FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________________ to _____________________
Commission File Number: 0-23110
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DIGITAL LINK CORPORATION
(Exact name of registrant as specified in its charter)
California 77-0067742
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
217 Humboldt Court, Sunnyvale, California 94089
(Address of principal executive offices, including zip code)
(408) 745-6200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 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
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The number of shares outstanding of the registrant's common stock at April 30,
1996 was 9,060,092.
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DIGITAL LINK CORPORATION
INDEX TO FORM 10-Q
Page
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PART I - FINANCIAL INFORMATION:
ITEM 1 - Financial Statements
Consolidated Balance Sheets as of March 31, 1996
and December 31, 1995 3
Consolidated Statements of Income for the three months
ended March 31, 1996 and March 31, 1995 4
Consolidated Statements of Cash Flows for the three months
ended March 31, 1996 and March 31, 1995 5
Notes to Consolidated Financial Statements 6
ITEM 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II - OTHER INFORMATION
ITEM 1 - Legal Proceedings 17
ITEM 2 - Changes in Securities 17
ITEM 3 - Defaults Upon Senior Securities 17
ITEM 4 - Submission of Matters to a Vote of Security Holders 17
ITEM 5 - Other Information 17
ITEM 6 - Exhibits and Reports on Form 8-K 17
SIGNATURE(S) 19
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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share amounts)
- - --------------------------------------------------------------------------------
March 31, Dec. 31,
1996 1995
---- ----
ASSETS (Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 9,000 $ 2,639
Short-term marketable securities 10,495 16,726
Accounts receivable, net 6,475 7,690
Inventories 4,493 4,603
Prepaid and other current assets 2,834 2,807
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Total current assets 33,297 34,465
Property and equipment, net 1,719 1,608
Long-term marketable securities 19,453 18,244
Other assets 439 438
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TOTAL ASSETS $54,908 $54,755
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,623 $ 1,371
Accrued payroll expense 1,426 1,433
Other accrued expenses 2,426 2,751
Income taxes payable 1,328 1,427
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Total current liabilities 6,803 6,982
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SHAREHOLDERS' EQUITY:
Preferred stock, no par value:
Authorized: 5,000,000 shares;
Issued and outstanding: none
Common stock, no par value:
Authorized: 25,000,000 shares;
Issued and outstanding: 9,010,800 shares in 1996
and 9,000,500 shares in 1995 29,338 29,283
Unrealized gain/(loss) on marketable securities 277 555
Retained earnings 18,490 17,935
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Total shareholders' equity 48,105 47,773
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $54,908 $54,755
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The accompanying notes are an integral part of these
consolidated financial statements.
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DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
FOR THE THREE MONTHS ENDED
MARCH 31, 1996 AND 1995
(Amounts in thousands, except per share amounts)
- - --------------------------------------------------------------------------------
Three Months Ended
March 31,
----------------------
1996 1995
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REVENUES:
Net sales $10,203 $10,415
Cost of sales 4,366 3,572
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Gross profit 5,837 6,843
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EXPENSES:
Research and development 2,050 2,204
Selling, general and administrative 3,584 3,436
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Total operating expenses 5,634 5,640
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Operating income 203 1,203
Other income 633 598
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Income before provision for income taxes 836 1,801
Provision for income taxes 280 558
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NET INCOME $ 556 $1,243
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NET INCOME PER SHARE $ 0.06 $ 0.13
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Shares used in computing per share amounts 9,352 9,445
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The accompanying notes are an integral part of these
consolidated financial statements.
