FORM 10-Q
UNITED STATES
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 September 30, 1997
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
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
The number of shares outstanding of the registrant's common stock at November
13, 1997 was 9,366,669.
<PAGE>
DIGITAL LINK CORPORATION
INDEX TO FORM 10-Q
Page
PART I - FINANCIAL INFORMATION:
ITEM 1 - Financial Statements
Consolidated Balance Sheets as of September 30, 1997 3
and December 31, 1996
Consolidated Statements of Income for the quarters 4
and nine months ended September 30, 1997 and September 30, 1996
Consolidated Statements of Cash Flows for the nine 5
months ended September 30, 1997 and September 30, 1996
Notes to Consolidated Financial Statements 6
ITEM 2 - Management's Discussion and Analysis of 9
Financial Condition and Results of Operations
ITEM 3 - Quantitative and Qualitative Disclosures About 16
Market Risk
PART II - OTHER INFORMATION
ITEM 1 - Legal Proceedings 17
ITEM 2 - Changes in Securities and Use of Proceeds 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) 18
<PAGE>
<TABLE>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share amounts)
- ----------------------------------------------------------------------------
Sept. 30, Dec. 31,
1997 1996
-------- --------
(Unaudited)
ASSETS
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents ............................................. $ 3,554 $ 2,043
Short-term marketable securities ...................................... 22,608 19,585
Accounts receivable, less allowance for doubtful accounts
of $495 at 9/30/97 and $465 at 12/31/96 ............................ 8,495 6,490
Inventories ........................................................... 7,725 5,920
Prepaid and other current assets ...................................... 1,158 1,131
Deferred income taxes ................................................. 2,285 2,285
------- -------
Total current assets ......................................... 45,825 37,454
Property and equipment at cost, net ................................... 3,161 2,147
Long-term marketable securities ....................................... 16,209 22,420
Other assets .......................................................... 2,690 712
------- -------
TOTAL ASSETS ................................................. $67,885 $62,733
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ...................................................... $ 4,076 $ 1,947
Accrued payroll expense ............................................... 2,979 1,648
Other accrued expenses ................................................ 3,834 3,795
Income taxes payable .................................................. 1,600 1,541
------- -------
Total current liabilities .................................... 12,489 8,931
------- -------
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: 9,287,000 shares at 9/30/97 and 9,218,000
shares at 12/31/96 .................................................... 32,131 30,913
Unrealized gain on marketable securities .............................. 159 257
Retained earnings ..................................................... 23,106 22,632
------- -------
Total shareholders' equity ................................... 55,396 53,802
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$67,885 $62,733
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
<TABLE>
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
FOR THE QUARTERS AND NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996
(Amounts in thousands, except per share amounts)
- --------------------------------------------------------------------------------
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
1997 1996 1997 1996
---- ---- ---- ----
REVENUES:
<S> <C> <C> <C> <C>
Net sales ...................................... $ 18,529 $ 14,127 $ 51,600 $ 36,355
Cost of sales .................................. 7,948 5,666 21,620 14,869
-------- -------- -------- --------
Gross profit ............................ 10,581 8,461 29,980 21,486
-------- -------- -------- --------
EXPENSES:
Research and development ....................... 2,602 2,749 8,229 7,135
Selling, general and administrative ............ 5,859 4,206 16,542 11,934
Purchased research and development ............. 3,651 0 3,651 0
-------- -------- -------- --------
Total operating expenses ................ 12,112 6,955 28,422 19,069
-------- -------- -------- --------
Operating income (loss) ................. (1,531) 1,506 1,558 2,417
Other Income ................................... 646 625 1,924 1,832
-------- -------- -------- --------
Income (loss) before provision for income
taxes .......................................... (885) 2,131 3,482 4,249
Provision (benefit) for income taxes ........... (270) 650 1,061 1,359
-------- -------- -------- --------
NET INCOME (LOSS) ....................... $ (615) $ 1,481 $ 2,421 $ 2,890
======== ======== ======== ========
NET INCOME (LOSS) PER SHARE .................... $ (0.07) $ 0.16 $ 0.25 $ 0.31
======== ======== ======== ========
Shares used in computing per share amounts ..... 9,240 9,451 9,585 9,417
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
<TABLE>
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30 , 1997 AND 1996
(Amounts in thousands)
- --------------------------------------------------------------------------------
<CAPTION>
Nine Months Ended
September 30,
----------------------
1997 1996
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net Income .......................................................... $ 2,421 $ 2,890
Adjustments to reconcile net income to net cash flows
provided by operating activities:
Depreciation and amortization .................................... 865 898
R&D write-off on acquisition ..................................... 3,651 0
Deferred tax on acquisition ...................................... (1,115) 0
Changes in assets and liabilities:
