adversely affect the Company’s operating results.

Operating results may also fluctuate due to a variety of factors, particularly:

delays in new product introductions by the Company;
market acceptance of new or enhanced versions of the Company’s products;
changes in the product or customer mix of sales;
changes in the level of operating expenses;
competitive pricing pressures;
the gain or loss of significant customers;
increased research and development and sales and marketing expenses associated with new product introductions; and
general economic conditions.

All of the above factors are difficult for the Company to forecast, and these or other factors can materially and adversely affect the Company’s business, financial condition and results of operations for one quarter or a series of quarters. The Company’s expense levels are based in part on its expectations regarding future sales and are fixed in the short term to a certain 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 in the past and may continue to do so.

Competition. The market for telecommunications network access equipment is characterized as highly competitive with price erosions on aging technologies. This market, in the past, has been subject to rapid technological change, regulatory developments and new entrants. The market for integrated access devices, such as the Access System 2000 and WANsuite product lines, and for enterprise termination devices, such as the PRISM 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 products based on new technologies, high product value in price versus performance comparisons, support for multiple types of communication services, increased network monitoring and control, product reliability, and quality of customer support. There can be no assurance that the Company’s current products and future products will be able to compete successfully with respect to these or other factors.

The Company’s principal competition for its current product offerings are Adtran, Inc., Paradyne Inc., Kentrox (owned by Platinum Equity Holdings), Vina Technologies, Inc., Quick Eagle Networks, Larscom, Inc. and Cisco Systems, Inc. for access routing with integrated WAN interface cards (WIC’s). Industry consolidation could lead to competition with fewer, but stronger competitors. 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, s uch as Cisco, Lucent Technologies, Inc. and Nortel Networks, into other equipment such as routers and switches. These include direct WAN interfaces in certain products, which may erode the addressable market for separate network termination products. To the extent that current or potential competitors can expand

their current offerings to include products that have functionality similar to the Company’s products and planned products, the Company’s business, financial condition and results of operations could be materially adversely affected.

The Company believes that the market for basic network termination products is mature and that margins are eroding, but the market for feature-enhanced network termination and high bandwidth network access products may continue to grow and expand, as more “capability” and “intelligence” moves outward from the central office to the enterprise. The Company expects emerging broadband standards and technologies like G.SHDSL, ATM, Ethernet and IP Services to start the next wave of spending in this market as carriers and enterprises update services to the network edge.

Many of the Company’s current and potential competitors have substantially greater technical, financial, manufacturing and marketing resources than the Company. In addition, many of the Company’s competitors have long-established relationships with network service providers. There can be no assurance that the Company will have the financial resources, technical expertise, manufacturing, marketing, distribution and support capabilities to compete successfully in the future. See “Factors Affecting Future Results — Competition”.

Rapid Technological Change. The network access and telecommunications equipment markets are characterized by rapidly changing technologies and frequent new product introductions. The rapid development of new technologies increases the risk that current or new competitors could develop products that would reduce the competitiveness of the Company’s products. The Company’s success will depend to a substantial degree upon its ability to respond to changes in technology and customer requirements. This will require the timely selection, development and marketing of new products and enhancements on a cost-effective basis. The development of new, technologically advanced products is a complex and uncertain process, requiring high levels of innovation. The Company may need to supplement its internal expertise and resources with specialized expertise or intellectual property from third parties to develop new products. The development of new products for the WAN access market requires competence in the general areas of telephony, data networking, network management and wireless telephony as well as specific technologies such as DSL, ISDN, Frame Relay, ATM and IP.

Furthermore, the communications industry is characterized by the need to design products that meet industry standards for safety, emissions and network interconnection. With new and emerging technologies and service offerings from network service providers, such standards are often changing or unavailable. As a result, there is a potential for product development delays due to the need for compliance with new or modified standards. The introduction of new and enhanced products also requires that the Company manage transitions from older products in order to minimize disruptions in customer orders, avoid excess inventory of old products and ensure that adequate supplies of new products can be delivered to meet customer orders. There can be no assurance that the Company will be successful in developing, introducing or managing the transition to new or enhanced products, or that any such products will be responsive to technological changes or will gain market acceptance. The Company’s business, financial condition and results of operations would be materially adversely affected if the Company were to be unsuccessful, or to incur significant delays in developing and introducing such new products or enhancements. See “Dependence on Recently Introduced Products and New Product Development”.

Compliance with Regulations and Evolving Industry Standards. The market for the Company’s products is characterized by the need to meet a significant number of communications regulations and standards, some of which are evolving as new technologies are deployed. In the United States, the Company’s products must comply with various regulations defined by the Federal Communications Commission and standards established by Underwriters Laboratories and Bell Communications Research. For some public carrier services, installed equipment does not fully comply with current industry standards, and this noncompliance must be addressed in the design of the Company’s products. Standards for new services such as Frame Relay, performance monitoring services and DSL have evolved, such as the G.SHDSL standard. As standards continue to 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 with the acquisition of the NAP products in January 2003, 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.

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 or WANsuite technologies. There can be no assurance that third parties have not or will not develop equivalent technologies or products without infringing the Company’s patents or that a court having jurisdiction over a dispute involving such patents would hold the Company’s patents valid, enforceable and infringed. The Company also typically enters into confidentiality and invention assignment agreements with its employees and independent contractors, and non-disclosure agreements with its suppliers, distributors and appropriate customers so as to limit access to and disclosure of its proprietary information. There can be no assurance that these statutory and contractual arrangements will deter misappropriation of the Company’s technologies or discourage independent third-party development of similar technologies. In the event such arrangements are insufficient, the Company’s business, financial condition and results of operations could be materially adversely affected. The laws of certain foreign countries in which the Company’s products are or may be developed, manufactured or sold may not protect the

Company’s products or intellectual property rights to the same extent as do the laws of the United States and thus, make the possibility of misappropriation of the Company’s technology and products more likely.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

At December 27, 2002, the Company’s investment portfolio consisted of fixed income securities of $101,000. These securities, like all fixed income instruments, are subject to interest rate risk and will decline in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels as of December 27, 2002, 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 its cash balances in excess of operating requirements in short-term securities, generally with maturities of 90 days or less.

The Company is subject to interest rate risks on its long-term debt. If market interest rates were to increase immediately and uniformly by 10% from levels as of December 27, 2002, the additional interest expense would not be material. The Company believes that the effect, if any, of reasonably possible near-term changes in interest rates on the Company’s financial position, results of operations and cash flows would not be material.

Item 4. Controls and Procedures.

(a) Within 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Executive Officer, and Vice President and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company’s President and Chief Executive Officer, and Vice President and Chief Financial Officer, have concluded that the Company’s disclosure controls and procedures are effective.

(b) There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

PART II. OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

(a)	The Annual Meeting of Stockholders of the Company was held on November 13, 2002 (the “Annual Meeting”). The voting of holders of record of 14,996,747 shares of the Company’s Common Stock outstanding at the close of business on September 30, 2002 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 III Directors of the Company at the Annual Meeting:

		Votes
		Withholding
Class III Director	Votes For	Authority
Leigh S. Belden	13,656,434	1,047,979
Steven C. Taylor	13,668,095	1,036,318

	The following Directors’ terms of office as Director continued after the meeting: Howard Oringer, John E. Major and John A. McGuire.

(c)	The amendment to the Company’s Amended and Restated Certificate of Incorporation to effect a 1-for-5 reverse stock split of all the issued and outstanding Common Stock of the Company was approved. The stockholders’ vote

	on this amendment was 14,135,249 shares FOR; 482,615 shares AGAINST; 86,549 shares ABSTAINED from voting; and 0 shares NO VOTE.

(d)	The approval of the Company’s 2002 Stock Incentive Plan and the reserve of 2,500,000 shares for Common Stock for issuance under the plan (before giving effect to the proposed one-for-five reverse stock split) were ratified. The stockholders’ vote on the plan was 7,200,698 shares FOR; 1,603,434 shares AGAINST; 102,949 shares ABSTAINED from voting; and 5,797,332 shares BROKER NON-VOTE.

(e)	The appointment of PricewaterhouseCoopers LLP as the Company’s independent certified public accountants for fiscal year 2003 was ratified. The stockholders’ vote on such appointment was 14,613,481 shares FOR; 22,242 shares AGAINST; 68,690 shares ABSTAINED from voting; and 0 shares NO VOTE.

Item 5. Other Information

On January 29, 2003, the Company announced that it signed a purchase agreement to acquire the net assets used in and directly relating to Polycom, Inc.’s network access product line for up to $3 million in cash. See Note 10 of Notes to Condensed Consolidated Financial Statements and “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Subsequent Event – NAP Acquisition.”

Item 6. Exhibits and Reports on Form 8-K

(a)	Exhibits Index:

	Exhibit Number	Description of Exhibit

	2.1	Asset Purchase Agreement by and between the Registrant and Polycom, Inc.
		dated as of January 28, 2003 (exhibits and schedules omitted, but will be
		furnished supplementally to the Securities and Exchange Commission upon
		request)

	99.1	Certification of Chief Executive Officer and Chief Financial Officer, Pursuant to
		18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-
		Oxley Act of 2002

	99.2	Certification of Chief Executive Officer and Chief Financial Officer, Pursuant to
		18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-
		Oxley Act of 2002


(b)	No reports on Form 8-K were filed during the quarter ended December 27, 2002.

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 7, 2003	By:	/s/	C. W. SMITH

			C. W. SMITH
			Vice President and Chief Financial Officer
			(Principal Financial and Accounting Officer)

CERTIFICATIONS

I, Leigh S. Belden, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of the registrant;

2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.	Based on my knowledge, the financial statements and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d- 14) for the registrant and we have:

	(a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

	(b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

	(c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.	The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the board of directors (or persons fulfilling the equivalent function):

	(a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	(b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.	The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.



Date: February 7, 2003
	By:	/s/	LEIGH S. BELDEN

			Leigh S. Belden
			President and Chief Executive Officer
			(Principal Executive Officer))

I, C. W. Smith, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of the registrant;

2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.	Based on my knowledge, the financial statements and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d- 14) for the registrant and we have:

	(a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

	(b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

	(c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.	The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the board of directors (or persons fulfilling the equivalent function):

	(a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	(b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.	The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.