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DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 1996 AND 1995
(Amounts in thousands)
- - --------------------------------------------------------------------------------
Three Months Ended
March 31,
---------------------
1996 1995
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 556 $ 1,243
Adjustments to reconcile net income to net cash flows
provided by operating activities:
Depreciation and amortization 315 346
Provision for doubtful accounts 20 38
Provision (reduction in allowance) for excess and
obsolete inventories 41 (80)
Changes in assets and liabilities:
Accounts receivable 1,195 1,460
Inventories 69 (134)
Prepaid and other assets (28) (23)
Accounts payable 252 (74)
Accrued payroll and other accrued expenses (336) (38)
Income taxes payable (95) 1,025
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Net cash flows provided by operating activities 1,989 3,763
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (13,753) (20,197)
Maturities of marketable securities 18,496 13,528
Acquisition of property and equipment (426) (447)
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Net cash flows provided by (used in) investing
activities 4,317 (7,116)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 55 83
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Net cash flows provided by financing activities 55 83
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Net increase (decrease) in cash and cash equivalents 6,361 (3,270)
Cash and cash equivalents at beginning of period 2,639 4,638
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Cash and cash equivalents at end of period $ 9,000 $ 1,368
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for income taxes $ 379 $ 29
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Unrealized gain on securities carried at market $ 277 $ 301
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
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DIGITAL LINK CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared
by the Company without audit in accordance with generally accepted
accounting principles for interim financial information and pursuant to
rules and regulations of the Securities and Exchange Commission. In the
opinion of management, all adjustments (consisting of only normal
recurring adjustments) considered necessary for a fair representation
have been included. These financial statements should be read in
conjunction with the Company's consolidated financial statements and
notes thereto contained in the Company's Annual Report on Form 10-K,
which was filed with the Securities and Exchange Commission on March
28, 1996.
The year-end balance sheet at December 31, 1995 was derived from
audited financial statements, but does not include all disclosures
required by generally accepted accounting principles.
Operating results for the three months ended March 31, 1996 may not
necessarily be indicative of the results to be expected for any other
interim period or for the full year.
2. COMPUTATION OF NET INCOME PER SHARE
Net income per share is computed using the weighted average number of
common and dilutive common equivalent shares outstanding during the
period. Dilutive common equivalent shares consist of stock options
(using the treasury stock method for all periods presented).
3. INVENTORIES
Inventories are valued at the lower of cost (determined using the
first-in, first-out method) or market. Inventories consisted of (in
thousands):
March 31, 1996 December 31, 1995
(Unaudited)
-------------- -----------------
Raw materials $ 2,660 $ 1,838
Work-in-process 1,122 1,965
Finished goods 711 800
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$ 4,493 $ 4,603
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4. CONTINGENCY
Certain third parties have expressed their belief that certain of the
Company's products may infringe patents held by them and have suggested
that the Company acquire licenses to such patents. The Company believes
that licenses, to the extent required, will be available; however, no
assurance can be given that the terms of any offered licenses would be
favorable to the Company. Management, after review and consultation
with counsel, believes that the ultimate resolution of these
allegations are uncertain and there can be no assurance that these
assertions will be resolved without costly litigation or in a manner
that is not adverse to the Company. Accordingly, while the Company has
accrued certain amounts for these matters, the ultimate resolution of
these matters could result in payments in excess of the amounts accrued
in the accompanying financial statements and require royalty payments
in the future which could adversely impact gross margins.
In April 1996, a class action complaint was filed against the Company
and certain of its officers and directors in the Superior Court of the
State of California, alleging violations of the California Corporations
Code and California Civil Code. The class period covers from September
12, 1994 through December 29, 1995, and the allegations include claims
that the defendants concealed and/or misrepresented material adverse
information about the Company and that the individual defendants sold
shares of the Company's stock based upon material nonpublic
information. The complaint seeks damages in an unspecified amount. The
Company believes that the action is without merit and intends to defend
against it vigorously. Litigation is subject to inherent uncertainties
and, thus, there can be no assurance that this suit will be resolved
favorably to the Company or will not have a material adverse effect on
the Company's financial condition and results of operations.
Accordingly, no provision for any liability that may result upon
adjudication has been made on the accompanying financial statements.
5. CHANGE IN DEPRECIATION METHOD
Effective January 1, 1996, the Company adopted the straight-line method
of depreciation for all property and equipment placed in service after
that date. Property and equipment placed in service prior to January 1,
1996 continue to be depreciated using the double-declining balance
method. The estimated useful lives under either method ranges from 3 to
5 years. Management believes that the change from the double-declining
balance method to the straight-line method provides a better matching
of costs and revenues over the lives of its property and equipment and
conforms to predominant industry practice. Use of the straight-line
method of depreciation on assets placed in service in 1996 versus the
double-declining balance method resulted in no material difference on
the pre-tax income or net income in the first quarter of 1996.
