UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
|_| 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 (IRS Employer
incorporation or organization) Identification Number)
217 Humboldt Court 94089
Sunnyvale, CA (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 745-6200
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
no par value
(Title of class)
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 |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 25, 1998, was approximately $13,823,068.00.
The number of shares outstanding of the registrant's Common Stock as of March
25, 1998, was 9,314,006 shares.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the definitive proxy statement (the "Definitive Proxy Statement") to
be filed with the Securities and Exchange Commission relative to the Company's
annual meeting of shareholders to be held May 20, 1998 are incorporated by
reference in Part III of this Form 10-K.
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<PAGE>
DIGITAL LINK CORPORATION
ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 1997
TABLE OF CONTENTS
Form 10-K
Item No. Name of Item Page
PART I
Item 1. Business.......................................................... 3
Item 2. Properties........................................................ 10
Item 3. Legal Proceedings................................................. 10
Item 4. Submission of Matters to a Vote of Security Holders............... 10
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters...................................................... 11
Item 6. Selected Financial Data........................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................ 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........ 23
Item 8. Financial Statements and Supplementary Data....................... 24
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures........................................ 42
PART III
Item 10. Directors and Executive Officers of the Registrant................ 42
Item 11. Executive Compensation............................................ 42
Item 12. Security Ownership of Certain Beneficial Owners and Management.... 42
Item 13. Certain Relationships and Related Transactions.................... 42
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.. 43
Signatures...................................................... 45
<PAGE>
PART I
ITEM 1. BUSINESS
Except for the historical statements contained herein, this Form 10-K
contains forward looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended ("the "Securities Act") and 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
this Form 10-K, including under the sections titled "Products and Technology,"
"Customers and End Users," "Research and Development," "Manufacturing,"
"Competition," "Intellectual Property and Other Proprietary Rights" and
"Employees" in Item 1 hereof 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," in Item 7 of this Form 10-K.
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.
When used in this Form 10-K words such as "believes," "anticipates,"
"expects," "intends," and similar expressions are intended to identify forward
looking statements, but are not the exclusive means of identifying such
statements. 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.
Overview
The Company designs, manufactures, markets and supports a broad range of
high speed digital access products, ranging from 56 Kbps to 155 Mbps for global
wide area networks ("WANs"). The Company's products are used by service
providers as infrastructure equipment and by business enterprises for
connectivity to WAN services, such as leased lines, Frame Relay, Switched
Multimegabit Data Service ("SMDS") and Asynchronous Transfer Mode ("ATM"). The
Company's products allow local area network ("LAN")-based internetworking
devices, such as routers, to access WANs and also integrate data with digitized
voice and video traffic for more efficient line utilization. Digital Link's
products are used both in the customer premise equipment ("CPE") environment and
in the networks of interexchange carriers ("IXCs"), Internet service providers
("ISPs") and telephone companies. The Company believes it is a leader in the WAN
access products market because of its broad range of products and its diverse
sales channels. The Company markets and sells its products in North America,
Europe, South America and Asia primarily through its direct sales force,
value-added resellers ("VARs") and original equipment manufacturers ("OEMs").
The Company was incorporated in California in 1985. Its principal executive
offices are located at 217 Humboldt Court, Sunnyvale, California 94089 and its
telephone number is (408) 745-6200.
<PAGE>
Industry Background
The growing reliance on enterprise-wide networks to facilitate the sharing
of information has created an environment in which the linkage of multiple LANs
over wide area networks is critical to daily operations. Two types of WANs have
developed to satisfy internetworking needs: private WANs, which are generally
based on dedicated leased lines; and public WANs, which are based on centralized
switching networks that route data to the proper destination. In private WANs,
the functions of switching, routing and multiplexing are performed on the
organization's premises utilizing customer-owned equipment and dedicated lines
leased from telephone companies and IXCs. As an alternative to private WANs,
telephone companies, ISPs and IXCs offer public WAN services. Companies that
provide products for connecting LAN-based data networks to WANs must support
both private and public WANs, including public WANs based on Frame Relay, SMDS
and ATM technologies.
