Vertical Xcelerator IP™ Wins 2007 TMC Labs Innovation Award

CAMBRIDGE, Mass., February 21, 2008 – Vertical Communications (VRCC.OB) (“Vertical”), a leading provider of next-generation, IP-based phone systems and applications that help businesses better serve their customers, announced today its financial results for the second quarter of fiscal 2008, which ended December 31, 2007.

For the second quarter of fiscal 2008, Vertical reported net revenue of $18.7 million, compared to net revenue of $18.1 million during the same quarter of fiscal 2007, an increase of 3%. For the six months ended December 31, 2007, Vertical reported net revenue of $38.4 million, compared to net revenue of $34.0 million during the six months ended December 31, 2006.  The increase in revenue is attributable to the acquisition of Vodavi Technology, Inc. (“Vodavi”), which was completed on December 1, 2006.  

Cost of sales for the second quarter of fiscal 2008 was $10.1 million, compared to $9.4 million during the same quarter of fiscal 2007, an increase of 7%.  For the six months ended December 31, 2007, cost of sales was $20.8 million, compared to cost of sales of $17.2 million during the six months ended December 31, 2006.

Gross profit for the second quarter of fiscal 2008 (46% of net revenue) and the second quarter of fiscal 2007 (48% of net revenue) was $8.7 million.  For the six months ended December 31, 2007, gross profit was $17.6 million (46% of net revenue), compared to $16.8 million (49% of net revenue)  for the same period in fiscal 2006.  The decrease in gross profit percentage is primarily attributable to the acquisition of Vodavi, whose products yield a lower gross profit than other Vertical product lines.

Operating expenses for the second quarter of fiscal 2008 were $13.4 million, compared to $11.0 million during the same quarter in fiscal 2007, an increase of 22%.  Operating expenses for the six months ended December 31, 2007 were $26.7 million compared to $22.1 million for the same period in fiscal 2006, an increase of 21%. This increase in operating expenses for both periods under review is attributable to the acquisition of Vodavi operations and to increased non-cash compensation charges related to stock option and restricted stock grants as discussed below, offset by a decrease in overall operating expenses from elimination of redundancies related to the acquisition of the operations of Vodavi.  Operating expenses include non-cash compensation charges relating to stock options and restricted stock grants of $1.7 million and $3.3 million, respectively, for the three and six months ended December 31, 2007 compared to $1.0 million $2.0 million, respectively for the same periods of fiscal 2007. Additionally, operating expenses include accruals for liquidated damages associated with certain shareholder-related registration right obligations of $0 for the three and six months ended December 31, 2007 compared to $0 and $0.6 million, respectively, for the same periods in fiscal 2007.

Loss from operations for the second quarter of fiscal 2008 was $4.8 million compared to $2.3 million for the same quarter of fiscal 2007.  Loss from operations for the six months ended December 31, 2007 was $9.1 million compare to $5.3 million for the same period of fiscal 2007.

Interest expense for the three and six months ended December 31, 2007 was $0.7 million and $1.4 million, respectively, compared with $1.2 million and $1.4 million, respectively, for the three and six months ended December 31, 2006.

Vertical reported GAAP net loss to common shareholders for the second quarter of fiscal 2008 of $6.5 million, or $0.13 cents per share, compared to GAAP net loss to common shareholders of $3.9 million, or $0.08 cents per share, during the same quarter of fiscal 2007.   For the six months ended December 31, 2007, Vertical reported GAAP net loss to common shareholders of $11.8 million, or $0.23 cents per share, compared to GAAP net loss to common shareholders of $7.4 million, or $0.16 cents per share for the same period in fiscal 2007.

GAAP net loss includes the impact of non-cash compensation charges, liquidated damages provisions and amortization related to intangible assets acquired in the acquisitions of Vertical Networks, Inc., Comdial Corporation and Vodavi.

Vertical’s cash and cash equivalents (including restricted cash), deferred revenue, total liabilities and shareholders’ equity balances at December 31, 2007 were $3.6 million, $13.0 million, $61.0 million and $30.6 million, respectively.  

Non-GAAP Disclosures

Certain disclosures prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) included in this release are accompanied by disclosures that are not prepared in conformity with GAAP. Management has determined that inclusion of these disclosures provides investors a meaningful presentation of the Company’s operating results in addition to the GAAP disclosure. These non-GAAP condensed consolidated statements of operations are provided to enhance overall understanding of our current financial performance and how management views our operating results. The presentation of this non-GAAP information is not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP and is not necessarily comparable to non-GAAP results published by other companies. These non-GAAP disclosures and management’s rationale for providing them are as follows:

SFAS 123R Expenses. The reported GAAP net loss to common shareholders for the quarters ended December 31, 2007 and 2006 includes costs related to the expensing of stock options and restricted stock grants in accordance with Statement of Financial Accounting Standards (SFAS) No. 123R “Share Based Payments,” which the Company adopted on July 1, 2005. The guidance on the impact of adopting SFAS No. 123R presumes that all unvested options and restricted stock are equity awards and are accounted for based on the guidance provided in the FASB staff position FAS 123R. Given the significance and non-cash nature of these expenses relative to the operating results for the periods presented, this expense has been excluded from the non-GAAP presentation of our operating results herein.  SFAS 123R costs totaled $1.7 million and $1.0 million in the quarters ended December 31, 2007 and 2006, respectively, as noted in the table below.

Amortization of Acquired Intangible Assets.  The reported GAAP net loss to common shareholders for the quarters ended December 31, 2007 and 2006 includes non-cash amortization expense related to the Company’s intangible assets acquired in the acquisitions of Vertical Networks, Inc., Comdial and Vodavi. These assets include trade names, customer and supplier relationships and existing technology. Given the significance and non-cash nature of these expenses relative to the operating results for the periods presented, this expense has been excluded from the non-GAAP presentation of our operating results herein. Amortization related to acquired intangible assets totaled $0.7 million and $0.5 million in the quarters ended December 31, 2007 and 2006, respectively, as noted in the table below.

The following table reconciles net loss on a GAAP basis for the quarters ended December 31, 2007 and 2006 to non-GAAP earnings before interest, taxes, depreciation and amortization, which exclude the effects of (1) SFAS 123R Expenses, (2) the impact of liquidated damages provisions with certain shareholder-related registration right obligations and (3) the impact of amortization related to the acquired intangible assets, each as discussed above:

“Overall, we were disappointed with our quarterly operating results. We had a large sale that moved out into a future quarter and our small key system business had a meaningful decline in the quarter. We believe we will capture the large sale in the near future and we have an exciting new product introduction in the small system market that we expect will again give us product leadership in that segment. Additionally, we remain excited about the opportunities provided by the recent launch of Wave IP 2500™, our next-generation IP business communications and applications platform. Sales results for Wave in the first two months after its launch have exceeded our expectations,” stated Bill Tauscher, chief executive officer.

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