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 June 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 August
11, 1997 was 9,233,641.
<PAGE>
DIGITAL LINK CORPORATION
INDEX TO FORM 10-Q
Page
PART I - FINANCIAL INFORMATION:
ITEM 1 - Financial Statements
Consolidated Balance Sheets as of June 30, 1997 3
and December 31, 1996
Consolidated Statements of Income for the quarters 4
and six months ended June 30, 1997 and June 30, 1996
Consolidated Statements of Cash Flows for the six 5
months ended June 30, 1997 and June 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 Disclosure About 17
Market Risk
PART II - OTHER INFORMATION
ITEM 1 - Legal Proceedings 18
ITEM 2 - Changes in Securities 18
ITEM 3 - Defaults Upon Senior Securities 18
ITEM 4 - Submission of Matters to a Vote of Security Holder 18
ITEM 5 - Other Information 18
ITEM 6 - Exhibits and Reports on Form 8-K 19
SIGNATURE(S) 20
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share amounts)
- ----------------------------------------------------------------------------
June 30, December 31,
1997 1996
---------- ----------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .............................. $ 4,045 $ 2,043
Short-term marketable securities ....................... 21,771 19,585
Accounts receivable, less allowance for doubtful accounts
of $478 at 6/30/97 and $465 at 12/31/96 .............. 6,901 6,490
Inventories ............................................ 6,479 5,920
Prepaid and other current assets ....................... 1,229 1,131
Deferred income taxes .................................. 2,285 2,285
------- -------
Total current assets .......................... 42,710 37,454
Property and equipment at cost, net .................... 2,576 2,147
Long-term marketable securities ........................ 19,109 22,420
Other assets ........................................... 1,013 712
------- -------
TOTAL ASSETS .................................. $65,408 $62,733
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ....................................... $ 3,212 $ 1,947
Accrued payroll expense ................................ 1,908 1,648
Other accrued expenses ................................. 3,586 3,795
Income taxes payable ................................... 1,298 1,541
------- -------
Total current liabilities ..................... 10,004 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: 9,205,979 shares
at 06/30/97 and 9,218,150 shares at 12/31/96 ...... 31,105 30,913
Unrealized gain on marketable securities ............... 183 257
Retained earnings ...................................... 24,116 22,632
------- -------
Total shareholders' equity .................... 55,404 53,802
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ..... $65,408 $62,733
======= =======
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 SIX MONTHS ENDED
JUNE 30, 1997 AND 1996
(Amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
<CAPTION>
Quarter Ended Six Months Ended
June 30, June 30,
---------------- -------------------
1997 1996 1997 1996
---- ---- ---- ----
REVENUES:
<S> <C> <C> <C> <C>
Net sales ..................................... $17,033 $12,026 $33,071 $22,228
Cost of sales ................................. 6,856 4,838 13,672 9,203
------- ------- ------- -------
Gross profit ........................... 10,177 7,188 19,399 13,025
------- ------- ------- -------
EXPENSES:
Research and development ...................... 2,594 2,335 5,627 4,386
Selling, general and administrative ........... 5,768 4,145 10,683 7,728
------- ------- ------- -------
Total operating expenses ............... 8,362 6,480 16,310 12,114
------- ------- ------- -------
Operating income ....................... 1,815 708 3,089 911
Other income .................................. 638 574 1,278 1,207
------- ------- ------- -------
Income before provision for income taxes 2,453 1,282 4,367 2,118
Provision for income taxes .................... 748 430 1,331 710
------- ------- ------- -------
NET INCOME ............................. $ 1,705 $ 852 $ 3,036 $ 1,408
======= ======= ======= =======
NET INCOME PER SHARE .......................... $ 0.18 $ 0.09 $ 0.32 $ 0.15
======= ======= ======= =======
Shares used in computing per share amounts .... 9,506 9,449 9,541 9,401
======= ======= ======= =======
</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 SIX MONTHS ENDED JUNE 30 , 1997 AND 1996
(Amounts in thousands)
- -------------------------------------------------------------------------------
<CAPTION>
Six Months Ended
June 30,
--------------------
1997 1996
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income ............................................... $ 3,036 $ 1,408
Adjustments to reconcile net income to net cash flows
provided by operating activities:
Depreciation and amortization ......................... 577 598
Changes in assets and liabilities:
Accounts receivable ................................. (411) 1,858
Inventories ......................................... (559) (130)
Prepaid and other assets ............................ (399) (391)
Accounts payable .................................... 1,265 (355)
Accrued payroll and other accrued expenses .......... 51 282
Income taxes payable ................................ (243) 267
-------- --------
Net cash flows provided by operating activities . 3,317 3,537
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities ....................... (7,020) (24,641)
Maturities of marketable securities ...................... 7,027 20,890