In order for LANs to be interconnected to WANs, an interface is required to
condition LAN-based data to a format appropriate for transmission over WANs. The
Company believes equipment providers addressing the WAN access market must
develop product solutions flexible enough to respond to the changing standards
and network requirements associated with emerging WAN technologies, forge strong
relationships with telephone companies and ISPs implementing these services and
actively participate in standards development.
Products and Technology
WAN Access and DL7100 Products
The Company's principal products offer 56/64Kbps, T1/E1 and T3/E3 access to
public and private WANs using Internet, Frame Relay, SMDS and ATM technology.
The Company's products range from simple desktop or rack-mounted units for
smaller sites to intelligent multi-processor systems that support multiple lines
and integrate data with digitized voice and video for larger and more complex
sites. Enterprises use these products to enable internetworking equipment such
as routers to access WANs. The Company's products may also be used within the
networks of telephone companies, ISPs and IXCs to provide access to their
backbone networks. The list prices of the Company's products generally range
from $300 to $40,000.
The Company's access products are classified as Digital Service
Units/Channel Service Units ("DSUs/CSUs"), access multiplexers and inverse
multiplexers. The Company's DSUs/CSUs generally provide the interface between a
single data port and a single WAN line, and its access multiplexers are used to
multiplex multiple data, voice or video ports over one or more WAN lines.
Digital Link's inverse multiplexers break down high-speed data from a single
source for transmission over multiple T1 WAN lines.
The Company introduced its first T1 access products in 1985. In 1993, the
Company introduced the second generation of its T1/E1 access products with
certain enhanced features. Known as the Encore product line, these products
provide interfaces to Ethernet and Token Ring LAN-based data traffic from
internetworking devices and connects them to dedicated or Frame Relay-based
56Kbps and T1/E1 lines. Recently, the Company released a T1 access product that
includes improved network management capabilities such as in-band management and
integrated performance monitoring ("IPM"). This product in conjunction with a
marketing agreement with NetScout Systems, Inc. will allow the Company to market
a comprehensive enterprise management solution.
In 1993, the Company introduced the DL3800 T1 inverse multiplexer in
response to marketplace demand for a method of transporting information at data
rates faster than T1 without the expense and availability issues associated with
T3 lines. The DL3800 accepts data from a single high-speed data device and
prepares it for transmission over as many as eight T1 lines. In June 1996, the
Company introduced an international version of its inverse multiplexer product
line.
The Company introduced its first T3 access products in 1990. The Company's
T3/E3 DSUs and multiplexers include the DL3100 T3/E3 Access Multiplexer which
connects networking equipment to T3/E3 lines and is available with single or
multiple ports. In May 1995, the Company introduced the DL3900 multiplexer shelf
that allows customers to reduce the shelf space needed when installing multiple
inverse multiplexers in the same location. It houses both T1 and inverse
multiplexer modules and T3 access multiplexer modules to provide connectivity
between central and DL3100 or DL3800 units at remote sites.
The Company's SMDS and ATM access products consist of DSUs/CSUs and DL7100
access concentrators. In 1991, the Company began shipping the DL200, which is a
DSU/CSU used to access public SMDS networks that operate over T1/E1 lines. In
1992, the Company began shipping the DL3200, which is a DSU used to access
public SMDS and ATM networks that operate over T3/E3 lines. The DL3200 is now
being used as a tool to facilitate the migration from SMDS to ATM networks.
In support of the ATM infrastructure and to complement the large capacity
ATM switches necessary for such an infrastructure, the Company has developed its
DL7100 product (formerly known as the W/ATM GateWay Product) to connect non-ATM
traffic and slower speed ATM traffic to these high-speed ATM switches. The
DL7100 is a high-capacity system that multiplexes and switches voice, data,
video, low-speed cell and Frame Relay for ATM transmissions. The Company
recently added inverse multiplexing for ATM ("IMA") capability to the DL7100,
which allows service providers to save costs by aggregating ATM cells onto
multiple T1 lines, rather than through a single, higher-priced T3 trunk. The
Company believes that its IMA capability is the first in the industry to fully
conform to the ATM Forum's latest approved multiplexing specifications. The
Company has experienced very limited customer interest to date for this product
and is continuing development to enhance its functionality. See "Management's
Discussion and Analysis of Financial Conditions and Results of Operations --
Other Factors That May Affect Future Operating Results -- Risks of Company's
Involvement with Products for Emerging Markets" in Item 7 of this Form 10-K.