Date: February 7, 2003
	By:	/s/	C. W. SMITH

			C. W. SMITH
			Vice President and Chief Financial Officer
			(Principal Financial and Accounting Officer)

EX-2 3 ex2-1.txt Exhibit 2.1 ASSET PURCHASE AGREEMENT By and Between VERILINK CORPORATION and POLYCOM, INC. January 28, 2003 TABLE OF CONTENTS Page ARTICLE 1 PURCHASE AND SALE..................................................1 1.1 Purchase and Sale of Assets....................................1 1.2 Delivery of Acquired Assets....................................1 1.3 Closing Deliveries by Seller and Buyer.........................1 1.4 Transferred Contracts..........................................2 1.5 Assumed Liabilities............................................2 1.6 Excluded Liabilities...........................................2 1.7 Closing........................................................2 1.8 Payment to Seller..............................................2 ARTICLE 2 REPRESENTATIONS AND WARRANTIES OF SELLER...........................4 2.1 Organization of Seller.........................................4 2.2 Authority......................................................4 2.3 No Conflict....................................................4 2.4 Transferred Contracts..........................................5 2.5 Consents.......................................................5 2.6 Title to Properties; Absence of Liens and Encumbrances.........5 2.7 Litigation.....................................................5 2.8 Compliance With Law............................................5 2.9 Intellectual Property..........................................5 2.10 Adequacy of Certain Acquired Assets............................6 2.11 Inventory......................................................6 ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF BUYER............................7 3.1 Organization of Buyer..........................................7 3.2 Authority......................................................7 3.3 No Conflict....................................................8 3.4 Consents.......................................................8 3.5 Compliance with Laws...........................................8 ARTICLE 4 COVENANTS AND AGREEMENTS...........................................8 4.1 Additional Documents and Further Assurances....................8 4.2 Confidentiality................................................9 4.3 Sales Taxes....................................................9 4.4 Taxes..........................................................9 4.5 Bulk Sales.....................................................9 4.6 Employee Matters..............................................10 4.7 Inventory.....................................................10 4.8 Assumed Liabilities...........................................13 4.9 Accounts Receivable...........................................13 4.10 Conduct of Business...........................................13 TABLE OF CONTENTS (continued) Page 4.11 Clear Permitted Liens..........................................14 4.12 Covenant Not to Compete........................................14 4.13 No Solicitation................................................14 4.14 Transition Services Agreement..................................15 4.15 Service Reimbursement..........................................15 ARTICLE 5 SURVIVAL OF REPRESENTATIONS, WARRANTIES AND COVENANTS; INDEMNIFICATION........................................................15 5.1 Survival of Representations, Warranties and Covenants..........15 5.2 Indemnification................................................15 5.3 Limitation on Liability........................................17 5.4 Exclusive Remedy...............................................18 ARTICLE 6 GENERAL............................................................18 6.1 Notices........................................................18 6.2 Entire Agreement; Assignment...................................19 6.3 Severability...................................................19 6.4 Amendment......................................................20 6.5 Extension; Waiver..............................................20 6.6 Dispute Resolution and Applicable Law..........................20 6.7 Rules of Construction..........................................21 6.8 Fees and Expenses..............................................21 6.9 Capitalized Terms..............................................21 6.10 Construction...................................................25 6.11 NO WARRANTY ON ACQUIRED ASSETS.................................25 6.12 Counterparts...................................................26 EXHIBITS Exhibit A............................Assignment and Assumption Agreement Exhibit B............................Bill of Sale and General Assignment Exhibit C..............................................License Agreement Exhibit D..................................Transition Services Agreement Exhibit E............................................Disclosure Schedule ASSET PURCHASE AGREEMENT THIS ASSET PURCHASE AGREEMENT (this "Agreement"), is made and entered into as of January 28, 2003, by and between Verilink Corporation, a Delaware corporation ("Buyer"), and Polycom, Inc., a Delaware corporation ("Seller"). Capitalized terms used but not otherwise defined herein shall have the meanings ascribed to them in Section 6.9 hereof. RECITALS: A. Buyer desires to purchase from Seller, and Seller desires to sell to Buyer, the assets of Seller specified below in exchange for the assumption of certain liabilities of Seller by Buyer and other consideration, all as set forth below (the "Acquisition"). B. The Board of Directors of each of Buyer and Seller, respectively, believe the Acquisition is in the best interests of such company and its respective shareholders and, in furtherance thereof, have approved this Agreement and the transactions contemplated thereby. NOW, THEREFORE, in consideration of the covenants, representations, warranties and mutual agreements hereinafter set forth, the parties hereto agree as follows: ARTICLE 1 PURCHASE AND SALE 1.1 Purchase and Sale of Assets. Subject to the terms and conditions set forth in this Agreement, Seller hereby agrees to sell, convey, transfer and assign to Buyer, and Buyer hereby agrees to purchase from Seller at the Closing all of Seller's right, title and interest in and to the Transferred Tangible Assets, the Transferred Technology, the Transferred Intellectual Property Rights and the Transferred Contracts, free and clear of any and all Liens, except Permitted Liens (collectively, the "Acquired Assets"). 1.2 Delivery of Acquired Assets. On the Closing Date and for a reasonable time thereafter, Seller shall make available to Buyer all of the Acquired Assets at Seller's facilities in Goleta, California, and anywhere else the Acquired Assets are located. 1.3 Closing Deliveries by Seller and Buyer. Without limiting the foregoing, at the Closing, (i) Buyer and Seller shall execute and deliver to each other the Assignment and Assumption Agreement substantially in the form attached hereto as Exhibit A (the "Assignment and Assumption Agreement"), (ii) Seller shall deliver to Buyer, duly executed by Seller, a Bill of Sale and General Assignment substantially in the form attached hereto as Exhibit B (the "Bill of Sale"), (iii) Buyer and Seller shall execute and deliver to each other a License Agreement in substantially the form attached hereto as Exhibit C (the "License Agreement"), and (vi) Buyer and Seller shall execute and deliver to each other a Transition Services Agreement in substantially the form attached hereto as Exhibit D (the "Transition Services Agreement") (the instruments referred to in this Section being referred to herein as the "Ancillary Agreements"). 1.4 Transferred Contracts. As of the date hereof: (i) Seller has transferred and assigned to Buyer all of the Transferred Contracts specifically set forth on Schedule 6.9(z) hereto; and (ii) for each Transferred Contract listed on Schedule 6.9(z) hereto, Seller has delivered to Buyer a written agreement signed by the party or parties (other than Seller) to such Transferred Contract pursuant to which such party or parties thereto consents to the transfer and assignment of such Transferred Contract to Buyer. 1.5 Assumed Liabilities. As of the Closing, Buyer hereby agrees to (a) assume all obligations arising out of or relating to sales and purchase orders for Products existing as of the date hereof, (b) assume all obligations arising out of or relating to repair, replacement, service and other warranty and support liabilities for Products existing as of the date hereof, and (c) to be responsible for all obligations with respect to any Claims relating to the Transferred Employees and any Claims relating to Products (including without limitation product liability Claims) that accrue following the Closing Date (collectively, the "Assumed Liabilities"). 1.6 Excluded Liabilities. Except for the Assumed Liabilities, Buyer shall not assume or shall not be responsible for, and the Assumed Liabilities shall expressly exclude, any debt, liability, duty or obligation, whether fixed or contingent, of Seller, including without limitation Seller's obligations arising out of or relating to the facilities in Goleta, California and any employee Claims or product liability Claims which accrue prior to the date hereof (the "Excluded Liabilities"). 1.7 Closing. The closing of the transactions contemplated by this Agreement (the "Closing") shall take place concurrently with the execution hereof to be held at the offices of Wilson Sonsini Goodrich & Rosati at 650 Page Mill Road, Palo Alto, California (the "Closing Date"). 1.8 Payment to Seller. (a) Payment of Purchase Price. The aggregate cash purchase price to be paid by Buyer to Seller for the Acquired Assets (the "Purchase Price") shall be up to Three Million Dollars ($3,000,000) to be paid by Buyer to Seller according to the following schedule: (i) $1,000,000 on the Closing Date, (ii) $250,000 on the one year anniversary of the Closing Date, and (iii) $1,750,000 to be paid according to Section 1.8(b). Buyer shall make each such payment to Seller by electronic funds transfer, such sum in immediately available funds in U.S. Dollars to an account or accounts designated by Seller. (b) Earnout Payments. (i) Payments. Subject to the provisions of Section 1.8(b)(ii) below, Buyer shall make quarterly payments to Seller in an amount equal to the Earnout Net Revenues multiplied by 0.10 for each Earnout Period until the sum of all quarterly payments equals $1,750,000; provided, however, that Buyer's payment in the final Earnout Period under this Section 1.8(b) may be in an amount less than the Earnout Net Revenues multiplied by 0.10, so long as the sum of all quarterly payments equals $1,750,000. Buyer shall make such quarterly payments no later than 45 days following the termination of each Earnout Period. -2- (ii) Offset. Seller agrees that Buyer shall have the right to offset any amounts payable by Buyer to Seller pursuant to this Section 1.8(b) following the Closing Date for any matter for which indemnification would be available to Buyer under Article 5 hereof and as set forth in Sections 4.4(a) and 4.11 herein below. (iii) Determination of Earnout. Buyer shall deliver to Seller as soon as practicable, and in any event no later than 45 days after the end of each Earnout Period, written notice (the "Earnout Notice") setting forth (i) the computation of the amount of the earnout for that Earnout Period, and (ii) a copy of the financial information used in making such computation. Buyer shall be required to maintain financial records supporting such calculations for a period of two (2) years after the date of the relevant Earnout Period, and Seller shall be entitled to inspect such records not more than one time per fiscal quarter in accordance with this Section 1.8(b)(iii). Seller shall, at its own cost, be entitled to conduct an audit ("Audit"), using an independent auditor of its own choice, of any given earnout payment or of some or all of the periods cumulatively. If the results of the Audit indicate a figure within a five percent variance of the figure set forth in the Earnout Notice (the "Earnout Notice Figure"), then the Earnout Notice shall be binding upon the parties. If the Audit figure differs by more than five percent