Accounts receivable ........................................ (1,550) 2,071
Inventories ................................................ (1,322) (1,357)
Prepaid and other assets ................................... (332) (298)
Accounts payable ........................................... 2,129 546
Accrued payroll and other accrued expenses ................. 1,094 1,332
Income taxes payable ....................................... 59 (138)
-------- --------
Net cash flows provided by operating activities ........ 5,900 6,019
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities .................................. (10,025) (31,971)
Maturities of marketable securities ................................. 13,117 25,593
Acquisition of Performance Telecom Corporation assets ............... (5,000) 0
Acquisition of property and equipment ............................... (1,749) (1,131)
-------- --------
Net cash flows used in investing activities ............ (3,657) (7,509)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options ............................. 1,692 495
Repurchase of common stock .......................................... (2,424) 0
-------- --------
Net cash flows provided by (used in) financing
activities .......................................................... (732) 495
-------- --------
Net increase (decrease) in cash and cash
equivalents ......................................................... (1,511) (995)
Cash and cash equivalents at beginning of year ...................... 2,043 2,639
-------- --------
Cash and cash equivalents at end of period .......................... $ 3,554 $ 1,644
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for income taxes ........................ $ 2,117 $ 1,443
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Unrealized loss on securities carried at market ..................... $ (98) $ (366)
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
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 presentation
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, 1997.
The year-end balance sheet at December 31, 1996 was derived from
audited financial statements, but does not include all disclosures
required by generally accepted accounting principles.
Operating results for the nine months ended September 30, 1997 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 (LOSS) PER SHARE
Net income (loss) 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. BUSINESS COMBINATION
On September 30, 1997 the Company acquired certain assets of
Performance Telecom Corporation ("Performance Telecom"), a manufacturer
of asymmetrical, symmetrical and rate-adaptive digital subscriber line
("DSL") products. The acquisition has been accounted for as a purchase,
and, accordingly, the results of operations will include the activities
related to the acquired assets from September 30, 1997. In connection
with the acquisition, the Company allocated the purchase price of
$5,000,000, to assets including acquired technology based upon accepted
valuation techniques. Amounts related to research and development for
which technological feasibility had not yet been established were
reflected in operations as of the date of acquisition. The Company
intends to continue devoting effort to developing commercially viable
products from the purchased in-process research and development,
although there can be no assurance that the Company will develop such
commercially viable products. As part of this transaction, the Company
recorded approximately $3.7 million in purchased research and
development expense and $0.6 million of goodwill and other intangible
assets in the third quarter of 1997. Amounts allocated to goodwill and
other intangibles are amortized on a straight-line basis over a
five-year period.
4. INVENTORIES
Inventories are valued at the lower of cost (determined using the
first-in, first-out method) or market. Inventories consisted of (in
thousands):
September 30, 1997 December 31, 1996
(Unaudited)
Raw materials $ 2,503 $ 2,255
Work-in-process 3,046 2,301
Finished goods 2,176 1,364
------------ -------------
$ 7,725 $ 5,920
============ =============
5. CONTINGENCIES
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 is 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. While the Company has accrued
certain amounts for these matters in prior years, it is currently
unable to estimate the possible loss or range of loss regarding these
matters. Therefore, 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 Santa Clara Superior
Court of the State of California, alleging violations of the California
Corporations Code and California Civil Code. In October 1996, a similar
parallel lawsuit against the Company and the same individuals was filed
in the United States District Court for the Northern District of
California alleging violations of the federal securities laws. The
class period in both lawsuits runs from September 12, 1994 through
December 29, 1995, and both complaints allege that the defendants
concealed and/or misrepresented material adverse information about the
Company and its future prospects. The complaints seek unspecified
monetary damages. On May 8, 1997, the Superior Court dismissed the
fraud allegations of plaintiff's first amended state court complaint
without leave to amend. The Superior Court also sustained the demurrer
of certain individual defendants to other portions of plaintiff's
complaint, while it overruled a similar demurrer by the Company and
other individual defendants. The Court granted plaintiff leave to file
another amended complaint. On October 9, 1997, the Superior Court
sustained the demurrers of certain individual defendants without leave
to amend, sustained the demurrer of one individual defendant with leave
to amend, and overruled the demurrers of the remaining individual
defendants and the Company. Plaintiffs are expected to file an amended
complaint in November 1997.