The Company believes that network reliability and management are among the
most important factors considered by users when selecting a network equipment
supplier. In order to maximize network reliability, the Company has built
monitoring and diagnostic tools into all of its products. In addition, the
Company offers access products via Simple Network Management Protocol ("SNMP"),
a standards-based network management system. SNMP provides a set of processes
and procedures to manage all elements of a network, allowing a user to manage
and control the entire network with one management system.
The Company also provides an SNMP-based graphical user interface in its
WANview technology solutions. WANview network management systems help service
providers achieve high levels of service, increased network efficiency and
reliability for improved operations because they can configure, maintain and
test the Company's products. The Company's Management Access Processor ("MAP")
allows customers to manage Digital Link products via a direct Ethernet LAN
interface. This cost-effective interface provides a management access
alternative independent of routers or terminal servers.
The markets for the Company's products are characterized by rapid
technological advances, product obsolescence, changes in customer requirements
and evolving regulatory requirements and industry standards. The Company's
future prospects will depend in part on its ability to enhance the functionality
of its existing WAN access products in a timely manner and to identify, develop
and achieve market acceptance of new products that address new technologies and
meet market requirements. Any failure by the Company to anticipate or to respond
adequately to technological developments in its industry, changes in customer
requirements, or changes in regulatory 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. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Other Factors That May Affect Future Operating Results
- -- Company Must Respond to Technological Change" in Item 7 of this Form 10-K. In
addition, customers could refrain from purchasing the Company's existing
products in anticipation of new product introductions by the Company or its
competitors.
Customers and End Users
Digital Link's customers and end users are diverse and represent many
industries. End users of private WANs that incorporate the Company's access
products, as well as telephone companies, ISPs and IXCs that either incorporate
the Company's products within their public networks or purchase the Company's
access products for resale to end users, include major interexchange carriers,
the Regional Bell Operating Companies ("RBOCs"), major domestic and
international carriers, industrial, electronics and other companies and
governments, universities and utilities.
The Company sells a majority of its products to a relatively limited number
of end users, VARs and telephone companies, certain of whom individually have
historically represented more than 10% of the Company's net sales. There can be
no assurance that the Company's current customers will continue to place orders
with the Company or that the Company will be able to obtain orders from new
customers. A significant portion of the Company's business is derived from
substantial orders placed by large end users and telephone companies, and the
timing of such orders could cause material fluctuations in the Company's
business and operating results. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Results of Operations -- Net
Sales," " -- Quarterly Results of Operations" and " -- Other Factors That May
Affect Future Operating Results -- Operating Results May Fluctuate; Absence of
Significant Backlog" in Item 7 of this Form 10-K.
Sales and Marketing
The Company primarily markets its products worldwide directly to large end
users, ISPs, IXCs and RBOCs and indirectly primarily through a network of VARs
and OEMs to accommodate specific markets and customer support requirements. The
Company's sales force focuses on (i) U.S. end users and ISPs, (ii) U.S. &
Canadian IXCs and telephone companies ("carriers") and (iii) international
customers. Each of these focus areas include one or more field-based system
engineers to provide technical sales support. In addition, the Digital Link
sales organization receives support from various groups within the Company such
as the marketing department, which is responsible, among other things, for
product marketing, customer service, and marketing communications.
U.S. End Users and ISPs
Sales to U.S. end users are generally made through the Company's direct
sales force and indirectly through VARs. Thus, the U.S. end users sales group is
primarily responsible for developing and maintaining relationships with selected
end users and for supporting the sales activities of its VARs. The Company's
agreements with its VARs generally have terms of 12 months, are subject to
renewal by mutual agreement and provide for discounts from the Company's list
prices for products based on the expected annual sales volumes and require the
Company to provide sales and application engineering support. The U.S. end user
sales group operates through the Company's headquarters in Sunnyvale, California
and twelve other sales offices.