Sales of marketable securities ........................... 1,000 --
Acquisition of property and equipment .................... (1,007) (743)
-------- --------
Net cash flows provided by (used in) investing
activities . .................................... 46 (4,494)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and employee stock
purchases .............................................. 585 408
Repurchase of common stock ............................... (1,946) 0
-------- --------
Net cash flows provided by (used in) financing
activities ...................................... (1,361) 408
-------- --------
Net increase (decrease) in cash and cash
equivalents ............................ 2,002 (549)
Cash and cash equivalents at beginning of period ......... 2,043 2,639
-------- --------
Cash and cash equivalents at end of period ............... $ 4,045 $ 2,090
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for income taxes ............. $ 1.574 $ 438
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Unrealized loss on securities carried at market .......... $ (74) $ (431)
======== ========
</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 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, 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 three months and six months ended June 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 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):
June 30, 1997 December 31, 1996
(Unaudited)
Raw materials $ 2,277 $ 2,255
Work-in-process 2,163 2,301
Finished goods 2,039 1,364
------------ -------------
$ 6,479 $ 5,920
============ =============
<PAGE>
4. 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 and plaintiffs filed a second amended
complaint on June 27, 1997.
The Company has sought relief from the California Court of Appeals with
respect to those allegations of the state court complaint that the
Superior Court did not dismiss. The Company's petition with the Court
of Appeals is still pending. The Company has also moved to dismiss the
federal complaint. The Court heard oral argument on defendants' motion
on April 18, 1997 and took the motion under submission.
The Company believes that both actions are without merit and intends to
defend both actions vigorously. However litigation is subject to
inherent
<PAGE>
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 on the accompanying
financial statements.
5. RECENT ACCOUNTING PRONOUNCEMENT
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
affect 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 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 second quarter of 1997 increased 42% to $17,033,000 from
$12,026,000 for the same period of the prior year. Net sales for the six months
ended June 30, 1997 increased 49% to $33,071,000 from $22,228,000 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 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
<PAGE>
in the first half of 1997. The Company anticipates that this increased pricing
pressure will continue during 1997. The Company does not believe that the
percentage change in net sales in the second quarter of 1997 or for the first
six 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 by 18% and decreased to 45% of
net sales in the second quarter of 1997 as compared to 54% in the second quarter
of 1996. Broadband sales increased in absolute dollars by 70% and increased as a
percentage of net sales to 55% in the second quarter of 1997 as compared to 46%
in the second quarter of 1996. Narrowband sales in absolute dollars increased by
19% and decreased to 50% of net sales in the first six months of 1997 as
compared to 63% in the first six months of 1996. Broadband sales increased in
absolute dollars by 100% and increased as a percentage of net sales to 50% in
the first six months of 1997 as compared to 37% for the same period in 1996. The
changes in narrowband sales and broadband sales as a percentage of net sales
were primarily due to higher sales of broadband products to certain domestic
carrier customers.
International sales, including Canada, represented 19% of net sales in the
second quarter of 1997 as compared to 15% in the second quarter of 1996, and 17%
of net sales for the six months ended June 30, 1997 as compared to 14% for the
same period of the prior year. These increases were primarily due to an increase
in unit sales of the Company's 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 42% in the second quarter of 1997 to $10,177,000 from
$7,188,000 for the same period of the prior year. Gross margin decreased
slightly to 59.7% of net sales in the second quarter of 1997 as compared to
59.8% in the second quarter of 1996. This slight decrease in gross margin was
primarily due to the above mentioned price reductions, offset by a shift in the
mix of products sold to include more broadband products, which generally have
higher gross margins than narrowband products. Gross profit increased 49% in the
six months ended June 30, 1997 to $19,399,000 from $13,025,000 for the same
period of the prior year. Gross margin increased slightly to 58.7% of net sales
for the first six months of 1997 as compared to 58.6% for the same period of the
prior year. This slight increase as a percentage of net sales reflects a shift
in the mix of products sold to include more broadband products, which generally
have higher gross margins than narrowband products, offset by the above
referenced price reductions.