from the Earnout Notice Figure, the parties shall attempt to negotiate a mutually agreeable solution which shall include, at a minimum, the term that if the Audit figure exceeds the Earnout Notice Figure by five percent or more, Buyer shall pay the Audit figure and all reasonable costs incurred by the Seller in connection with the Audit. Seller shall use its commercially reasonable efforts not to interfere with Buyer's business operations in the exercise of its audit rights hereunder and all information obtained in any such audit shall be subject to Section 4.2 hereof. (iv) Buyout. If Buyer enters into any merger, consolidation, reorganization, joint venture or other business combination with any Person which results in a change of control of Buyer or sells, conveys, disposes of or transfers to any Person any asset or other property that is material to the Acquired Assets as of the date of closing of any such transaction (including, without limitation, as part of a sale of all or substantially all the assets of Buyer) at any time following the Closing, then: (a) (i) Buyer shall pay to Seller any remaining balance under Buyer's payment obligation under this Section 1.8(b) immediately prior to any such event, or (ii) Buyer's payment obligation under this Section 1.8(b) shall be expressly assumed by such Person in writing; and (b) such Person shall expressly assume all other obligations of Buyer hereunder. (c) Allocation of Purchase Price. Within thirty (30) days of the Closing, Buyer shall prepare Schedule 1.8(c) setting forth a proposed tax allocation of the Purchase Price (plus Assumed Liabilities) to the Acquired Assets in a manner consistent with Section 1060 of the Internal Revenue Code of 1986, as amended (the "Code"), and the income tax regulations promulgated thereunder and shall deliver such schedule to Seller for its approval. Buyer and Seller agree to use all commercially reasonable efforts to resolve any disagreements regarding such allocation as soon as practicable thereafter, but in no event later than 30 days subsequent to the date that Buyer delivers such allocation. In the event that the Buyer and Seller are able to agree upon such allocation, (such final, mutually agreed upon allocation of the Purchase Price referred to herein as the "Allocation"), the parties agree that all Tax Returns and reports (including Internal Revenue Service ("IRS") Form 8594) and all financial statements shall be prepared in a manner consistent with (and the parties shall not otherwise take a position -3- inconsistent with) the Allocation unless required by the IRS or state taxing authority. In the event that the Buyer and Seller are unable to agree upon such allocation, each party shall allocate the Purchase Price (plus Assumed Liabilities) to the Acquired Assets in the manner as separately determined by each party. ARTICLE 2 REPRESENTATIONS AND WARRANTIES OF SELLER Except as disclosed in the disclosure schedule attached hereto as Exhibit E (the "Disclosure Schedule"), as an inducement to Buyer to enter into this Agreement, Seller hereby represents and warrants to Buyer, as follows: 2.1 Organization of Seller. Seller is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. Seller has all requisite corporate power and authority to own and use the properties owned and used by it and to carry on its business as currently conducted. Seller is duly qualified or licensed to do business and in good standing in each jurisdiction in which the failure to be so qualified or licensed would have a Material Adverse Effect. 2.2 Authority. Seller has all requisite power and authority to enter into this Agreement and each Ancillary Agreement, to perform its obligations hereunder and thereunder and to consummate the transactions contemplated hereby and thereby. The execution and delivery of this Agreement and the Ancillary Agreements and the consummation of the transactions contemplated hereby and thereby have been duly authorized by all necessary corporate action on the part of Seller, and no further action is required on the part of Seller to authorize this Agreement and the Ancillary Agreements and the transactions contemplated hereby and thereby. This Agreement and the Ancillary Agreements constitute valid and binding obligations of Seller, enforceable in accordance with their respective terms, except as such enforceability may be limited by principles of public policy and subject to the laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance, injunctive relief or other equitable remedies. 2.3 No Conflict. The execution and delivery by Seller of this Agreement and the Ancillary Agreements, and the consummation of the transactions contemplated hereby and thereby, do not and will not conflict with or result in any violation of, or default under, or give rise to a right of termination, cancellation, modification or acceleration of any obligation or loss of any benefit (any such event, a "Conflict") under (i) any provision of Seller's Amended and Restated Certificate of Incorporation or Seller's Bylaws, each as currently in effect, (ii) any material mortgage, indenture, lease, contract, covenant or other agreement, instrument or commitment, permit, concession, franchise or license or any Transferred Contract (each a "Material Contract" and collectively the "Material Contracts") to which Seller or any of its properties or assets is subject, or (iii) any judgment or any order or decree issued by a Governmental Entity, or to Seller's knowledge, any other order or decree, statute, law, ordinance, rule or regulation applicable to Seller or any of its properties or assets (tangible and intangible). -4- 2.4 Transferred Contracts. Schedule 6.9(z) lists each Transferred Contract. Seller has delivered to Buyer true and complete copies of each Transferred Contract. Seller is not in default nor, to Seller's knowledge, has there occurred an event or condition which, with the passage of time or giving of notice (or both), would constitute a material default with respect to the payment or performance of any obligation of Seller or any other party thereunder; and no written claim of such a default has been received by Seller and to Seller's knowledge there is no basis or alleged basis upon which such a claim could be made. 2.5 Consents. No consent, waiver, approval, order or authorization of, or registration, declaration or filing with any Governmental Entity, or a party to any Material Contract with Seller (so as not to trigger any Conflict) is required by or with respect to Seller in connection with the execution and delivery of this Agreement or any Ancillary Agreement or the consummation of the transactions contemplated hereby or thereby, except (i) those that are required to be obtained or made by Buyer unilaterally, or (ii) those set forth on Schedule 2.5. 2.6 Title to Properties; Absence of Liens and Encumbrances. Seller has good and marketable title to the Acquired Assets, free and clear of any Liens, except Permitted Liens. The location of each of the Acquired Assets is identified in Schedule 2.6. 2.7 Litigation. There is no action, suit, claim, proceeding, arbitration, hearing, demand or cause of action or investigation of any nature pending or, to Seller's knowledge, threatened against Seller relating to the Acquired Assets, nor is there any reasonable basis therefor. To Seller's knowledge, there is no investigation or other proceeding pending or threatened relating to the Acquired Assets by or before any Governmental Entity, nor is there any reasonable basis therefor. There are no judgments and no orders or decrees issued by any Governmental Entity, and to Seller's knowledge, there are no other orders or decrees, citations, fines or penalties heretofore assessed against Seller affecting the Acquired Assets under any foreign, federal, state or local law. 2.8 Compliance With Law. Seller has complied and is in compliance with all applicable federal, state and local laws, statutes, licensing requirements, rules and regulations, and judicial or administrative decisions applicable to the Acquired Assets or the Assumed Liabilities. There is no order issued, investigation or proceeding pending or, to Seller's knowledge, threatened, or notice served with respect to any violation of any law, ordinance, order, writ, decree, rule or regulation issued by any Governmental Entity applicable to the Acquired Assets or the Assumed Liabilities. 2.9 Intellectual Property. (a) Section 2.9(a) of the Disclosure Schedule lists all Transferred Intellectual Property Rights that are Registered Intellectual Property Rights. All such Registered Intellectual Property Rights are currently in compliance with formal legal requirements (including payment of filing, examination and maintenance fees and proofs of use) and are not subject to any unpaid maintenance fees or actions falling due within thirty (30) days after the Closing Date. -5- (b) Except as set forth in Schedule 2.9(b), Seller has not transferred or pledged ownership of, or granted any license of or right to use, or authorized the retention of any rights to use, any Transferred Intellectual Property Right to any other Person. (c) Subject to Section 2.9(f) hereof, the Transferred Technology does not infringe or misappropriate the Intellectual Property Rights of any Person, and Seller has not received notice from any Person claiming that the Transferred Technology constitutes unfair competition or trade practices under the laws of any jurisdiction. (d) To the Seller's Knowledge, no Person is infringing or misappropriating the Transferred Intellectual Property Rights. (e) The Transferred Intellectual Property Rights, which are Registered Intellectual Property Rights, are not subject to any proceedings or actions before any court, tribunal (including the PTO or equivalent authority anywhere in the world) to which Seller is a party thereto. The Transferred Intellectual Property Rights are not subject to any outstanding decree, order, judgment, agreement or stipulation that restricts in any manner the use, transfer or licensing thereof. (f) To Seller's Knowledge, the Transferred Technology does not infringe or misappropriate the Patents of any Person. 2.10 Adequacy of Certain Acquired Assets. The Acquired Assets are substantially all of the assets used by Seller in the production of Products. Except as set forth on Schedule 2.10, the production, testing, tooling, measurement and lab equipment used by Seller in the production of the Products are in good operating condition, and have been properly maintained. 2.11 Inventory. Seller owns the Inventory free and clear of any restriction on transfer or liens (other than Permitted Liens) and, to Seller's Knowledge, the Inventory (excluding any third party components) does not infringe the rights of any person or entity. 