<PAGE>
Carriers
Digital Link's carrier sales force focuses on developing relationships with
carriers in the U.S. and Canada and on understanding the network deployment
strategies of these carriers. Products sold to carriers may be used (i) within a
carrier's network in conjunction with the provision of their services, (ii) for
resale in conjunction with a carrier's provision of services to an end user, or
(iii) to satisfy the needs of a carrier's management information systems, where
the carrier is an end user of the products. The Company has entered into
agreements with certain carriers in the United States to purchase its products.
However, these agreements do not obligate the carriers to purchase any minimum
quantity of the Company's products.
International Customers
Sales to international customers are primarily made through OEMs and
selected VARs. International VARs authorized to sell the Company's products are
located in several countries within Europe, South America and Asia. Support for
the Company's products sold internationally is provided by the Company or its
authorized VARs. The Company currently has offices in the United Kingdom and
Germany.
Customer Support
The Company believes that a high level of continuing service and support is
integral to its objective of developing and maintaining long-term relationships
with its customers. The Company's customer support personnel are responsible for
servicing the Company's products and provide installation, technical training
and post-sales support (primarily over the telephone). The Company's products
generally have a warranty of at least 2 years and some CPE products have
lifetime warranties. The Company offers free telephone support during normal
business hours. The Company also offers customers the option of entering into a
maintenance and support contract that can include telephone support seven days a
week and 24 hours a day, emergency replacement programs and on-site support.
Internationally, the Company provides customer support either directly or
through full service VARs.
Research and Development
The Company's research and development efforts are focused on developing
new products, core technologies and enhancements to existing products. The
Company's product development activities are based on customer requirements,
marketplace needs and active participation by the Company in industry standards
groups and forums.
In 1997, 1996 and 1995, the Company's research and development expenditures
were $11.0 million, $10.1 million, and $8.9 million, which represented 16.7%,
19.4% and 20.1%, respectively, of net sales. In addition, the Company incurred a
charge for purchased research and development of $3.7 million in 1997 in
connection with its acquisition of Performance Telecom Corporation. The
Company's research and development efforts in 1997 primarily focused on the
continued development of the Company's DL7100 product as well as on the
expansion of its Encore product family by introducing new products and new
features, including IPM, for existing Encore products. During 1998, the Company
expects that it will continue to devote research and development resources to
the development of its DL7100 product and anticipates continuing to maintain its
focus on developing new products and features within its WAN access business.
The Company considers its research and development efforts to be vital to its
future success and anticipates that research and development expenditure, as a
percentage of net sales will remain significant for the foreseeable future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Research and Development" and
"--Purchased Research and Development" in Item 7 of this Form 10-K.
As referenced above, the Company's product development activities
frequently address new WAN services and applications based on emerging
technologies. The Company believes this strategy has often resulted in early
market penetration for products based on these technologies. However, industry
standards and requirements are more likely to change in new markets, which can
adversely impact the Company's business and operating results. Moreover,
technology and implementation approaches selected by the Company may be rendered
obsolete by such changes, and a new market may not become widespread. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Other Factors That May Affect Future Operating Results -- Company
Must Respond to Technological Change" in Item 7 of this Form 10-K.
The Company's success will depend upon its ability to develop new products
that achieve market acceptance and to provide enhancements to existing products
as required by the Company's customers and the communications marketplace. In
order to meet the challenges of rapidly changing technologies and services and
new industry standards that can render obsolete the Company's products, the
Company has invested and expects to continue to invest substantial resources in
the development of new products and technologies. 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.
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.
As of December 31, 1997, the Company's research and development staff
consisted of 72 employees, of whom 68 were engineers, and approximately half of
such engineers were engaged principally in the development of software. The
Company believes its ability to attract and retain qualified development
personnel is essential to the success of its development programs. The market
for such personnel is highly competitive, and the Company's development
activities could be adversely affected if the Company is unsuccessful in
attracting and retaining skilled technical personnel.