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6. RECENT ACCOUNTING PRONOUNCEMENT
During October 1995, the Financial Accounting Standards Board issued
Statement No. 123 (SFAS No. 123), "Accounting for Stock-Based
Compensation," which establishes a fair value based method of
accounting for stock-based compensation plans. The Company intends to
continue to account for employee stock options under APB Opinion No.
25, "Accounting for Stock Issued to Employees." SFAS 123 is effective
for fiscal years beginning after December 15, 1995 and will require
certain additional disclosures in the financial statements for the year
ending December 31, 1996.
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DIGITAL LINK CORPORATION
ITEM 2. Management's Discussion And Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
Net Sales
Except for the historical statements contained herein, this Form 10-Q contains
forward looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended. These forward looking statements involve a
number of risks and uncertainties, such as the impact of competitive products
and pricing, the Company's timely development of new products, including its
W/ATM GateWay product, and their acceptance by the market, delays in the
deployment of and confusion regarding various evolving technologies, such as
SMDS, ATM and Frame Relay, the loss of, or differences in actual from
anticipated levels of purchases from, the Company's major customers, and other
risks which are described throughout the Company's reports filed with the
Securities and Exchange Commission, including its Form 10-K for the year ended
December 31, 1995, and within this "Management's Discussion and Analysis of
Financial Condition and Results of Operations," including under the title "Other
Factors That May Affect Future Operating Results." The actual results that the
Company achieves may differ materially from any forward looking statements due
to such risks and uncertainties. The Company has identified by an asterisk (*)
various paragraphs within this "Management's Discussion and Analysis of
Financial Condition and Results of Operations," which contain such forward
looking statements. Actual results could differ materially from such forward
looking statements as a result of the factors discussed in such paragraphs and
those factors discussed in the sections referenced above and in other sections
of this and other documents filed with the Securities and Exchange Commission.
In addition, when used in this Form 10-Q, words such as "believes,"
"anticipates," "expects," "intends" and similar expressions are intended to
identify forward looking statements, but are not the exclusive means of
identifying such statements. The Company undertakes no obligation to revise any
forward looking statements in order to reflect events or circumstances that may
arise after the date of this report.
Net sales for the first quarter of 1996 decreased 2% to $10,203,000 from
$10,415,000 for the same period of the prior year. This decrease in net sales
over the prior year's first quarter was primarily attributable to a decrease in
unit sales of the Company's broadband products (products with transmission rates
greater than T1, including the Company's inverse multiplexer products and its
SMDS and ATM access products that operate at these higher transmission rates),
in particular its broadband SMDS access products. This decrease was offset in
part by increased unit sales of the Company's narrowband products (products with
transmission rates of T1 and slower, including most of the Company's Encore
products and its Frame Relay and SMDS access products that operate at these
slower transmission rates),
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in particular its Encore family of products, resulting from increased sales
to Internet Service Providers.
*The Company believes that the decrease in sales of broadband SMDS access
products is due in part to delays in Europe, and in particular in the United
Kingdom, in the further deployment of the SMDS network due to technical problems
within the network and to market confusion among Frame Relay, SMDS and ATM
technologies. The Company anticipates that these market conditions will continue
through at least the first half of 1996, which will result in lower levels of
sales of its broadband SMDS access products as compared to sales in the first
half of 1995.
*During the first quarter of 1996, the Company also experienced decreased demand
from certain domestic carrier customers, in particular with respect to its
broadband products. The Company anticipates a lower level of demand from these
customers through at least the first half of 1996 as a result of the level of
supply of the Company's products within these carriers' infrastructures.
*As a result of the factors discussed above, the Company anticipates that its
net sales for the second quarter of 1996 may remain at levels similar to the
last quarter of 1995 and the first quarter of 1996, although no assurances can
be given that such levels of sales will be maintained.