<PAGE>
The Company anticipates that gross margins will decline for at least the
remainder of 1997 as a result of competitive pricing pressures and changes in
the mix of products sold. 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 increased pricing
pressure will continue during 1997. 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 increased 11% to $2,594,000 in the second quarter of 1997
from $2,335,000 in the second quarter of 1996. This increase was due primarily
to an increase in personnel-related expenses and material costs for prototype
products, offset by a decrease in consulting fees primarily related to the
Company's DL7100 product (formerly known as W/ATM GateWay). As a percentage of
net sales, R&D expenses were 15.2% in the second quarter of 1997 as compared to
19.4% in the second quarter of 1996. This decrease as a percentage of net sales
primarily reflects higher sales volumes during the second quarter of 1997. R&D
expenses increased 28% to $5,627,000 in the six months ended June 30, 1997 from
$4,386,000 for the same period of the prior year. As a percentage of net sales,
R&D expenses decreased to 17.0% for the first six months of 1997 as compared to
19.7% for the same period of the prior year. The absolute dollar increase for
the six-month period is attributable to higher personnel-related expenses,
higher material costs for prototype products, and higher consulting fees
primarily related to its DL7100 product. The Company anticipates that its R&D
expenses will continue to increase in absolute dollars and as a percentage of
sales may remain relatively flat. 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 during such periods 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, and travel and
<PAGE>
entertainment. SG&A expenses increased 39% in the second quarter of 1997 to
$5,768,000 from $4,145,000 for the same period of the prior year. As a
percentage of net sales, SG&A expenses were 33.9% in the second quarter of 1997
as compared to 34.5% in the second quarter of 1996. SG&A expenses increased 38%
for the six months ended June 30, 1997 to $10,683,000 from $7,728,000 for the
same period of the prior year. As a percentage of net sales, SG&A expenses were
32.3% for the first six months of 1997 as compared to 34.8% for the same period
of the prior year. These increases in absolute dollars were primarily due to
higher personnel-related expenses and travel and entertainment, primarily within
the sales organization, and an increase in consulting fees. These decreases as a
percentage of net sales were primarily the result of operating efficiencies from
higher net sales in the first half of 1997.
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 the periods.
Other Income
Other income includes primarily interest income and purchase discounts. Other
income increased 11% in the second quarter of 1997 to $638,000 from $574,000 for
the same period of the prior year. For the six months ended June 30, 1997, other
income increased 6% to $1,278,000 from $1,207,000 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 decreased to 30.5% for the second quarter and
first six months of 1997 compared to 33.5% for the same periods in 1996. This
decrease is due primarily to an increase in R&D tax credit.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $32.7 million and cash, cash equivalents and
marketable securities of $44.9 million at June 30, 1997. Net cash provided by
operating activities was $3.3 million for the first half of 1997 primarily as a
result of a generation of net income before depreciation and amortization, an
increase in accounts payable and depreciation and amortization, offset to some
extent by an increase in inventories and accounts receivable. This compares to
net cash provided by operating activities of $3.5 million for the first half of
1996 primarily as a result of a decrease in accounts receivable and generation
<PAGE>
of net income before depreciation and amortization, offset to some extent by an
increase in prepaid and other assets and a decrease in accounts payable. Cash
provided by investing activities during the first half of 1997 was primarily
from the maturity and sales of marketable securities of $8.0 million offset by
additional purchases of $7.0 million. Cash used by investing activities during
the first half of 1996 was primarily from the additional purchases of marketable
securities of $24.6 million offset by the maturity of marketable securities of
$20.9 million. Leasehold improvements and capital equipment additions were $1.0
million in the first half of 1997 as compared to $743,000 in the first half of
1996.
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 $1.4 million in the first half of
1997, primarily from the repurchase of common stock offset by the proceeds from
the exercise of stock options and employee stock purchases. Net cash provided by
financing activities was $408,000 in the first half of 1996 from the exercise of
stock options and employee stock purchases. During February and March 1997, the
Company repurchased on the open market a total of 117,000 shares of common stock
at prices ranging from $15.00 to $17.88 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.
<PAGE>
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. The Company
has experienced delays in the development of the DL7100 product, in part related
to technical problems which required some software to be redesigned. This
product completed beta evaluation trials in the first half of 1997 and is
available for revenue shipments in the second half of 1997. 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 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.
<PAGE>
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 increased
pricing pressure will continue during 1997.