Manufacturing
The Company's manufacturing operations consist primarily of component
procurement and final assembly, test and quality control of subassemblies and
systems. The Company uses local third party contractors to manufacture and
assemble printed circuit boards. The manufacturing process enables the Company
to configure the hardware and software in combinations to meet a wide variety of
customer requirements. The Company performs "burn-in" procedures and functional
tests, as well as comprehensive inspections to assure the quality and
reliability of its products.
The Company's product designs are proprietary but generally incorporate
industry standard hardware components. However, certain semiconductor devices
and components and subassemblies are presently available only from single
sources, and certain other components are presently available or acquired only
from a limited number of sources. To date, the Company has been able to obtain
adequate supplies of these components, as well as subassemblies from third party
contractors, in a timely manner from existing sources or, when necessary, from
alternative sources, or to redesign its products to accommodate an alternative
component. The inability to obtain sufficient sole or limited source components
or subassemblies as required in the future, or to develop alternative sources or
redesign its products if and as required in the future, could result in delays
or reductions in product shipments that could materially adversely affect the
Company's business and operating results or damage customer relationships.
<PAGE>
Competition
The market for the Company's products is highly competitive. Many of the
Company's customers purchase products from both the Company and the Company's
competitors. The Company currently competes primarily with Adtran, Inc.
("Adtran"), Kentrox Industries, Inc., a subsidiary of ADC Telecommunications,
Inc. ("Kentrox"), Larscom Inc. ("Larscom"), Paradyne Corporation ("Paradyne"),
Verilink Corporation ("Verilink") and Visual Networks, Inc. ("Visual Networks").
Many of the Company's current and potential competitors have greater financial,
research and development, intellectual property, marketing and other resources
than those of the Company and have broader product lines and longer standing
relationships with customers than the Company.
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 suppliers of
internetworking equipment, such as routers, and telephone equipment, such as
switches, which are including direct WAN interfaces in certain of their
products. An increased reliance by customers on such suppliers for WAN access
would reduce demand for the Company's products, which could have a material
adverse affect on the Company's business and operating results. Increased
competition has also placed increasing pressures on the pricing of the Company's
products, which has resulted in lower operating results. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Results of Operations -- Net Sales" and "-- Gross Profit" in Item 7 of this Form
10-K. The Company anticipates that this increased pricing pressure will continue
during 1998.
The Company believes that its ability to compete successfully depends on a
number of factors both within and outside of its control, including, but not
limited to, price; announcements by the Company and its competitors; rapid
development of new products and features; product quality and performance;
experienced sales, marketing and service organizations; and evolving industry
standards. There can be no assurance that the Company will be able to continue
to compete successfully with its existing competitors or that it will be able to
compete successfully with new competitors.
Intellectual Property and Other Proprietary Rights
The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of patent
infringement. The Company has been contacted by two separate parties who have
expressed their belief that certain of the Company's products may infringe upon
patents held by these two parties. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Other Factors That May Affect
Future Operating Results -- Risk of Third Party Claims of Infringement," in Item
7 of this Form 10-K.
The Company treats its software and hardware designs as proprietary and
relies primarily on a combination of copyrights, trademark and trade secret
laws, and employee and third party nondisclosure agreements, to protect its
proprietary information. There can be no assurance that the contractual
obligations to maintain the confidentiality of the Company's trade secrets or
proprietary information will not be breached by employees, consultants, advisors
or others, or that the Company's trade secrets or proprietary technology will
not otherwise become known or be independently developed by competitors. The
Company has one patent with the U.S. Patent and Trademark office for certain ATM
technology that expires in September 2011. However, there can be no assurance
that such patent will prove to be important in the Company's product development
efforts. Certain technologies used in the Company's products are licensed from
third parties on a non-exclusive basis.