*Narrowband sales in absolute dollars increased by 59% and increased to 72% of
net sales in the first quarter of 1996 as compared to 44% in the first quarter
of 1995. Broadband sales decreased in absolute dollars by 51% and decreased as a
percentage of net sales to 28% in the first quarter of 1996 as compared to 56%
in the first quarter of 1995. The percentage changes in narrowband sales and
broadband sales as a percentage of net sales were primarily due to lower sales
in Europe of broadband products as well as lower broadband sales to certain
domestic carrier customers, as discussed above. As indicated above, the Company
anticipates lower levels of broadband sales through at least the first half of
1996 as compared to the levels experienced during the first half of 1995.
*International sales represented 12% of net sales in the first quarter of 1996
as compared to 39% in the first quarter of fiscal 1995. This decrease was
primarily due to a decrease in unit sales of SMDS products in Europe. For the
reasons discussed above, the Company anticipates that international sales of its
SMDS access products will decrease as a percentage of net sales during at least
the first half of 1996, as compared to the first half of 1995, which would
result in a decrease in international sales as a percentage of net sales for
such period. International sales are subject to inherent risks, including longer
payment cycles, gains and losses on the conversion of U.S. dollars, 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, which may in the future
contribute to fluctuations in the Company's business and operating results.
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*During the first quarter of 1996, sales to BBN Planet Corporation and MCI
accounted for 28% and 11%, respectively, of the Company's net sales. The Company
anticipates that sales to BBN Planet Corporation will decrease as a percentage
of net sales and may decrease in absolute dollars in the second quarter of 1996
as a result of fluctuations in activities associated with the build out of its
Internet infrastructure.
Gross Profit
*Gross profit decreased 15% in the first quarter of 1996 to $5,837,000 from
$6,843,000 for the same period of the prior year. Gross margin decreased to
57.2% of net sales in the first quarter of 1996 as compared to 65.7% in the
first quarter of 1995. This decrease in gross margin primarily resulted from a
shift in the mix of products sold to include more narrowband products, which
have lower gross margins than broadband products. Gross margins may vary
significantly from quarter to quarter depending on factors such as competitive
pricing pressures, changes in the mix of products sold and the channels through
which they are distributed, the timing of orders and the timing of new product
introductions by the Company. The Company anticipates that its gross margins for
the second quarter of 1996 will remain relatively flat as compared to the first
quarter of 1996, but could be adversely affected by the factors discussed above,
in particular any required reductions in the prices of the Company's products to
address competition.
Research and Development
*Research and development (R&D) expenses decreased 7% to $2,050,000 in the first
quarter of 1996 from $2,204,000 in the first quarter of 1995. As a percentage of
net sales, R&D expenses were 20.1% in the first quarter of 1996 as compared to
21.2% in the first quarter of 1995. These decreases are due primarily to lower
materials costs for prototype products and reduced use of professional services,
offset by an increase in consulting fees primarily related to its W/ATM GateWay
product. The Company anticipates that its R&D expenses, especially consulting
expenses related to its W/ATM GateWay product, will increase in absolute dollars
and may increase as a percentage of net sales subject to, among other factors
set forth or referenced in "Net Sales" above and "Other Factors That May Affect
Future Operating Results" below the Company's ability to accelerate or defer
operating expenses, achieve revenue levels during such period and hire new
personnel during the remainder of 1996.
All of the Company's R&D expenditures to date have been expensed as incurred. In
the future, the Company may be required to capitalize a portion of its software
development costs pursuant to Statement of Financial Accounting Standards No.
86, "Accounting for Costs of Computer Software to be Sold, Leased or Otherwise
Marketed."
Selling, General and Administrative
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Selling, general and administrative (SG&A) expenses increased 4% in the first
quarter of 1996 to $3,583,000 from $3,436,000 for the same period of the prior
year. As a percentage of net sales, SG&A expenses were 35.1% in the first
quarter of fiscal 1996 as compared to 32.9% in the first quarter of fiscal 1995.
The absolute dollar increase was primarily due to increased personnel-related
expenses and customer support-related costs. The increase as a percentage of
sales was due to this absolute dollar increase as well as lower levels of
revenue.