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 have
only recently joined the Company. For example, in September 1996, Alan Fraser
joined the Company as President and Chief Executive Officer, replacing Vinita
Gupta, who remains as Chairperson of the Board of Directors. In February 1997,
Steve Tabaska joined the Company as Chief Technical Officer and Vice President,
Engineering and in April 1997, John Eddon joined the Company as Vice President
and General Manager, International. There can be no assurance that the Company
will be successful in attracting and retaining skilled personnel to hold
important management positions or will be able to successfully integrate any new
management personnel.
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 and plaintiffs filed a second amended complaint on
June 27, 1997. The Company has sought relief from the California Court of
Appeals with respect to those allegations of the state court complaint that the
Superior Court did not dismiss. The Company's petition with the Court of Appeals
is still pending. The Company has also moved to dismiss the federal complaint.
The Court heard oral argument on defendants'
<PAGE>
motion on April 18, 1997 and took the motion under submission. 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.
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 4 of Notes to Consolidated Financial Statements in Part 1, 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'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
<PAGE>
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 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 5 of Notes to Consolidated Financial
Statements in Part 1 of this Form 10-Q.
ITEM 3. Quantitative and Qualitative Disclosure 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 4 of Notes to
Consolidated Financial Statements in Part 1 of this Form 10-Q.
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
On May 21, 1997, the Company held its annual meeting of shareholders. At that
meeting, five of the Company's incumbent directors were reelected to office by
the following vote:
Votes
Name Votes for Withheld
- ---- --------- --------
Vinita Gupta 8,171,343 319,735
Richard C. Alberding 8,171,343 319,735
Gregory M. Avis 8,171,343 319,735
Alan I. Fraser 8,171,343 319,735
Narendra K. Gupta 8,171,343 319,735
Also at the meeting, the shareholders approved an amendment to the Company's
1992 Equity Incentive Plan to increase the number of shares reserved for
issuance thereunder by 800,000. The stockholders cast the following votes:
5,135,290 votes for, 1,078,562 votes against, 26,815 votes abstaining, and
2,250,411 broker non-votes.
Also at that meeting, the shareholders ratified the selection of Coopers &
Lybrand, L.L.P. as independent auditors for the Company's current fiscal year,
with 8,476,163 votes for, 2,820 votes against, and 12,095 votes abstaining.
ITEM 5. OTHER INFORMATION
In April 1997, Lance B. Boxer joined the Company's board of directors. Mr.
Boxer currently serves as chief information officer for MCI Telecommunications.
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.05 Registrant's 1992 Equity Incentive Plan, as amended. (1)
11.01 Statement of Computation of Net Income Per Share.
27.01 Financial Data Schedule
-----------------------------------------
(1) Filed as an exhibit to Registrant's Registration
Statement on Form S-8 (No. 333-27855) filed on May 27,
1997 and incorporated herein by reference.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended June
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: August 11, 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
Exhibit 11.01
DIGITAL LINK CORPORATION
STATEMENT OF COMPUTATION OF NET INCOME PER SHARE
(In thousands, except per share data, unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
------------ --------------
1997 1996 1997 1996
---- ---- ---- ----
Primary:
Net income ................................. $1,705 $ 852 $3,036 $1,408
====== ====== ====== ======
Weighted average number of shares from:
Common shares outstanding ......... 9,188 9,082 9,189 9,045
Common equivalent shares
from stock options
outstanding .................. 318 367 352 356
------ ------ ------ ------
Common and common equivalent
shares used in computing per
share amounts .......................... 9,506 9,449 9,541 9,401
====== ====== ====== ======
Net income per share ....................... $ 0.18 $ 0.09 $ 0.32 $ 0.15
====== ====== ====== ======
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 income and consolidated
statement of cash flows included in the Company's Form 10-Q for the period
ending June 30, 1997, and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 4,045
<SECURITIES> 21,771
<RECEIVABLES> 6,901
<ALLOWANCES> 478
<INVENTORY> 6,479
<CURRENT-ASSETS> 42,710
<PP&E> 8,692
<DEPRECIATION> 6,116
<TOTAL-ASSETS> 65,408
<CURRENT-LIABILITIES> 10,004
<BONDS> 0
0
0
<COMMON> 31,105
<OTHER-SE> 24,299
<TOTAL-LIABILITY-AND-EQUITY> 65,408
<SALES> 33,071
<TOTAL-REVENUES> 33,071
<CGS> 13,672
<TOTAL-COSTS> 29,982
<OTHER-EXPENSES> (1,278)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 4,367
<INCOME-TAX> 1,331
<INCOME-CONTINUING> 3,036
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,036
<EPS-PRIMARY> 0.32
<EPS-DILUTED> 0.32
</TABLE>