<PAGE>
Employees
As of December 31, 1997, the Company had 281 employees, of whom 72 were
primarily engaged in research and development, 112 in sales, marketing and
administration, 12 in customer support and 85 in manufacturing. From time to
time, Digital Link employs contract labor to assist with its short-term
personnel needs. 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 key
management personnel have only recently joined the Company, and certain
personnel have only limited experience in the Company's industry. In February
1998, Alan I. Fraser, the Company's President and Chief Executive Officer,
resigned to pursue other interests. Vinita Gupta, Chairman of the Board, assumed
the responsibilities of President and Chief Executive Officer upon Mr. Fraser's
departure, and the Company recently began searching for an individual to succeed
Ms. Gupta as President and Chief Executive Officer. In addition, the Company is
searching for a Vice President, Sales. The current availability of qualified
sales and engineering personnel is quite limited, and competition among
companies for such personnel is intense. The Company is currently attempting to
hire a number of sales and engineering personnel and has experienced delays in
filling such positions. There can be no assurance that the Company will be
successful in attracting and retaining skilled personnel to hold these important
positions. The Company expects to continue to experience growth in the number of
its employees, resulting in increased responsibilities for the Company's
management. The Company's employees are not represented by any collective
bargaining organization, and the Company has never experienced a work stoppage.
The Company believes that its employee relations are good.
ITEM 2. PROPERTIES
The Company leases its 60,030 square foot principal facility, which is
located in Sunnyvale, California, pursuant to a lease that expires in October
2003. Digital Link also leases 11,500 square feet of space in Rochester, New
York, as a research and development facility. The Company maintains sales
operations in North America in Oak Brook, Illinois; Fort Lee, New Jersey;
Houston, Texas; Irving, Texas; and Markham, Ontario. In Europe, the Company
leases facilities in London, England, Munich, Germany and near Stuttgart,
Germany. The Company believes that its existing facilities are adequate to meet
its current needs and that suitable additional or alternative space will be
available in the future on commercially reasonable terms. See Note 3 of Notes to
Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
In April 1996, a class action complaint was filed against the Company and
certain of its officers and directors in Santa Clara Superior Court of the State
of California, alleging violations of the California Corporations Code and
California Civil Code and in October 1996, a similar parallel lawsuit was filed
in the United States District Court for the Northern District of California
alleging violations of federal securities laws. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Other Factors That
May Affect Future Operating Results -- Legal Proceedings," in Item 7 of this
Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Common Stock of the Company began trading in the over-the-counter
market on the Nasdaq National Market on February 1, 1994 under the symbol
"DLNK." The following table sets forth the high and low closing prices for the
Company's Common Stock as reported on the Nasdaq National Market for each
quarterly period since January 1, 1996. These prices reflect inter-dealer
prices, without retail mark-up, markdown or commission, and may not necessarily
represent actual transactions.
1997 1996
High Low High Low
-------------------------------------------
1st Quarter................... $24.25 $12.50 $14.13 $ 8.19
2nd Quarter................... $21.75 $13.75 $22.00 $ 9.75
3rd Quarter................... $27.38 $18.88 $18.25 $12.75
4th Quarter................... $26.25 $ 9.41 $23.75 $16.50
As of December 31, 1997, there were 122 holders of record of the Company's
Common Stock and approximately 1,200 beneficial owners.
The Company has never declared or paid any cash dividends on its capital
stock. The Company currently intends to retain any future earnings for use in
its business and, therefore, does not anticipate paying any cash dividends in
the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the consolidated financial statements and the notes thereto
included elsewhere herein. The consolidated statement of income data for the
years ended December 31, 1997, 1996 and 1995, and the consolidated balance sheet
data at December 31, 1997 and 1996 are derived from, and are qualified by
reference to, the audited consolidated financial statements included elsewhere
in this report and should be read in conjunction with those financial statements
and the notes thereto. The consolidated statement of income data for the years
ended December 31, 1994 and 1993 and the consolidated balance sheet data at
December 31, 1995, 1994 and 1993 are derived from audited financial statements
not included in this report.