2.12 Employee Matters. (a) Seller is not a party to, and there does not otherwise exist, any agreements with any labor organization or collective bargaining or similar agreement with respect to the employees. Seller is not a party to any outstanding contract, commission agreement, settlement agreement, or compensation agreement with any Transferred Employee. To the knowledge of Seller, there are no complaints, grievances, arbitrations, employment-related proceedings or administrative proceedings, either pending or threatened orally or in writing, involving any Transferred Employee; during the past five years, the business has not suffered or sustained any labor dispute resulting in any work stoppage and no such work stoppage is, to the knowledge of Seller, threatened. To the knowledge of Seller, the employees are not engaged in any active union organizing campaign as demonstrated by the circulation of union authorization cards, requests for voluntary recognition or the filing of a representation petition with the National Labor Relations Board. -6- (b) There is no litigation brought by any of the employees currently pending against Seller in any municipal, state or federal court or agency. (c) Seller has identified to Buyer each "employee benefit plan" (as such term is defined in Section 3(3) of the Employment Retirement Income Security Act of 1974 (ERISA)) providing for benefits in connection with the performance of services to Seller and maintained by Seller with respect to the employees. Seller retains and does not transfer to Buyer any liability or obligation with respect to or under any agreement between Seller and any of its employees except as set forth in this Agreement, or under any such "employee benefit plan". (d) Each group health plan (within the meaning of either Section 5000(b)(1) of the Code or Section 607(1) of ERISA) maintained or contributed to, currently or in the past, by Seller is and at all times has operated in material compliance with the continuation coverage requirements of Part 6, Subtitle B of Title I of ERISA and Section 4980B of the Code, with respect to the Employees and their spouses and dependents. (e) There is no lien upon any property of Seller outstanding pursuant to Section 412(n) of the Code in favor of any Seller "employee pension benefit", within the meaning of Section 3(2) of ERISA or in favor of the Pension Benefit Guaranty Corporation pursuant to Section 4068 of ERISA and no assets of Seller have been provided as security to any Seller "employee benefit pension plan" that is or was subject to Title IV of ERISA. (f) Seller does not have and has not in the past had any obligation or liability to contribute to any "multiemployer plan," as defined in Section 3(37) of ERISA. ARTICLE 3 REPRESENTATIONS AND WARRANTIES OF BUYER As an inducement to Seller to enter into this Agreement, Buyer hereby represents and warrants to Seller: 3.1 Organization of Buyer. Buyer is a corporation duly organized, validly existing, and in good standing under the laws of Delaware. Buyer has all requisite corporate power and authority to own and use the properties owned and used by it and to carry on its business as currently conducted and as currently contemplated to be conducted. Buyer is duly qualified or licensed to do business and in good standing in each jurisdiction in which the failure to be so qualified or licensed would have a Material Adverse Effect. 3.2 Authority. Buyer has all requisite corporate power and authority to enter into this Agreement, each Ancillary Agreement to which it is a party, to perform its obligations hereunder and thereunder and to consummate the transactions contemplated hereby and thereby. The execution and delivery of this Agreement and the Ancillary Agreements and the consummation of the transactions contemplated hereby and thereby have been duly authorized by all necessary corporate action on the part of Buyer, and no further action is required on the part of Buyer to authorize this Agreement or the Ancillary Agreements and the transactions contemplated hereby -7- or thereby. This Agreement and the Ancillary Agreements have been duly executed and delivered by Buyer and constitute the valid and binding obligations of Buyer, enforceable in accordance with their respective terms, except as such enforceability may be limited by principles of public policy and subject to the laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance, injunctive relief or other equitable remedies. 3.3 No Conflict. The execution and delivery of this Agreement and the Ancillary Agreements to which Buyer is a party, and the consummation of the transactions contemplated hereby and thereby, do not and will not conflict with, or result in any violation of, or default under, or give rise to a Conflict under (i) any provision of Buyer's Certificate of Incorporation or Buyer's Bylaws, each as currently in effect, (ii) any Material Contract to which Buyer or any of its properties or assets are subject, or (iii) any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to Buyer or its properties or assets. 3.4 Consents. No consent, waiver, approval, order or authorization of, or registration, declaration or filing with, any Governmental Entity, or any third party, including a party to any Material Contract with Buyer (so as not to trigger any Conflict), is required by or with respect to Buyer in connection with the execution and delivery of this Agreement or the Ancillary Agreements or the consummation of the transactions contemplated hereby or thereby. 3.5 Compliance with Laws. To Buyer's knowledge, Buyer has complied with, is not in violation of, and has not received any notices of violation with respect to, any foreign, federal, state or local statute, law or regulation with respect to the conduct or operation of its business. ARTICLE 4 COVENANTS AND AGREEMENTS 4.1 Additional Documents and Further Assurances. (a) Each party hereto, at the request of another party hereto, shall execute and deliver such other instruments and do and perform such other acts and things as may be reasonably necessary or desirable for effecting completely the consummation of this Agreement and the transactions contemplated hereby. (b) Following the Closing, Seller will afford Buyer, its counsel and its accountants, during normal business hours, reasonable access to the books, records and other data, if any, relating to the Acquired Assets in Seller's possession and the Assumed Liabilities with respect to periods prior to the Closing and the right to make copies and extracts therefrom, to the extent that such access may be reasonably required by Buyer in connection with: (i) the preparation of Tax Returns; (ii) compliance with the requirements of any Governmental Entity; and (iii) in connection with any actual or threatened action or proceeding by a third party; provided, however, that Seller may require Buyer to execute a confidentiality agreement in connection therewith. -8- 4.2 Confidentiality. Each of the parties hereto hereby agrees that the terms hereof, the information obtained pursuant to the negotiation and execution of this Agreement, and the effectuation of the transactions contemplated hereby, shall be governed by the terms of the Non-Disclosure Agreement dated July 31, 2002, as amended by that certain Amendment No. 1 dated December 11, 2002, between Buyer and Seller (the "NDA"). 4.3 Sales Taxes. All transfer, documentary, sales, use, registration, value-added, real estate transfer, and any similar taxes and related fees (including interest, penalties and additions to tax) incurred in connection with this Agreement, the Ancillary Agreements and the transactions contemplated hereby and thereby ("Transfer Taxes") shall be borne by Buyer, in addition to the consideration provided for in Section 1.8. 4.4 Taxes. (a) In the case of any real or personal property taxes (or other similar Taxes) ("Property Taxes") attributable to the Acquired Assets which returns cover a taxable period commencing before the Closing Date and ending thereafter (a "Straddle Period"), Buyer shall prepare such returns and make all payments required with respect to any such return (subject to Seller's approval of such returns to the extent they relate to Taxes Seller will be required to pay, which approval will not be unreasonably withheld). Any Property Taxes attributable to the portion of the Straddle Period prior to and including the Closing Date shall be the responsibility of the Seller, and any Property Taxes attributable to a portion of the Straddle Period beginning after the Closing Date shall be the responsibility of the Buyer. For purposes of such Straddle Periods, Property Taxes shall be allocated on a per diem basis. To the extent Seller has paid or will pay Property Taxes attributable to a portion of the Straddle Period for which Seller is not responsible, Buyer shall reimburse Seller within fourteen (14) days upon receiving written notification (and supporting documentation) that Seller has paid such Property Taxes. To the extent Buyer has paid or will pay Property Taxes attributable to a portion of the Straddle Period for which Buyer is not responsible, Buyer may off-set any such amount from its payment obligations under Section 1.8(b)(i) hereinabove. (b) To the extent relevant to the Acquired Assets, each party shall (i) provide the other with such assistance as may reasonably be required in connection with the preparation of any Tax Return and the conduct of any audit or other examination by any taxing authority or in connection with judicial or administrative proceedings relating to any liability for Taxes and (ii) retain and provide the other with all records or other information that may reasonably be relevant to the preparation of any Tax Return, or the conduct of any audit or examination, or other proceeding relating to Taxes for so long as the applicable statute of limitations has not expired. Seller shall provide Buyer with copies of all documents, including prior years' Tax Returns, supporting work schedules and other records or information with respect to all sales, use, property and employment tax returns, absent the receipt by Seller of the relevant tax clearance certificates. The parties hereto agree to keep all such information confidential in accordance with Section 4.2 hereof. 4.5 Bulk Sales. Buyer and Seller hereby agree to waive the requirement, if any, that each comply with any bulk transfer law which may be applicable to the transactions -9- contemplated by this Agreement and the Ancillary Agreements. Seller covenants to pay all of its vendors in accordance with the terms of its obligations. 4.6 Employee Matters. (a) Seller acknowledges that Buyer may extend offers of employment pursuant to offer letters to certain employees of Seller as set forth on Schedule 4.6 hereto (collectively, the "Key Employees"). (b) Each Key Employee who accepts such offer (each a "Transferred Employee") shall commence employment with Buyer promptly following the Closing Date. Key Employees who reject or who are not offered employment with Buyer shall remain employees of Seller following the Closing Date, subject to Seller's termination rights. (c) Buyer shall have no obligation with respect to payments of salary, compensation, wages, health or similar benefits, commissions, bonuses (deferred or otherwise), severance, accrued vacation and sick leave, stock or stock options or any other sums due to any Key Employee or any other employee of Seller that accrued on or before the Closing Date (including any payments accruing due to the transaction contemplated by this Agreement), and Seller shall hold Buyer harmless therefor and indemnify Buyer from and against all Claims in connection therewith. Seller will be fully responsible for all amounts owing to the Key Employees as a result of their employment with the Seller prior to the Closing Date and shall under no circumstances be responsible for any amounts payable to any Transferred Employee that accrues after the Closing Date. (d) If within six months of the Closing Date Buyer extends an offer of employment to any employee terminated by Seller following the Closing Date, Buyer shall pay any and all liabilities of Seller relating to such termination, other than employee Claims against Seller relating to employees' employment with Seller, including without limitation any payments and benefits due to such employee pursuant to accrued salary and wages, pension, retirement, savings, health, welfare and other benefits and severance payments or similar payments required under any law or regulations in respect of such termination including, without limitation COBRA. (e) Buyer shall permit each Transferred Employee to participate in any Buyer Employee Benefit Plan with participation rights and benefits under each Buyer Employee Benefit Plan for each Transferred Employee that are equivalent or comparable to the rights and benefits of employees of Buyer with positions and responsibilities substantially similar to the Transferred Employees for each such Buyer Employee Benefit Plan. 4.7 Inventory. (a) Schedule 4.7 specifically sets forth all raw materials, supplies, manufactured and purchased parts, goods in process and finished goods (such items generally, the "Inventory") owned by Seller as of January 18, 2003 (the "Preliminary Inventory Balance"). Promptly following Closing, Seller shall deliver, on consignment to Buyer, the Inventory set forth on the Preliminary Inventory Balance. Seller agrees to sell and Buyer agrees to purchase, accept and pay for such Inventory as Buyer incorporates such Inventory into -10- Products at prices set forth on the Preliminary Inventory Balance. Buyer agrees that, to the extent the Inventory contains or includes those items need by Buyer, the Inventory shall be the exclusive source for all raw materials, supplies, manufactured and purchased parts, goods in process and finished goods with respect to the business to be operated by Buyer in connection with the Acquired Assets following the Closing, for so long as the Inventory