*The Company has in the past hired more of its SG&A personnel and incurred
increased expenses related to trade shows and other promotional activities
during the first half of the year. Accordingly, SG&A expenses as a percentage of
net sales are generally higher during the first half of the year, and the
Company anticipates that this will be true for the first half of 1996. The
Company anticipates that its SG&A expenses will increase in absolute dollars and
may increase as a percentage of net sales during 1996 as a result, in part, of
increases in legal expenses associated with its defense of the recently filed
class action lawsuit against the Company.
Other Income
Net other income increased 6% in the first quarter of 1996 to $633,000 from
$598,000 for the same period of the prior year. This increase was primarily due
to higher interest income due to higher cash balances.
Provision for Income Taxes
*The Company's effective tax rate increased to 33.5% for the first quarter of
1996 compared to 31% for the first quarter of 1995. This increase was due
primarily to the prior use of the Company's R&D tax credit. The Company
anticipates that its effective tax rate during the remainder of 1996 will remain
at levels similar to that experienced in the first quarter of 1996, subject to
the elimination of the Company's R&D tax credit.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $26.5 million and cash, cash equivalents and
marketable securities of $38.9 million at March 31, 1996. Net cash provided by
operating activities was $2.0 million for the first quarter of 1996 primarily as
a result of a decrease in accounts receivable and net income before depreciation
and amortization, offset to some extent by a decrease in accrued payroll and
other accrued expenses. This compares to net cash provided by operating
activities of $3.8 million for the first quarter of 1995 primarily as a result
of a decrease in accounts receivable, net income before depreciation and
amortization and an increase in income taxes payable. Cash provided by investing
activities during the first quarter of 1996 was primarily from the maturity of
marketable securities. Leasehold improvements and capital equipment additions
were $426,000 in the first quarter of 1996 as compared to $447,000 in the first
quarter of 1995. Net cash
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provided by financing activities was $55,000 in the first quarter of 1996 from
the exercise of stock options, as compared to $83,000 in the first quarter of
1995.
*The Company believes that existing cash and cash flows from operations will be
sufficient to meet its anticipated cash requirements for working capital and
capital expenditures for at least the next 12 months.
OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
*As indicated above, there are a number of factors that may affect the Company's
future operating results. In addition, a significant portion of the Company's
business is derived from substantial orders placed by large end users and
telephone companies, and the timing of such orders could cause material
fluctuations in the Company's business and operating results. For example, in
the fourth quarter of 1995, the Company had lower operating results than
expected due in part to a weaker than expected demand from certain domestic
carrier customers, as well as the slow down of sales of its SMDS access
products.
*The Company believes that changes in the product mix sold toward narrowband
products that yield lower gross margins have in the past and could in the future
affect operating results. In addition, a significant portion of the Company's
business is very price competitive, which has in the past and may in the future
require the Company to lower its prices, resulting in fluctuations in the
Company's business and operating results. For example, in the first quarter of
1995, the Company reduced the prices on some of its access products to address
competitive pricing pressures, which adversely affected the Company's gross
margins during 1995. Other factors that may cause fluctuations in the Company's
operating results include changes in sales volumes through the Company's
distribution channels, seasonal capital spending patterns of large domestic
customers, the gain or loss of significant customers, the timing of new product
announcements and introductions by the Company and its competitors, market
acceptance of new or enhanced versions of the Company's products, availability
and cost of components from the Company's suppliers (some of which are in short
supply and are key to new product development), and economic conditions
generally or in various geographic areas. In addition, the Company's expense
levels are based in part on its expectations of future revenue. The Company
typically operates with limited order backlog, and a substantial majority of its
revenues in each quarter result from orders booked in that quarter. The Company
has occasionally recognized a substantial portion of its revenues in a given
quarter from sales booked and shipped in the last month of that quarter. If
revenue levels are below expectations, the Company may be unable to adjust
spending in a timely manner, which could adversely affect operating results.