The Company has also moved to dismiss the federal complaint. The court
dismissed plaintiff's complaint with leave to amend on September 9,
1997. Plaintiffs filed an amended complaint on November 10, 1997.
The Company believes that both actions are without merit and intends to
defend both actions vigorously. However litigation is subject to
inherent uncertainties and, thus, there can be no assurance that these
lawsuits will be resolved favorably to the Company or that they will
not have a material adverse affect on the Company's financial condition
and results of operations. Accordingly, no provision for any liability
that may result upon adjudication has been made in the accompanying
financial statements.
6. RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board (FASB)
issued Statement No. 128, "Earnings Per Share" (SFAS 128), and
Statement No. 129, "Disclosure of Information About Capital Structure"
(SFAS 129). These Statements will be effective for the Company's fiscal
year 1997. SFAS 128 requires a revised presentation and calculation of
earnings per share (EPS) and that prior periods be restated to conform
to that revised presentation and calculation. SFAS 129 requires
disclosure about the entity's capital structure and contains no change
in disclosure requirements for entities that were subject to the
previously existing requirements. Early adoption of these Statements is
not permitted and the adoption of SFAS 129 will not have a material
effect on the Company's financial position and results of operations.
The impact of the adoption of SFAS 128 on the financial statements of
the Company has not yet been determined.
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive
Income". SFAS 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of
general-purpose financial statements. It is effective for the Company's
fiscal year 1998. The Company will be studying the implications of the
Statement, but the impact of its implementation on the financial
statements of the Company has not yet been determined.
In June 1997, the FASB issued SFAS 131, "Disclosures About Segments of
an Enterprise and Related Information". SFAS 131 changes current
practice under SFAS 14 by establishing a new framework on which to base
segment reporting (referred to as the "management" approach) and also
requires interim reporting of segment information. It is effective for
the Company's fiscal year 1998. The Company will be studying the
implications of the Statement, but the impact of its implementation on
the financial statements of the Company has not yet been determined.
<PAGE>
DIGITAL LINK CORPORATION
ITEM 2. Management's Discussion And Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
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 (the "Exchange Act"). These forward-looking
statements involve a number of risks, known and unknown, and uncertainties, such
as the loss of, or difference in actual from anticipated levels of purchases
from, the Company's major customers, the impact of competitive products and
pricing, risks and uncertainties associated with the acquisition and integration
of other businesses and technology, in particular Performance Telecom 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, 1996, and within "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 Digital Link
Corporation (the "Company" or "Digital Link") achieves may differ materially
from any forward-looking statements due to such risks and uncertainties.
Readers are urged to carefully review and consider the various disclosures made
by the Company in this report and in the Company's reports filed with the
Securities and Exchange Commission that attempt to advise interested parties of
the risks and factors that may affect the Company's business.
Due to all the foregoing factors, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as an indication of future performance. Similarly,
past performances are not necessarily indicative of future results. It is likely
that, in some future quarters, the Company's operating results will be below the
expectations of stock market analysts and investors. In such event, the price of
the Company's Common Stock would likely be materially adversely affected.
Consequently, the purchase or holding of the Company's Common Stock involves an
extremely high degree of risk.