remains unused or unsold by Buyer. Within the later of (i) 90 days following the Closing Date, and (ii) two business days following Seller's final purchase under all purchase orders relating to the Acquired Assets that are open as of Closing ("Open Purchase Orders"), Seller shall deliver to Buyer an accurate and complete list of the Inventory owned by Seller as of the Closing Date, subject to adjustment for Open Purchase Orders ("Closing Inventory Balance"). Buyer and Seller agree that the Closing Inventory Balance will include Inventory purchased by Seller pursuant to Open Purchase Orders. Buyer and Seller agree that the prices set forth on the Preliminary Inventory Balance shall be the prices to be paid by Buyer for any corresponding Inventory that appears on the Closing Inventory Balance. To the extent necessary, the Closing Inventory Balance shall contain prices for any Inventory that did not appear on the Preliminary Inventory Balance and Buyer agrees to purchase, accept and pay for such Inventory at the prices set forth therein. In the event of a dispute regarding the Closing Inventory Balance, the parties will work together in good faith to resolve the dispute. (b) Prior to the date hereof, Buyer has provided Seller with written delivery instructions for the Inventory to be held or stored by Buyer pursuant to this Section 4.7. All costs and expenses related to the delivery of the Inventory to Buyer, including all costs to insure the Inventory during delivery by Seller, shall be borne by Buyer. Seller and Buyer agree that such insurance of the Inventory can take place pursuant to Buyer's insurance policies, so long as Seller as added as an additional insured under such policies with respect to the Inventory. (c) Seller shall at all times retain title to the Inventory delivered to Buyer under this Section 4.7. Until fully paid therefor, Seller shall have a security interest in the Inventory, any proceeds thereof, and all accounts and rights to payment of every kind now and hereafter arising out of or relating to the Inventory. Buyer agrees to assume the risk of Loss for the Inventory immediately upon delivery by Seller. Buyer agrees to keep the Inventory fully insured at its own expense from all Losses related to the Inventory for the benefit of and in the name of Seller. Buyer agrees to use commercially reasonable efforts to keep and maintain the Inventory in good condition and repair, provided such Inventory was delivered to Buyer in such condition. (d) Subject to the terms and conditions of this paragraph, Buyer may sell the Inventory that is branded with the Seller trademarks. Buyer shall add an additional label to each unit of Inventory directing the customer to call Buyer for any inquiries regarding such unit of Inventory. If Seller receives any inquiries from customers regarding the Inventory, Seller will direct such customers to contact Buyer, and Buyer shall promptly respond to each such customer. Except as already branded by Seller, Buyer shall have no right to use the Seller trademarks to advertise or promote the Inventory. The foregoing right to sell the Inventory as branded with the Seller trademarks does not grant any additional right or license to Buyer with respect to the Seller trademarks. Buyer shall indemnify and hold Seller harmless from and against any and all claims, losses, liabilities, -11- damages, costs and expenses arising out of or related to Buyer's promotion and/or sale of the Seller branded Inventory, so long as the claims, losses, liabilities, damages, costs and expenses do not arise out of or relate to an inaccuracy in or breach of any representation or warranty made by Seller in this Agreement. EXCEPT AS SPECIFICALLY PROVIDED IN THIS AGREEMENT, THE INVENTORY IS PROVIDED "AS-IS" WITHOUT WARRANTY OF ANY KIND, AND SELLER HEREBY DISCLAIMS ALL WARRANTIES OF ANY KIND WITH RESPECT TO THE INVENTORY, WHETHER EXPRESS, IMPLIED, STATUTORY OR OTHERWISE, INCLUDING THE IMPLIED WARRANTIES OF NON-INFRINGEMENT, FITNESS FOR A PARTICULAR PURPOSE AND MERCHANTABILITY. SELLER SHALL NOT BE LIABLE FOR DAMAGES OF ANY KIND, DIRECT OR INDIRECT, INCLUDING INCIDENTAL, SPECIAL, CONSEQUENTIAL, OR EXEMPLARY, ARISING OUT OF OR RELATED TO THE INVENTORY AND BUYER AGREES THAT THE FOREGOING IS A REASONABLE ALLOCATION OF RISK. (e) Buyer shall maintain a daily record of all Inventory used or sold by Buyer. Buyer shall deliver payment for any Inventory used or sold by Buyer with an accompanying purchase order for such Inventory ("Inventory Purchase Order") to Seller within 30 days from the first date of use or sale by Buyer of such Inventory. (f) Buyer shall perform a physical inspection of the Inventory once every year following delivery of the Inventory by Seller. Within 30 days of the physical inspection, Buyer shall provide Seller with written notice setting forth the amount and description of the Inventory held or stored by Buyer (the "Inventory Notice"). All costs and expenses relating to such physical inspection shall be borne by Buyer. If the results of Buyer's physical inspection as reflected in the Inventory Notice indicate a discrepancy between (i) the Inventory balance set forth in such Notice, and (ii) the inventory balance calculated by taking the Closing Inventory Balance and subtracting from it the aggregate of all Inventory Purchase Orders delivered by Buyer to Seller prior to the inspection date, or between any other information provided by Buyer to Seller with respect to the Inventory, then Buyer shall make payment to Seller in an amount equal to such discrepancy, within thirty (30) days of the identification thereof (any such payment, an "Adjustment Payment"). (g) Seller shall be entitled to conduct an audit and perform a physical inspection of the Inventory held or stored by Buyer at any time during the consignment period under this Section 4.7; provided, however, that such audit and inspection right by Seller provided under this Section 4.7(f) shall not be available to Seller more than once during any consecutive 90 day period. If the results of any audit or physical inspection by Seller indicate a discrepancy between (i) the Inventory balance determined by such audit or inspection, and (ii) the Inventory balance calculated by taking the Closing Inventory Balance and subtracting from it the sum of (x) the aggregate of all Inventory Purchase Orders delivered by Buyer to Seller prior to the inspection date, and (y) any Adjustment Payments made by Buyer to Seller prior to the inspection date, or between any information provided by Buyer to Seller with respect to the Inventory, then Buyer shall make immediate payment to Seller in an amount equal to such discrepancy. If such discrepancy equals or exceeds 5% of the Inventory balance determined by Seller's audit or inspection, then all costs and expenses relating to such audit and inspection shall be borne by Buyer, in addition to the payment obligation of Buyer relating to any discrepancy provided herein. Seller shall use its commercially reasonable efforts not to interfere with Buyer's business operations in the exercise of its audit rights hereunder and shall keep all -12- information obtained in any such audit confidential in accordance with the requirements of Section 4.2 hereof. (h) Buyer shall execute all financing statements and other documents that Seller reasonably deems necessary or advisable to effectuate the purpose of this Section 4.7. (i) Seller covenants to deliver Inventory that is in good operating condition and that has been properly maintained by Seller. Subject to Buyer's obligations under Section 4.7(a), and to the extent any Inventory delivered to Buyer in accordance therewith is not in good operating condition or has not been properly maintained by Seller, Buyer shall have a credit in the amount paid for such Inventory by Buyer under Section 4.7(a). In such event, Buyer shall provide Seller with written notice stating: (i) Buyer's good faith determination that certain items of Inventory are not in good operating condition or have not been properly maintained, and (ii) the specific items of Inventory identified by Buyer for purposes of this Section 4.7(i). If such notice is undisputed, Seller shall provide Buyer with a credit under this Section 4.7(i) within ten (10) days following receipt of such notice. In the event of a dispute in connection with the notice provided by Buyer in this Section 4.7(i), the parties shall agree to resolve such dispute in accordance with Section 6.6 of this Agreement. (j) Subject to Buyer's obligations under Section 4.7(a), and to the extent any Inventory delivered to Buyer in accordance therewith is not used, sold or consumed by Buyer within eighteen (18) months from the date of such delivery, Buyer may provide Seller with written notice stating: (i) Buyer's good faith determination that the Inventory is unusable based on Buyer's inability, despite commercially reasonable efforts to use or sell the Inventory, to do so, (ii) the specific items of such unused Inventory identified by Buyer for purposes of this Section 4.7(j), and (iii) Buyer's intended method of disposal of such Inventory. Within ten (10) days following receipt of such notice and if such notice remains undisputed, Seller may elect to have Buyer deliver the unused Inventory to Seller or coordinate the retrieval of such unused Inventory from Buyer, each at Seller's sole cost and expense. In the event of a dispute in connection with the notice provided by Buyer in this Section 4.7(j), the parties shall agree to resolve such dispute in accordance with Section 6.6 of this Agreement. 4.8 Assumed Liabilities. Buyer shall discharge the Assumed Liabilities on a timely basis and in accordance with their terms and Buyer agrees that Seller shall have no liability for any failure of Buyer to discharge the Assumed Liabilities in accordance with their terms. 4.9 Accounts Receivable. All accounts receivable related to the Transferred Contracts outstanding as of the Closing Date are the sole property and responsibility of Seller. 4.10 Conduct of Business. Following Closing Date and until the Earnout Termination Date, Buyer shall use its commercially reasonable efforts: (i) to fund and operate the business related to the Acquired Assets in a prudent manner so as to preserve the value of the Acquired Assets, generally; (ii) to sell Earnout Products to satisfy the obligations set forth in Section 1.8 hereof; and (iii) to preserve the goodwill of the employees, representatives and customers of the business related to the Acquired Assets, and other persons with which there are significant relationships essential to the operation of the business related to the Acquired Assets. Following the Closing Date, Buyer shall not engage in any activity with the primary purpose of, or having -13- the principal effect of, materially impairing or delaying Buyer's ability to satisfy Buyer's payment obligations under Section 1.8(b) hereof. 4.11 Clear Permitted Liens. Seller shall use commercially reasonable efforts to clear, satisfy and remove all of the Permitted Liens within 45 days of the Closing Date. If such Permitted Liens are not cleared, satisfied and removed within such 45-day period, Buyer may clear, satisfy and remove such Permitted Liens at Seller's cost and expense, which such cost and expense may be set-off against Buyer's payment obligations pursuant to Section 1.8(b) hereinabove. 