*The Company's future prospects will also depend in part on its ability to
enhance the functionality of its existing WAN access products in a timely manner
and to identify, develop and achieve market acceptance of new products that
address new technologies and meet customer needs in the WAN access market. Any
failure by the Company to anticipate or to respond adequately to technological
developments in its industry, changes in customer requirements, or changes in
regulatory
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requirements or industry standards, or any significant delays in the
development, introduction or shipment of products, could have a material adverse
effect on the Company's business and operating results. For example, the Company
has experienced decreased sales of its SMDS and ATM access products, which the
Company believes is due in part to delays in the further deployment of SMDS
networks due to technical problems within the networks and to market confusion
in Europe among Frame Relay, SMDS and ATM technologies. There can be no
assurance that the Company's product development efforts will result in
commercially successful products or that product delays will not result in
missed market opportunities. In addition, customers could refrain from
purchasing the Company's existing products in anticipation of new product
introductions by the Company or its competitors. New products could also render
certain of the Company's existing products obsolete. Any of these events could
materially adversely affect the Company's business and operating results.
*The Company believes that its future success will depend in large part upon the
continued contributions of members of the Company's senior management and other
key personnel, and upon its ability to attract and retain highly skilled
managerial, engineering, sales, marketing and operations personnel, the
competition for whom is intense. In October 1995, Daniel L. Palmer, the
Company's President and Chief Operating Officer, resigned to pursue other
interests. Vinita Gupta resumed the duties of President upon Mr. Palmer's
departure, and the Company recently began searching for an individual to succeed
Ms. Gupta as President. There can be no assurance that the Company will be
successful in attracting and retaining skilled personnel to hold this or other
important positions. In addition, certain of the Company's key management
personnel have only recently joined the Company.
*The Company is currently developing and may in the future develop products with
which the Company has only limited exposure and/or that are targeted at emerging
market segments, including the Company's W/ATM GateWay product. The W/ATM
GateWay product has not been deployed to end user customers, and the Company has
experienced delays in the development of this product, in part related to
technical problems which required some software to be redesigned. The Company
has entered into an agreement with an OEM to market this product once its
development has been completed, but such agreement does not obligate the OEM to
purchase any minimum number of products. An agreement with AT&T Network Systems
to market the W/ATM GateWay under that company's name expired in September 1995.
According to the Company's current plan, this product is not anticipated to be
available for customer evaluation before the fourth quarter of 1996. Given its
complexity, there can be no assurance that this product will not encounter
further technical or other difficulties which could significantly delay its
deployment or acceptance or could result in the termination of the development
program for this product. There can be no assurance that markets for the W/ATM
GateWay will continue to develop, that the W/ATM GateWay will meet the needs of
the emerging ATM market or that products currently under development by others
will not be introduced that would directly compete with the W/ATM GateWay
product, any of which could have a material adverse effect on the Company's
business, operating results or financial condition.
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*The market for the Company's products is highly competitive. The Company
expects competition to increase in the future from existing competitors and from
other companies that may enter the Company's existing or future markets. The
Company anticipates that it will face competition from internetworking equipment
and other telecommunications equipment manufacturers, certain of whom are
including a direct WAN interface in their products. For example, in 1995, the
Company signed an OEM agreement with Cisco Systems, Inc. ("Cisco") pursuant to
which the Company supplies DSU cards for inclusion in one of Cisco's key product
lines. Increased sales to Cisco or other internetworking equipment and
telecommunications equipment manufacturers could adversely affect the Company's
gross margins, as sales to OEMs generally have higher discounts than sales to
end users. Further, to the extent that these internetworking equipment and
telecommunications equipment manufacturers independently develop a direct WAN
interface for inclusion in their products, overall demand for the Company's
products would be reduced, which would have a material adverse effect on the
Company's business and operating results. As discussed above, increased
competition has also placed increasing pressures on the pricing of the Company's
products, which has resulted in lower operating results. The Company anticipates
that this increased pricing pressure will continue during 1996.