Net Sales
Net sales for the third quarter of 1997 increased 31% to $18,529,000 from
$14,127,000 for the same period of the prior year. Net sales for the nine months
ended September 30, 1997 increased 42% to $51,600,000 from $36,355,000 for the
same period of the prior year. These increases in net sales were primarily
attributable to an increase in unit sales of both broadband (i.e., transmission
rates in excess of T1/E1) products primarily within the Inverse Multiplexer
product family and narrowband (i.e., transmission rates up to T1/E1) products
primarily within the Encore product family. These increases were offset in part
by decreased average selling prices on certain narrowband and broadband products
as a result of price reductions made throughout 1996 and in the first half of
1997. The Company anticipates that this pricing pressure will continue into at
least 1998. The Company does not believe that the percentage change in net sales
in the third quarter of 1997 or for the first nine months of 1997 as compared to
the same periods of the prior year are necessarily indicative of the percentage
change in net sales to be expected for the entire fiscal year.
Narrowband sales in absolute dollars increased 39% and increased as a percentage
of net sales to 56% in the third quarter of 1997 as compared to 53% in the third
quarter of 1996. Broadband sales increased in absolute dollars 23% and decreased
as a percentage of net sales to 44% in the third quarter of 1997 as compared to
47% in the third quarter of 1996. Narrowband sales in absolute dollars increased
26% and decreased as a percentage of net sales to 52% for the first nine months
of 1997 as compared to 59% for the first nine months of 1996. Broadband sales
increased in absolute dollars 65% and increased as a percentage of net sales to
48% for the first nine months of 1997, as compared to 41% for the first nine
months of the prior year. The changes in narrowband and broadband sales as a
percentage of net sales for the third quarter and first nine months were
primarily due to higher sales of narrowband products within the Company's Encore
product family and its original equipment manufacturer product. The Company
anticipates that its mix of products sold will change to include a higher
percentage of narrowband products, which generally have lower gross margins and
would therefore adversely affect the Company's overall gross margins.
International sales, including Canada, represented 19% of net sales in the third
quarter of 1997 as compared to 18% in the third quarter of 1996, and 18% of net
sales for the nine months ended September 30, 1997 as compared to 15% for the
same period of the prior year. These increases were primarily due to an increase
in unit sales of the Company's international narrowband and broadband products.
International sales are subject to inherent risks, including difficulties in
homologating products in other countries, difficulties in staffing and managing
foreign operations, greater difficulty in accounts receivable collection,
unexpected changes in regulatory requirements and tariffs, and potentially
adverse tax consequences, which may in the future contribute to fluctuations in
the Company's business and operating results.
Gross Profit
Gross profit increased 25% in the third quarter of 1997 to $10,581,000 from
$8,461,000 for the same period of the prior year. Gross margin decreased to 57%
of net sales in the third quarter of 1997 as compared to 60% in the third
quarter of 1996. This decrease in gross margin was primarily due to the above
mentioned price reductions and by a shift in the mix of products sold to include
more narrowband products, which generally have lower gross margins than
broadband products. Gross profit increased 40% in the nine months ended
September 30, 1997 to $29,980,000 from $21,486,000 for the same period of the
prior year. Gross margin decreased to 58% of net sales for the first nine months
of 1997 as compared to 59% for the same period of the prior year. This decrease
in gross margin reflects the above referenced price reductions, which were
somewhat offset by a shift in the mix of products sold to include more broadband
products, which generally have higher gross margins than narrowband products
A significant portion of the Company's business is very price competitive, which
has in the past and will in the future require the Company to lower its prices,
resulting in fluctuations in the Company's business and operating results. The
Company anticipates that this pricing pressure will continue into at least 1998.
In addition, the Company anticipates that its mix of products sold will change
to include a higher percentage of narrowband products, which generally have
lower gross margins and would therefore adversely affect the Company's overall
gross margins.