4.12 Covenant Not to Compete. (a) Each Party acknowledges that the Transferred Technology and Transferred Intellectual Property Rights are an integral component of the value of the retained business of Seller and the assets acquired by Buyer under this Agreement, and that the non-compete terms set forth below are reflected in the consideration to be received by Seller and Buyer under this Agreement. Each Party acknowledges that the limitations of time, geography and scope of activity agreed to in this Agreement are reasonable. (b) During the Non-Compete Period, Buyer shall not, without the prior written consent of Seller, use the Transferred Technology or Transferred Intellectual Property Rights to engage or participate anywhere in the world directly or indirectly (e.g. license a third party), in a "Seller Competing Business." (c) During the Non-Compete Period, Seller shall not, without the prior written consent of Buyer, engage or participate anywhere in the world directly or indirectly (e.g. license a third party), in a "Buyer Competing Business." (d) The covenants contained in the preceding paragraph shall be construed as a series of separate covenants, one for each country, province, state, city or other political subdivision of the world in which Seller or Buyer, as the case may be, is currently engaged in business or otherwise sells its products. Except for geographic coverage, each such separate covenant shall be identical in terms to the covenant contained in the preceding paragraphs. If, in any proceeding, a court refuses to enforce any of such separate covenants (or any part thereof), then such unenforceable covenant (or such part) shall be eliminated from this Agreement to the extent necessary to permit the remaining separate covenants (or portions thereof) to be enforced. In the event that the provisions of this Section 4.12 are deemed to exceed the time, geographic or scope limitations permitted by applicable law, then such provisions shall be reformed to the maximum time, geographic or scope limitations, as the case may be, permitted by applicable laws. Notwithstanding, in the event one of the covenants set forth above is not enforceable in whole or part, the other covenant shall also terminate. 4.13 No Solicitation. For a period of one year following the Closing Date, neither Seller nor Buyer (nor any affiliate, officer, director or representative thereof) shall indirectly or directly solicit or contact for the purpose of soliciting for employment any current or future employee of the other party, except for any solicitation made through general advertisement. -14- 4.14 Transition Services Agreement. Buyer expressly agrees to comply with all its obligations under the Transition Services Agreement, including without limitation to vacate the Facilities (as defined in the Transition Services Agreement) by not later than 11:59 p.m. California time on February 14, 2003. Buyer and Seller agree that the provisions of this Section do not expand, in any manner, the remedies available to the parties under the Transition Services Agreement. 4.15 Service Reimbursement. Seller agrees to reimburse Buyer for certain reasonable costs and expenses actually incurred and paid by Buyer with respect to certain service obligations as described in Schedule 4.14. 4.16 Transfer of Certification Rights. Following the Closing, Seller and Buyer shall cooperate and use all commercially reasonable efforts to do promptly, or cause to be done promptly, all things necessary, proper or advisable to convey, assign and transfer Seller's rights and interests relating to the certification and homologation of its Products to Buyer. 4.17 Return of Materials. Following the Closing Date, if Buyer becomes aware of, or receives notice from Seller, that it is in possession of any Technology or Intellectual Property Rights not specifically transferred hereunder, including and not limited to information about trade secrets, computer programs, designs, formulas, compositions, data or other proprietary materials inadvertently obtained from Seller in connection with the transactions contemplated by this Agreement ("Seller's Materials"), Buyer agrees that Seller's Materials shall not constitute any Transferred Technology, and that Buyer shall promptly return Seller's Materials to Seller and destroy any remaining copies of Seller's Materials following such delivery. Seller agrees to be responsible for all costs and expenses related to the delivery or destruction of Seller's Materials by Buyer. ARTICLE 5 SURVIVAL OF REPRESENTATIONS, WARRANTIES AND COVENANTS; INDEMNIFICATION 5.1 Survival of Representations, Warranties and Covenants. The representations, warranties and covenants of Seller contained in this Agreement, or in any certificate or other instrument delivered pursuant to this Agreement, shall terminate on the one year anniversary of the Closing Date. The representations, warranties and covenants of Buyer contained in this Agreement, or in any certificate or other instrument delivered pursuant to this Agreement, shall terminate on the one year anniversary of the Closing Date. 5.2 Indemnification. (a) Buyer hereby agrees to indemnify and hold harmless Seller, its affiliates, officers, directors, employees and agents from and against any and all losses, liabilities, damages, demands, claims, suits, actions, judgments or causes of action, assessments, costs and expenses, including, without limitation, interest, penalties, reasonable attorneys' fees, any and all expenses incurred in investigating, preparing or defending against any litigation, commenced or threatened, or any claim whatsoever, and any and all amounts paid in settlement of any claim or -15- litigation (collectively, "Damages"), asserted against, resulting to, imposed upon, or incurred or suffered by Seller, its affiliates, officers, directors, employees or agents, directly or indirectly, as a result of or arising from any of the following ("Buyer Indemnifiable Claims"): (i) Any inaccuracy in or breach or nonfulfillment of any of the representations, warranties, covenants or agreements made by Buyer in this Agreement and the Ancillary Agreements; (ii) Any Assumed Liabilities; and (iii) Any Claim by any Person for brokerage or finders' fees or commissions or similar payments based upon any agreement or understanding alleged to have been made by such Person directly or indirectly with Buyer or any of its officers, directors or employees in connection with any of the transactions contemplated by the Agreement or the Ancillary Agreements. (b) Seller hereby agrees to indemnify and hold harmless Buyer, its affiliates, officers, directors, employees and agents from and against any and all Damages asserted against, resulting to, imposed upon, or incurred or suffered by Buyer, its affiliates, officers directors, employees or agents, directly or indirectly, as a result of or arising from any of the following ("Seller Indemnifiable Claims" and together with Buyer Indemnifiable Claims, the "Indemnifiable Claims"): (i) Any inaccuracy in or breach or nonfulfillment of any of the representations, warranties, covenants or agreements made by Seller in this Agreement or any Ancillary Agreement; (ii) Any Excluded Liabilities; and (iii) Any Claim by any Person for brokerage or finders' fees or commissions or similar payments based upon any agreement or understanding alleged to have been made by such Person directly or indirectly with Seller or any of its officers, directors or employees in connection with any of the transactions contemplated by the Agreement or the Ancillary Agreements. (c) The procedures for effecting the indemnification contemplated hereby shall be as follows: (i) If Buyer or Seller determines to seek indemnification under this Article 5 with respect to Indemnifiable Claims (the party seeking such indemnification hereinafter referred to as the "Indemnified Party" and the party against whom such indemnification is sought hereinafter referred to as the "Indemnifying Party") resulting from the assertion of liability by third parties (a "Third Party Claim"), the Indemnified Party shall give notice to the Indemnifying Party within 30 days of the Indemnified Party becoming aware of any such Indemnifiable Claim or of facts upon which any such Indemnifiable Claim will be based; the notice shall set forth such material information with respect thereto as is then reasonably available to the Indemnified Party. In case any such liability is asserted against the Indemnified Party, and the Indemnified Party notifies the Indemnifying Party thereof, the -16- Indemnifying Party shall be entitled, at its expense, to participate in any defense of such claim. The Indemnified Party shall promptly defend any such Third Party Claim and shall have the right to settle any Third Party Claim on reasonable terms with the written consent of the Indemnifying Party (which consent shall not be unreasonably withheld). Notwithstanding the foregoing, (i) the Indemnified Party shall also have the right to employ its own counsel in any such case, and the fees and expenses of such counsel shall be at the expense of the Indemnified Party and (ii) the rights of the Indemnified Party to be indemnified hereunder in respect of Indemnifiable Claims resulting from the assertion of liability by third parties shall not be adversely affected by its failure to give notice pursuant to the foregoing unless, and, if so, only to the extent that, the Indemnifying Party is materially prejudiced thereby. With respect to any assertion of liability by a third party that results in an Indemnifiable Claim, the parties hereto shall make available to each other all relevant information in their possession material to any such assertion. (ii) In the event that the Indemnifying Party, within 30 days after receipt of the aforesaid notice of an Indemnifiable Claim, fails to assume the defense of the Indemnified Party against such Indemnifiable Claim, the Indemnified Party shall have the right to undertake the defense of such action on behalf of and for the account and risk of the Indemnifying Party; provided that the Indemnifying Party must consent in writing to the settlement of any such claim (which consent shall not be unreasonably withheld). (iii) Notwithstanding anything in this Section to the contrary, the Indemnified Party shall have the right to participate in such defense, compromise or settlement and the Indemnifying Party shall not, without the Indemnified Party's written consent (which consent shall not be unreasonably withheld), settle or compromise any Indemnifiable Claim or consent to entry of any judgment in respect thereof unless such settlement, compromise or consent includes as an unconditional term thereof the giving by the claimant or the plaintiff of the Indemnified Party a release from all liability in respect of such Indemnifiable Claim. (d) In the event that the Indemnified Party asserts the existence of a claim giving rise to Damages (but excluding claims resulting from the assertion of liability by third parties), it shall give written notice to the Indemnifying Party. Such written notice shall state that it is being given pursuant to this Section 5.2, specify the nature and amount of the claim asserted and indicate the date on which such assertion shall be deemed accepted and the amount of the claim deemed a valid claim (such date to be established in accordance with the next sentence). If the Indemnifying Party, within 60 days after the mailing of notice by the Indemnified Party, shall not give written notice to the Indemnified Party announcing its intent to contest such assertion of the Indemnified Party, such assertion shall be deemed accepted and the amount of claim shall be deemed a valid claim. In the event, however, that the Indemnifying Party contests the assertions of a claim by giving such written notice to the Indemnified Party within said period, then the parties shall act in good faith to reach agreement regarding such claim. If agreement regarding such claim is not reached, then the matter shall be resolved by arbitration between the parties as set forth in Section 6.6 below. 