*As discussed under "Legal Proceedings" in Part II hereof, in April 1996, a
class action complaint was filed against the Company and certain of its officers
and directors in the Superior Court of the State of California alleging
violations of the California Corporations Code and California Civil Code. The
class period covers from September 12, 1994 through December 29, 1995, and the
allegations include claims that the defendants concealed and/or misrepresented
material adverse information about the Company and that the individual
defendants sold shares of the Company's stock based upon material nonpublic
information. The complaint seeks damages in an unspecified amount. The Company
believes that the action is without merit and intends to defend against it
vigorously. However, litigation is subject to inherent uncertainties and thus
there can be no assurance that this suit will be resolved favorably to the
Company or will not have a material adverse effect on the Company's financial
condition and results of operations.
*The telecommunications industry is characterized by the existence of a large
number of patents and frequent litigation based on allegations of patent
infringement. For example, a third party has expressed its belief that certain
of the Company's products, including its CSU/DSUs, may infringe upon six patents
held by it and has suggested that the Company acquire a license to such patents.
The Company recently received further notice from this third party reiterating
its demand that the Company obtain a license for these patents. There can be no
assurance that these assertions will be resolved without costly litigation or in
a manner that is not adverse to the Company. The Company believes that a
license, to the extent required, will be available; however, no assurance can be
given that the terms of any offered license would be favorable to the Company.
Should a license be unavailable, the Company could be required to discontinue
the sale of or to redesign certain of its products. In addition, Larscom, a
competitor of the Company, has continued to express its belief that the
Company's inverse
15
<PAGE>
multiplexer products may infringe a patent jointly owned by Larscom and a third
party and has suggested that the Company acquire a license to the patent. There
can be no assurance that other third parties will not assert infringement claims
against the Company in the future, that any such claims will not result in
costly litigation or that the Company will prevail in any such litigation or be
able to license any valid and infringed patents from third parties on
commercially reasonable terms. The Company's management, after review and
consultation with counsel, believes that the ultimate resolution of these
allegations are uncertain and there can be no assurance that these assertions
will be resolved without costly litigation or in a manner that is not adverse to
the Company. Accordingly, while the Company has accrued certain amounts for
these matters, the ultimate resolution of these matters could result in payments
in excess of the amounts accrued in the Company's financial statements and
require royalty payments in the future which could adversely impact gross
margins.
*The risks outlined herein are difficult for the Company to forecast, and these
or other factors can materially affect the Company's operating results and stock
price for one quarter or a series of quarters. Further, in recent years the
stock market has experienced extreme price and volume fluctuations that have
particularly affected the market prices of securities of many high technology
companies, for reasons frequently unrelated to the operating performance of the
specific companies. These fluctuations, as well as general economic, political
and market conditions, may materially adversely affect the market price of the
Company's common stock.
*During October 1995, the Financial Accounting Standards Board issued Statement
No. 123 (SFAS No. 123), "Accounting for Stock-Based Compensation," which
establishes a fair value based method of accounting for stock-based compensation
plans. The Company intends to continue to account for employee stock options
under APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123
is effective for fiscal years beginning after December 15, 1995 and will require
certain additional disclosures in the financial statements for the year ending
December 31, 1996.
16
<PAGE>
PART II. OTHER INFORMATION
- - ------- -----------------
ITEM 1. LEGAL PROCEEDINGS
- - ------ -----------------
On April 22, 1996, a class action complaint was filed in the Superior Court of
the State of California, Santa Clara County against the Company, certain of its
officers and directors and Bear Stearns & Co. Inc., alleging violations of the
California Corporations Code and California Civil Code. The class period covers
from September 12, 1994 through December 29, 1995, and the allegations include
claims that the defendants concealed and/or misrepresented material adverse
information about the Company and that the individual defendants sold shares of
the Company's stock based upon material nonpublic information. The complaint
seeks damages in an unspecified amount, including compensatory and/or punitive
damages, pre-judgment and post-judgment interest, reasonable attorneys' fees,
expert witness fees and other costs and extraordinary, equitable and/or
injunctive relief as permitted by law. The Company believes that the action is
without merit and intends to defend against it vigorously. However, litigation
is subject to inherent uncertainties and thus there can be no assurance that
this suit will be resolved favorably to the Company or will not have a material
adverse effect on the Company's financial condition and results of operations.