Research and Development
The primary types of expenses included in research and development ("R&D")
expenses are personnel, consulting, prototype materials and professional
services. R&D expenses decreased 5% to $2,602,000 in the third quarter of 1997
from $2,749,000 in the third quarter of 1996. This decrease was primarily due to
a decrease in consulting fees primarily related to the Company's DL7100 product,
offset by an increase in personnel-related expenses and material costs for
prototype products. As a percentage of net sales, R&D expenses were 14% in the
third quarter of 1997 as compared to 19% in the third quarter of 1996. This
decrease as a percentage of net sales primarily reflects higher sales volumes
during the third quarter of 1997. R&D expenses increased 15% to $8,229,000 in
the nine months ended September 30, 1997 from $7,135,000 for the same period of
the prior year. As a percentage of net sales, R&D expenses were 16% for the
first nine months of 1997 as compared to 20% for the same period of the prior
year. The absolute dollar increase for the nine-month period is primarily
attributable to higher personnel related expenses and material costs for
prototype products, offset by a decrease in consulting fees related to the
Company's DL7100 product. The decrease as a percentage of net sales was
primarily the result of operating efficiencies from higher sales volume during
the period. The Company anticipates that its R&D expenses in the fourth quarter
of 1997 will increase in absolute dollars and may increase as a percentage of
net sales as compared to the third quarter of 1997 as a result of an increase in
personnel related to the acquisition of Performance Telecom. However, actual
results could vary from the foregoing forward looking statement due to, among
other factors set forth or referenced in "Other Factors That May Affect Future
Operating Results" below, the Company's ability to accelerate or defer operating
expenses, achieve revenue levels and hire new personnel during the remainder of
1997.
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
The primary types of expenses included in selling, general and administrative
("SG&A") expenses are personnel, advertising, other promotional, consulting, and
travel and entertainment. SG&A expenses increased 39% in the third quarter of
1997 to $5,859,000 from $4,206,000 for the same period of the prior year. As a
percentage of net sales, SG&A expenses were 32% in the third quarter of 1997 as
compared to 30% in the third quarter of 1996. These increases were primarily due
to higher personnel-related expenses, primarily within the sales organization.
SG&A expenses increased 39% for the first nine months of 1997 to $16,542,000
from $11,934,000 for the same period of the prior year. As a percentage of net
sales, SG&A expenses were 32% for the first nine months of 1997 as compared to
33% for the same period of the prior year. The increase in absolute dollars was
primarily a result of higher personnel-related and consulting expenses. The
decrease as a percentage of net sales was primarily the result of operating
efficiencies from higher sales volume during the period
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. However, any
decrease in such expenses as a percentage of net sales in the second half of the
year is 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 and achieve revenue
levels during such periods.
Purchased Research and Development
The Company incurred an expense of $3.7 million related to purchased research
and development in the third quarter of 1997 arose from the acquisition of
Performance Telecom Corporation. See Note 3 of Notes to Consolidated Financial
Statements in Part I of this Form 10-Q.
Other Income
Other income includes primarily interest income and purchase discounts. Other
income increased 3% in the third quarter of 1997 to $646,000 from $625,000 for
the same period of the prior year. For the nine months ended September 30, 1996,
other income increased 5% to $1,924,000 from $1,832,000 for the same period of
the prior year. These increases were primarily due to higher interest income
from higher cash balances.
Provision for Income Taxes
The Company's effective tax rate remained at 30.5% for the third quarter of 1997
as compared to the third quarter of 1996. The Company's effective tax rate
decreased to 30.5% for the first nine months of 1997 as compared to 32.0% for
the same period of the prior year. This decrease is due primarily to an increase
in the R&D tax credit.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $33.3 million and cash, cash equivalents and
marketable securities of $42.4 million at September 30, 1997. Net cash provided
by operating activities was $5.9 million for the first nine months of 1997,
primarily as a result of net income before depreciation and amortization as
adjusted for a write-off of purchased R&D and an increase in accounts payable,
offset by an increase in accounts receivable and an increase in inventories.
This compares to net cash provided by operating activities of $6.0 million for
the first nine months of 1996, primarily as a result of net income before
depreciation and amortization, a decrease in accounts receivable, and an
increase in accrued payroll and other accrued expenses, offset by an increase in
inventories. Cash used in investing activities during the first nine months of
1997 was primarily from net purchases of marketable securities of $10.0 million
and the acquisition of Performance Telecom assets of $5.0 million, offset by
maturity of marketable securities of $13.1 million. Cash used in investing
activities during the first nine months of 1996 was primarily from net purchases
of securities of $32.0 million, offset by maturities of marketable securities of
$25.6 million. Leasehold improvements and capital equipment additions were $1.7
million in the first nine months of 1997 as compared to $1.1 million for the
same period of the prior year.