5.3 Limitation on Liability. (a) Notwithstanding anything to the contrary set forth in this Agreement or any of the Ancillary Agreements and except as expressly stated otherwise below, Seller shall not -17- be liable for any amounts with respect to any inaccuracy in or breach or nonfulfillment of any representations, warranties, covenants or agreements set forth in this Agreement or any of the Ancillary Agreements unless and until such amounts shall exceed in the aggregate $25,000 (the "Limitation Amount") (in which case the Seller shall be liable for the full amount of the claims, including the first $25,000). Notwithstanding the foregoing, the Buyer may seek indemnification for claims of fraud or willful misconduct or claims related to the Excluded Liabilities without regard to the Limitation Amount. Notwithstanding the foregoing, in no event shall Seller's liability with respect to any inaccuracy in or breach or nonfulfillment of any representations, warranties, covenants or agreements (except for any liability arising out of Seller's fraud or willful misconduct or the Excluded Liabilities) set forth in this Agreement or any of the Ancillary Agreements exceed the $300,000 in the aggregate. (b) Notwithstanding anything to the contrary set forth in this Agreement or any of the Ancillary Agreements and except as expressly stated otherwise below, Buyer shall not be liable for any amounts with respect to any inaccuracy in or breach or nonfulfillment of any representations, warranties, covenants or agreements set forth in this Agreement or any of the Ancillary Agreements unless and until such amounts shall exceed the Limitation Amount (in which case the Buyer shall be liable for the full amount of the claims, including the first $50,000). Notwithstanding the foregoing, the Seller may seek indemnification for claims of fraud or willful misconduct, claims related to the Assumed Liabilities and claims related to Buyer's failure to fulfill the obligations set forth in Section 1.8 hereof, without regard to the Limitation Amount. Notwithstanding the foregoing, in no event shall Buyer's liability with respect to any inaccuracy in or breach or nonfulfillment of any representations, warranties, covenants or agreements (except for any liability arising out of Buyer's fraud or willful misconduct, the Assumed Liabilities and the obligations set forth in Section 1.8 hereof) set forth in this Agreement or any of the Ancillary Agreements exceed the $300,000 in the aggregate. (c) Neither Buyer or Seller, or any of their affiliates, shall be responsible for any indirect, incidental, punitive, special or consequential damages whatsoever, including loss of profits or goodwill. 5.4 Exclusive Remedy. Except in the event of fraud or willful misconduct, the indemnification remedies and other remedies provided in this Article 5 shall be deemed to be the exclusive remedy for any inaccuracy in or breach or nonfulfillment of any of the representations, warranties, covenants or agreements made by Buyer and Seller in this Agreement or any Ancillary Agreement, irrespective of any other rights that Buyer or Seller may have respect to any matter for which indemnification is provided herein. ARTICLE 6 GENERAL 6.1 Notices. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally or by commercial messenger or courier service, or mailed by certified mail (return receipt requested) or sent via nationally recognized overnight -18- delivery service to the parties at the following addresses (or at such other address for a party as shall be specified by like notice: (a) if to Buyer, to: Verilink Corporation 127 Jetplex Circle Madison, Alabama 35758-8989 Attention: C.W. Smith with a copy to: Powell, Goldstein, Frazer & Murphy, LLP 191 Peachtree Street, 16th Floor Atlanta, GA 30303 Attention: Eliot Robinson, Esq. (b) if to Seller, to: Polycom, Inc. 4750 Willow Road Pleasanton, CA 94588 Attention: General Counsel with a copy to: Wilson Sonsini Goodrich & Rosati 650 Page Mill Road Palo Alto, CA 94304 Attention: Mark A. Bertelsen, Esq. Notices sent via certified mail shall be deemed effective three postal days after deposit in the U.S. mail and those sent via overnight delivery shall be deemed effective upon receipt or refusal. 6.2 Entire Agreement; Assignment. This Agreement, the Ancillary Agreements, the Schedules and Exhibits hereto, the Disclosure Schedule, and the documents and instruments and other agreements among the parties hereto referenced herein, including the NDA: (i) constitute the entire agreement among the parties with respect to the subject matter hereof and supersede all prior agreements and understandings both written and oral, among the parties with respect to the subject matter hereof; (ii) are not intended to confer upon any other person any rights or remedies hereunder; and (iii) shall not be assigned by operation of law or otherwise. 6.3 Severability. In the event that any provision of this Agreement or the application thereof, becomes or is declared by a court of competent jurisdiction to be illegal, void or unenforceable, the remainder of this Agreement will continue in full force and effect and the application of such provision to other persons or circumstances will be interpreted so as reasonably to effect the intent of the parties hereto. The parties further agree to replace such void -19- or unenforceable provision of this Agreement with a valid and enforceable provision that will achieve, to the extent possible, the economic, business and other purposes of such void or unenforceable provision. 6.4 Amendment. This Agreement may be amended by the parties hereto at any time by execution of an instrument in writing signed on behalf of each of the parties hereto. 6.5 Extension; Waiver. At any time prior to the Closing, Buyer, on the one hand, and Seller, on the other hand, may, to the extent legally allowed, (i) extend the time for the performance of any of the obligations of the other party hereto, (ii) waive any inaccuracies in the representations and warranties made to such party contained herein or in any document delivered pursuant hereto, and (iii) waive compliance with any of the agreements or conditions for the benefit of such party contained herein. Any agreement on the part of a party hereto to any such extension or waiver shall be valid only if set forth in an instrument in writing signed on behalf of such party. A waiver by a party of the performance of any covenant, agreement, obligation, condition, representation or warranty will not be construed as a waiver of any other covenant, agreement, obligation, condition, representation or warranty. A waiver by any party of the performance of any act will not constitute a waiver of the performance of any other act or an identical act required to be performed at a later time. 6.6 Dispute Resolution and Applicable Law. (a) The parties shall attempt in good faith to resolve any dispute arising out of or relating to this Agreement. In particular, those executives of the respective parties who have authority to settle the controversy and have direct responsibility for administration of the relationships established pursuant to this Agreement shall attempt in good faith to negotiate a settlement pursuant to the following process: (b) Any party having a dispute or claim shall give the other party written notice stating the nature of the dispute in reasonable detail. Within ten business days after delivery of the notice, the receiving party shall submit to the other a written response also in reasonable detail. Within ten business days after delivery of the written response, decision-makers from both parties shall meet (in person or by telephone) at a mutually acceptable time and place (including telephonic conference), and thereafter as often as they reasonably deem necessary, to attempt to resolve the dispute. All reasonable requests for information made by one party to the other shall be honored. (c) If the matter has not been resolved by the persons referred to above within ten days of the first meeting of such persons, the dispute shall be referred to more senior executives of each party who have authority to settle the dispute and who shall likewise meet (in person or by telephone) to attempt to resolve the dispute. If after such 10 day period the dispute remains unresolved, the parties shall participate in a mediation conducted by a mutually agreed upon mediator. If the parties resolve such dispute either alone or with the aid of the mediator, such resolution shall be binding on the parties and a settlement agreement shall be signed by each party. -20- (d) In the event the parties are unable to resolve such dispute following the mediation procedures provided in Section 6.6(c), either party may avail itself of any remedies available to it, whether at law or in equity, including recourse to any court of competent jurisdiction. Each party shall have the right to apply to a court of competent jurisdiction at any time for a temporary restraining order, preliminary injunction, or other interim or conservatory relief, as necessary, notwithstanding any informal dispute resolution procedures herein. (e) In connection with any court proceeding relating to this Agreement or any Ancillary Agreement, Buyer and Seller hereto irrevocably waive any jury trial. (f) The parties hereto each agree to the jurisdiction of any state or federal court sitting in the State of Delaware and waive personal service of any and all process upon it, and consent that all services of process be made as provided in herein and directed to it at its address as set forth in Section 6.1, and service so made shall be deemed to be completed when received. The parties hereto each waive any objection based on forum non convenience and waive any objection to venue of any action instituted hereunder. Nothing in this paragraph shall affect the right of the parties hereto to serve legal process in any other manner permitted by law. (g) This Agreement and the transactions related hereto shall be governed by the laws of the State of Delaware, without regard for conflicts of laws principles thereof. 6.7 Rules of Construction. The parties hereto agree that they have been represented by counsel to the fullest extent desired by each party during the negotiation and execution of this Agreement and, therefore, waive the application of any law, regulation, holding or rule of construction providing that ambiguities in an agreement or other document will be construed against the party drafting such agreement or document. 6.8 Fees and Expenses. All expenses, including without limitation all legal, accounting, financial advisory, consulting and other fees, incurred in connection with the negotiation or effectuation of this Agreement or consummation of such transactions, shall be the obligation of the respective party incurring such expenses. 6.9 Capitalized Terms. The following capitalized terms shall have the meanings set forth below: (a) "Buyer Competing Business" shall mean the design, development, engineering, and manufacture of a Network Access Device. Notwithstanding the foregoing, Buyer Competing Business shall not include the design, engineering, manufacture, sale or distribution of (1) communication or collaboration products related to application level gateways that connect communication devices to Wide Area Networks, or (2) products which have Network Access Device as part of the functionality of the product (but not the sole functionality of the product). (b) "Buyer Employee Benefit Plan" shall mean any plan, program, policy, practice, contract, agreement or other arrangement providing for compensation, severance, termination pay, deferred compensation, performance awards, stock or stock-related awards, fringe benefits or other employee benefits or remuneration of any kind, whether written, unwritten or otherwise, funded or unfunded, without limitation, each "employee benefit plan," -21- within the meaning of Section 3(3) of ERISA (whether or not ERISA is applicable to such plan), that is or has been maintained, contributed to, or required to be contributed to, by the Buyer, any ERISA Affiliate or any predecessor entity of Buyer for the benefit of any employee of the Buyer of any ERISA Affiliate, or with respect to which Buyer or any ERISA Affiliate has or may have any liability or obligation. (c) "Claims" shall mean any action, suit, claim, proceeding, arbitration, hearing, demand, cause of action, or investigation of any nature pending or, to the knowledge of Buyer or Seller, threatened against either Buyer or Seller, or any event or condition providing a reasonable basis therefor. (d) "Earnout Net Revenues" shall mean revenues generated from the sale, license or other transfer of products related to, derived from, or using the Acquired Assets, the Transferred Intellectual Property Rights, the Transferred Tangible Assets, the Transferred Technology, or Inventory (such products, the "Earnout Products") by the Buyer or by any business unit or subsidiary of Buyer and recognized by Buyer during the Earnout Period (including any revenues generated from services, warranties and maintenance) in accordance with generally accepted accounting principals ("GAAP") and in a manner consistent with Buyer's revenue recognition policies less the sum of amounts (i) collected for sales, use, excise, customs, value-added, withholding or other taxes or duties (other than on net income); (ii) paid or credited for rebates, discounts, returns, refunds or other allowances; (iii) collected for freight, shipping, handling or other transaction fees (including credit card processing fees); and (iv) commissions or other sales incentives. (e) "Earnout Termination Date" shall be the final day of the Earnout Period in which Buyer shall fully