ITEM 2. CHANGES IN SECURITIES
- - ------ ---------------------
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- - ------ --------------------------------
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- - ------ ---------------------------------------------------
Not applicable.
ITEM 5. OTHER INFORMATION
- - ------ -----------------
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- - ------ --------------------------------
(a) Exhibits
11.01 Statement of Computation of Net Income Per Share.
18.01 Letter from Coopers & Lybrand L.L.P. Regarding Change in
Accounting Principle.
27.01 Financial Data Schedule.
(b) Reports on Form 8-K
17
<PAGE>
There were no reports on Form 8-K filed during the quarter ended March
31, 1996.
18
<PAGE>
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.
DIGITAL LINK CORPORATION
Date: May 14, 1996 /s/ Vinita Gupta
----------------------
Vinita Gupta
Chief Executive Officer
Date: May 14, 1996 /s/ Stanley Kazmierczak
-----------------------------
Stanley Kazmierczak
Chief Financial Officer
19
<PAGE>
EXHIBIT INDEX
Sequential
Exhibits Page No.
- - -------- --------
11.01 Statement of Computation of Net Income Per Share. 21
18.01 Letter from Coopers & Lybrand L.L.P. Regarding Change 22
in Accounting Principle.
27.01 Financial Data Schedule. 23
20
Exhibit 11.01
DIGITAL LINK CORPORATION
STATEMENT OF COMPUTATION OF NET INCOME PER SHARE
(In thousands, except per share data, unaudited)
Quarter Ended
March 31, March 31,
1996 1995
---- ----
Primary:
Net income $ 556 $1,243
====== ======
Weighted average number of shares from:
Common shares outstanding 9,007 8,659
Common equivalent shares from
stock options outstanding 345 786
------ ------
Common and common equivalent
shares used in computing per
share amounts 9,352 9,445
====== ======
Net income per share $ 0.06 $ 0.13
====== ======
Note: There is no material difference in the computation of net income per share
on a fully diluted basis.
Exhibit 18.01
DIGITAL LINK CORPORATION
217 Humboldt Court
Sunnyvale, CA 94089
We are providing this letter to you for inclusion as an exhibit to your Form
10-Q filing pursuant to item 601 of Regulation S-K.
We have read management's justification for the change in accounting from the
double declining balance method to the straight line method contained in the
Company's Form 10-Q for the quarter ended March 31, 1995. Based on our reading
of the data and discussions with Company officials of the business judgment and
business planning factors relating to the change, we believe management's
justification to be reasonable. Accordingly, we concur that the newly adopted
accounting principle described above is preferable in the Company's
circumstances to the method previously applied.
We have not audited any financial statements of Digital Link Corporation as of
any date or for any period subsequent to December 31, 1995, nor have we audited
the application of the change in accounting principle disclosed in the Form 10-Q
of Digital Link Corporation for the three months ended March 31, 1996;
accordingly, our comments are subject to revision on completion of an audit of
the financial statements that include the accounting change.
COOPERS & LYBRAND L.L.P.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet, consolidated statement of operations and
consolidated statement of cash flows included in the Company's Form 10-Q for the
period ending March 31, 1996, and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 9,000,161
<SECURITIES> 29,947,568
<RECEIVABLES> 7,354,434
<ALLOWANCES> 879,223
<INVENTORY> 4,493,023
<CURRENT-ASSETS> 33,297,749
<PP&E> 6,820,923
<DEPRECIATION> 5,102,152
<TOTAL-ASSETS> 54,907,664
<CURRENT-LIABILITIES> 6,802,442
<BONDS> 0
<COMMON> 29,337,528
0
0
<OTHER-SE> 18,767,694
<TOTAL-LIABILITY-AND-EQUITY> 54,907,664
<SALES> 10,202,583
<TOTAL-REVENUES> 10,202,583
<CGS> 4,366,014
<TOTAL-COSTS> 9,999,480
<OTHER-EXPENSES> (632,841)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 835,944
<INCOME-TAX> 280,042
<INCOME-CONTINUING> 555,902
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 555,902
<EPS-PRIMARY> .06
<EPS-DILUTED> .06
</TABLE>