In October 1996, the Company approved the repurchase of up to 500,000 shares of
common stock for cash from time-to-time at market prices and as market and
business conditions warrant, in open market, negotiated or block transactions.
Net cash used in financing activities was $0.7 million in the first nine months
of 1997, primarily from the repurchase of common stock offset somewhat by the
proceeds from the exercise of stock options and employee stock purchases. Net
cash provided by financing activities was $0.5 million in the first nine months
of 1996 from the exercise of stock options and employee stock purchases. During
the first nine months of 1997, the Company repurchased on the open market a
total of 142,000 shares of common stock at prices ranging from $15.00 to $19.125
a share. This stock has subsequently been retired.
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
In addition to the factors set forth above in the "Management's Discussion and
Analysis of Financial Conditions and Results of Operations," there are a number
of other factors that may affect the Company's future operating results. Most of
the following discussion consists of forward looking statements and accompanying
risks.
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, including the completion of the build out of carrier and ISP
infrastructures, 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 certain other
factors. Other factors that may cause fluctuations in the Company's operating
results include the gain or loss of significant customers, seasonal capital
spending patterns of large domestic customers, changes in sales volumes through
the Company's distribution channels, changes in product mix sold toward
narrowband products that yield lower gross margins, 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 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. If revenue
levels are below expectations, the Company may be unable to adjust spending in a
timely manner, which would adversely affect operating results.
The Company is currently developing and may in the future develop products with
which the Company has only limited experience and/or that are targeted at
emerging market segments, including the Company's DL7100 product (formerly known
as the W/ATM GateWay Product). The Company has experienced delays in the
development of the DL7100 product, in part related to technical problems that
required some software to be redesigned. This product completed beta evaluation
trials in the first half of 1997 and became available for revenue shipments in
the second half of 1997. The Company does not anticipate that the DL7100 revenue
will become a significant portion of the Company's revenue until at least the
second half of 1998. Given its complexity, there can be no assurance that this
product will not encounter further technical or other difficulties that 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 the DL7100 will meet the needs of the emerging ATM market, that
products currently available or under development by competitors would not
directly compete with the DL7100 product or that markets for the DL7100 will
continue to develop, any of which would have a material adverse affect on 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. Certain of the Company's senior management team
have only recently joined the Company. In addition, the Company is currently
searching for a Vice President, Sales. There can be no assurance that the
Company will be successful in attracting and retaining skilled personnel to hold
these or other important management positions or will be able to successfully
integrate any new management personnel.
The Company completed an acquisition of Performance Telecom in the third quarter
of 1997 and may complete additional acquisitions in the future. The process of
integrating an acquired company's business into the Company's operations may
result in unforeseen operating difficulties and expenditures and may absorb
significant management attention that would otherwise be available for the
ongoing development of the Company's business. Moreover, there can be no
assurance that the anticipated benefits of an acquisition will be realized. In
addition, acquisitions involve numerous risks, including difficulties in
managing diverse geographic sales and research and development operations, risks
of entering markets in which the Company has no or limited direct prior
experience, difficulties in the assimilation of the technologies and products of
the acquired companies and the potential loss of key employees of the acquired
company. The inability of the Company's management to respond to changing
business conditions effectively, including the changes associated with its
recent acquisition, could have a material adverse effect on the Company's
business, financial condition and results of operations.
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. In addition,
the Company faces competition from internetworking suppliers, such as routers,
and telephone equipment, such as switches, which are including a direct WAN
interface in their products that could reduce demand for the Company's products,
which would have a material adverse affect 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 pricing
pressure will continue into at least 1998.
In 1996, class action complaints were filed against the Company and certain of
its officers and directors in California state court, as well as federal court.
These lawsuits allege that the defendants concealed and/or misrepresented
material adverse information about the Company and its future prospects and seek
unspecified monetary damages. See paragraphs two, three and four of Note 5 of
Notes to Consolidated Financial Statements in Part I of this Form 10-Q. The
Company believes that both actions are without merit and intends to defend both
actions vigorously. However, litigation is subject to inherent uncertainties
and, thus there can be no assurance that these lawsuits will be resolved
favorably to the Company or that they will not have a material adverse effect on
the Company's financial condition and results of operations.