satisfy Buyer's payment obligations under Section 1.8(b) hereof (f) "Governmental Entity" means any U.S. court, administrative agency or commission or other U.S. federal, state, county, or local governmental authority, instrumentality, agency or commission. (g) "Intellectual Property Rights" means any or all of the following throughout the world: (i) all patents and applications therefor and all reissues, divisions, renewals, extensions, provisionals, continuations and continuations-in-part thereof ("Patents"); (ii) all inventions (whether patentable or not), invention disclosures and improvements, all trade secrets, proprietary information, know how and technology ("Trade Secrets"); (iii) all works of authorship, copyrights, mask works, copyright and mask work registrations and applications ("Copyrights"); and (iv) all trade names, logos, trademarks and service marks; trademark and service mark registrations and applications and all rights to Uniform Resource Locators, Web site addresses and domain names ("Trademarks"). (h) "Loss" shall mean any loss, damage, judgment, debt, liability, obligation, fine, penalty cost or expense (including and not limited to any legal and accounting fee or expense). (i) "Lien" means, with respect to any asset, any mortgage, lien, pledge, charge, security interest or encumbrance (other than a license) in respect of such asset. -22- (j) "Material Adverse Effect" shall mean any event, change, circumstance or effect that is materially adverse to the business, operations, financial condition, results of operation, assets (including intangible assets) or liabilities of Seller or Buyer, as applicable; provided, however, that none of the following shall be deemed in and of themselves, either alone or in combination, to constitute, and none of the following shall be taken into account in determining whether there has been or will be, a Material Adverse Effect (i) any adverse change, effect, event, occurrence, state of facts or development attributable to conditions generally affecting the industries as a whole in which Seller and Buyer, as applicable, participate, the U.S. economy as a whole or the foreign economies as a whole in any locations where Seller or Buyer, as applicable, has material operations or sales, (ii) any change resulting from the announcement or pendency of the Acquisition or (iii) any material change resulting solely from compliance with the terms of, or the taking of any action explicitly required by, this Agreement. (k) "Network Access Device" means a device that enables communication: (1) between communication devices (e.g. telephones or video conference devices) and network equipment and services in Wide Area Networks (WAN) over a physical connection, and/or (2) between Local Area Networks (LAN) connected to data network devices (e.g. PCs) and network equipment and services in Wide Area Networks (WAN) over a single physical connection. (l) "Non-Compete Period" means the period commencing with the Closing Date and ending on the third (3rd) anniversary thereof. (m) "Permitted Liens" shall mean: (i) Liens for Taxes, assessments and governmental charges due and being contested in good faith by Seller; (ii) Liens for Taxes either not due and payable or due but for which notice of assessment has not been given, or which may thereafter be paid without penalty; (iii) any statutory Liens, charges, adverse claims, security interests or encumbrances of any nature whatsoever claimed or held by any Governmental Entity that have not at the time been filed or registered against title to the Acquired Assets or that relate to obligations that are not due or delinquent; (iv) security given in the ordinary course of business to any public utility, Governmental Entity or statutory or public authority in connection with the Acquired Assets; and (v) any Liens described on Schedule 6.9(m) hereto. (n) "Person" means any individual, partnership, firm, corporation, association, trust, unincorporated organization or other entity, as well as any syndicate or group of any of the foregoing. (o) "Products" means any and all versions and releases of the products and services of Seller related to the Acquired Assets, and any products and services under development by Seller related to the Acquired Assets, and all documentation and training materials related to any of the foregoing. (p) "PTO" means the United States Patent and Trademark Office. (q) "Registered Intellectual Property" means all United States, international and foreign: (i) Patents and Patent applications (including provisional applications); (ii) registered trademarks or service marks, applications to register trademarks, intent-to-use applications, or other registrations or applications related to trademarks or service marks; -23- (iii) registered copyrights and applications for copyright registration; (iv) domain name registrations; and (v) any other Intellectual Property Rights that are the subject of an application, certificate, filing, registration or other document issued, filed with or recorded by any Governmental Entity. (r) "Seller Competing Business" shall mean the design, development, engineering, manufacture, sale or distribution of communications devices including, but not limited to, communications gateways, bridges, call processing servers or other communication devices which incorporate any form of voice, video or data communications capabilities, and that enable communications across and between different types of networks and end-points. Notwithstanding the foregoing, Seller Competing Business shall not include the design, engineering, manufacture, sale or distribution of Network Access Devices. (s) "Seller's Knowledge" means the actual knowledge of David Boyle, Wayne Dunlap, Robert C. Hagerty, Sanjay Idnani, Michael R. Kourey, William R. Paape, Jerry Schwab, Hans Schwarz and Adam Vexler. (t) "Software" means any and all computer software and code, including assemblers, applets, compilers, source code, object code, data (including image and sound data), design tools and user interfaces, in any form or format, however fixed. Software shall include source code listings and documentation. (u) "Tax" or, collectively, "Taxes," means (i) any and all federal, state, local and foreign taxes, and similar assessments and other governmental charges, duties, impositions and liabilities, including taxes based upon or measured by gross receipts, income, profits, sales, use and occupation, and value added, ad valorem, transfer, franchise, withholding, payroll, recapture, employment, excise and property taxes, together with all interest, penalties and additions imposed with respect to such amounts; (ii) any liability for the payment of any amounts of the type described in clause (i) as a result of being a member of an affiliated, consolidated, combined or unitary group for any period; and (iii) any liability for the payment of any amounts of the type described in clause (i) or (ii) as a result of any express or implied obligation to indemnify any other person or as a result of any obligations under any agreements or arrangements with any other person with respect to such amounts and including any liability for taxes of a predecessor entity. (v) "Taxing Authority" means any governmental agency, board, bureau, body, department or authority of any United States federal, state or local jurisdiction or any foreign jurisdiction, having or purporting to exercise jurisdiction with respect to any Tax. (w) "Tax Returns" means any return, report, information return, schedule, certificate, statement or other document (including any related or supporting information) filed or required to be filed with, or, where none is required to be filed with a Taxing Authority, the statement or other document issued by, a Taxing Authority in connection with any Tax. (x) "Technology" shall mean any and all technology, including all know-how, show-how, techniques, design rules, trade secrets, inventions (whether or not patented or patentable), algorithms, routines, software, files, databases, works of authorship, processes, -24- devices, prototypes, schematics, breadboards, netlists, mask works, test methodologies, hardware development tools, any media on which any of the foregoing is recorded and any other tangible embodiments of any of the foregoing but not the Intellectual Property Rights thereto. (y) "Third Party Technology" means any Technology owned by a third Person. (z) "Transferred Contracts" means those contracts, leases, agreements and other instruments listed on Schedule 6.9(z). (aa) "Transferred Intellectual Property Rights" means only those Intellectual Property Rights listed on Schedule 6.9(aa), (including the Registered Intellectual Property Rights listed therein). (bb) "Transferred Tangible Assets" means those tangible assets of Seller listed on Schedule 6.9(bb). (cc) "Transferred Technology" means only that Technology listed on Schedule 6.9(cc), but excludes, in all instances, any Third Party Technology. 6.10 Construction. (a) For purposes of this Agreement, whenever the context requires: the singular number will include the plural, and vice versa; the masculine gender will include the feminine and neuter genders; the feminine gender will include the masculine and neuter genders; and the neuter gender will include the masculine and feminine genders. (b) Any rule of construction to the effect that ambiguities are to be resolved against the drafting party will not be applied in the construction or interpretation of this Agreement. (c) As used in this Agreement, the words "include" and "including" and variations thereof will not be deemed to be terms of limitation, but rather will be deemed to be followed by the words "without limitation." (d) Except as otherwise indicated, all references in this Agreement to "Schedules," "Sections" and "Exhibits" are intended to refer to Schedules, Sections and Exhibits to this Agreement. (e) The headings in this Agreement are for convenience of reference only, will not be deemed to be a part of this Agreement, and will not be referred to in connection with the construction or interpretation of this Agreement. 6.11 NO WARRANTY ON ACQUIRED ASSETS. WITH RESPECT TO ANY AND ALL OF THE ACQUIRED ASSETS, BUYER ACKNOWLEDGES THAT SELLER IS TRANSFERRING SUCH ACQUIRED ASSETS "AS IS" WITHOUT ANY REPRESENTATIONS OR WARRANTIES REGARDING FUNCTIONALITY, PERFORMANCE, USE, OPERATION OR SPECIFICATIONS, AND WITHOUT EXPRESS -25- OR IMPLIED REPRESENTATIONS OR WARRANTIES OF ANY KIND, INCLUDING BUT NOT LIMITED TO THE IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE OR NONINFRINGEMENT (EXCEPT FOR THE EXPRESS REPRESENTATIONS, WARRANTIES AND COVENANTS SET FORTH HEREIN). IN NO EVENT SHALL SELLER BE LIABLE TO BUYER FOR LOSS OF PROFITS, COSTS OF PROCUREMENT OF SUBSTITUTE GOODS, OR OTHER SPECIAL, INDIRECT OR CONSEQUENTIAL DAMAGES WITH RESPECT TO A DEFECT IN SUCH ACQUIRED ASSETS. 6.12 Counterparts. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party, it being understood that all parties need not sign the same counterpart. -26- IN WITNESS WHEREOF, this Asset Purchase Agreement has been executed by the parties hereto as of the date first above written. SELLER POLYCOM, INC. By: /s/ WILLIAM R. PAAPE --------------------------------- Name: William R. Paape Title: Vice President, Treasurer BUYER VERILINK CORPORATION By: /s/ C. W. SMITH --------------------------------- Name: C. W. Smith Title: Vice President & CFO EX-99 4 ex99-1.txt Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Verilink Corporation (the "Company") on Form 10-Q for the period ending December 27, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Leigh S. Belden, President and Chief Executive Officer, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company. /s/ LEIGH S. BELDEN - ------------------------------------- Leigh S. Belden President and Chief Executive Officer (Principal Executive Officer) February 7, 2003 EX-99 5 ex99-2.txt Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Verilink Corporation (the "Company") on Form 10-Q for the period ending December 27, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, C. W. Smith, Vice President and Chief Financial Officer, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company. /s/ C. W. SMITH - -------------------------------------------- C. W. Smith Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) February 7, 2003 -----END PRIVACY-ENHANCED MESSAGE-----