The Company's future prospects will depend in part on its ability to enhance the
functionality of its existing WAN access products and DL7100 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
competitive solutions, technological developments in its industry, changes in
customer requirements, or changes in regulatory requirements or industry
standards, or any significant delays in the development, introduction or
shipment of products, could have a material adverse affect on the Company's
business and operating results. 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.
Either of these events could materially adversely affect the Company's business
and operating results.
The Company is currently in the process of evaluating its information technology
infrastructure for Year 2000 compliance. The Company does not currently have any
information concerning the Year 2000 compliance status of its suppliers and
customers. In the event that any of the Company's significant suppliers or
customers does not successfully and timely achieve Year 2000 compliance, the
Company's business or operations could be adversely affected.
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 on several occasions expressed its
belief that certain of the Company's products, including its CSU/DSUs, may
infringe upon patents held by it and has suggested on such occasions that the
Company acquire a license to such patents. 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
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. See
Note 5 of Notes to Consolidated Financial Statements in Part I, Item 1 of this
Form 10-Q. 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 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.
The Company is in the process of evaluating the impact on its financial
statements of several recent accounting pronouncements made by the Financial
Accounting Standards Board (FASB). See Note 6 of Notes to Consolidated Financial
Statements in Part I of this Form 10-Q.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable.
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and certain of its officers and directors are parties to various
lawsuits described in paragraphs two, three and four in Note 5 of Notes to
Consolidated Financial Statements in Part I of this Form 10-Q.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
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
On October 2, 1997, John Eddon, Vice President and General Manager,
International resigned his position with the Company. On October 31, 1997,
Timothy Montgomery, Vice President, Sales, resigned his position with the
Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
11.01 Statement of Computation of Net Income Per Share.
27.01 Financial Data Schedule.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended
September 30, 1997.
<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: November 13, 1997 /s/ Stanley E. Kazmierczak
-----------------------------
Stanley E. Kazmierczak
Vice President, Finance and Administration,
Chief Financial Officer and Secretary
(Duly Authorized Officer and Principal
Financial Officer)
<PAGE>
EXHIBIT INDEX
Exhibits
11.01 Statement of Computation of Net Income Per Share.
27.01 Financial Data Schedule.
DIGITAL LINK CORPORATION
STATEMENT OF COMPUTATION OF NET INCOME (LOSS) PER SHARE
(In thousands, except per share data, unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
----------------- ---------------
1997 1996 1997 1996
---- ---- ---- ----
Primary:
Net income (loss) ..................... $ (615) $ 1,481 $ 2,421 $ 2,890
======= ======= ======= =======
Weighted average number of shares from:
Common shares outstanding .... 9,240 9,149 9,206 9,080
Common equivalent shares
from stock options
outstanding ............. 0 302 379 337
------- ------- ------- -------
Common and common equivalent
shares used in computing per
share amounts ..................... 9,240 9,451 9,585 9,417
======= ======= ======= =======
Net income (loss) per share ........... $ (0.07) $ 0.16 $ 0.25 $ 0.31
======= ======= ======= =======
Note: There is no material difference in the computation of net income per
share on a fully diluted basis.
<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 September 30, 1997, and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 3,554
<SECURITIES> 22,608
<RECEIVABLES> 8,495
<ALLOWANCES> 495
<INVENTORY> 7,725
<CURRENT-ASSETS> 45,825
<PP&E> 9,564
<DEPRECIATION> 6,403
<TOTAL-ASSETS> 67,885
<CURRENT-LIABILITIES> 12,489
<BONDS> 0
0
0
<COMMON> 32,131
<OTHER-SE> 23,265
<TOTAL-LIABILITY-AND-EQUITY> 67,885
<SALES> 51,600
<TOTAL-REVENUES> 51,600
<CGS> 21,620
<TOTAL-COSTS> 50,042
<OTHER-EXPENSES> (1,924)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 3,482
<INCOME-TAX> 1,061
<INCOME-CONTINUING> 2,421
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,421
<EPS-PRIMARY> 0.25
<EPS-DILUTED> 0.25
</TABLE>