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
(in thousands, except per share data) 1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Statement of Income Data:
<S> <C> <C> <C> <C> <C>
Net sales ..................................... $66,008 $52,078 $44,344 $35,222 $22,509
Cost of sales ................................. 29,078 21,457 16,769 11,927 7,540
------- ------- ------- ------- -------
Gross profit .......................... 36,930 30,621 27,575 23,295 14,969
------- ------- ------- ------- -------
Expenses:
Research and development ................. 11,005 10,120 8,922 7,300 4,316
Selling, general and administrative ...... 22,019 16,150 13,958 10,514 7,494
Purchased research & development ......... 3,651 0 0 0 0
------- ------- ------- ------- -------
Total expenses ........................ 36,675 26,270 22,880 17,814 11,810
------- ------- ------- ------- -------
Operating income ...................... 255 4,351 4,695 5,481 3,159
Other income .................................. 2,524 2,495 2,281 1,098 242
------- ------- ------- ------- -------
Income before provision
for income taxes ...................... 2,779 6,846 6,976 6,579 3,401
Provision for income taxes .................... 847 2,149 2,162 2,171 1,197
------- ------- ------- ------- -------
Net income ............................ $ 1,932 $ 4,697 $ 4,814 $ 4,408 $ 2,204
======= ======= ======= ======= =======
Earnings per share (basic)
- --------------------------
Net income per share(1) ....................... $ 0.21 $ 0.52 $ 0.55 $ 0.55 $ 0.32
======= ======= ======= ======= =======
Shares used in computing per share
amounts(1) .................................... 9,249 9,107 8,783 7,976 6,891
======= ======= ======= ======= =======
Earnings per share (diluted)
- ----------------------------
Net income per share(1) ....................... $ 0.20 $ 0.50 $ 0.51 $ 0.48 $ 0.31
======= ======= ======= ======= =======
Shares used in computing per share
amounts(1) .................................... 9,600 9,478 9,467 9,113 7,169
======= ======= ======= ======= =======
</TABLE>
<PAGE>
Year Ended December 31,
-----------------------
(in thousands) 1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Balance Sheet Data:
Cash, cash equivalents and
marketable securities ... $42,429 $44,048 $37,609 $31,688 $ 4,505
Working capital ............. 28,901 28,523 27,483 23,352 8,789
Total assets ................ 66,056 62,733 54,755 46,829 14,687
Total shareholders' equity .. 57,334 53,802 47,773 40,211 9,905
- ------------------
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of the number of shares used in computing net income
per share. Amounts have been restated for the adoption of Statement of
Financial Accounting Standard No. 128 "Earnings Per Share."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except for the historical statements contained herein, this Form 10-K
contains forward looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended ("the "Securities Act") and 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
this Form 10-K, including under the sections titled "Products and Technology,"
"Customers and End Users," "Research and Development," "Manufacturing,"
"Competition," "Intellectual Property and Other Proprietary Rights" and
"Employees" in Item 1 hereof 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," in Item 7 of this Form 10-K.
The actual results that Digital Link achieves may differ materially from any
forward looking statements due to such risks and uncertainties.
When used in this Form 10-K words such as "believes," "anticipates,"
"expects," "intends," and similar expressions are intended to identify forward
looking statements, but are not the exclusive means of identifying such
statements. 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.
Overview
The Company designs, manufactures, markets and supports a broad range of
high speed digital access products, ranging from 56 Kbps to 155 Mbps for global
WANs. The Company's products are used by service providers as infrastructure
equipment and by business enterprises for connectivity to WAN services, such as
leased lines, Frame Relay, SMDS and ATM. The Company's products allow LAN-based
internetworking devices, such as routers, to access WANs and also integrate data
with digitized voice and video traffic for more efficient line utilization.
Digital Link's products are used both in the CPE environment and in the networks
of IXCs, ISPs and telephone companies. The Company believes it is a leader in
the WAN access products market because of its broad range of products and its
diverse sales channels. The Company markets and sells its products in North
America, Europe, South America and Asia primarily through its direct sales
force, VARs and OEMs.
<PAGE>
Results of Operations
The following table sets forth statement of income data as a percentage of
net sales for the years ended December 31, 1997, 1996 and 1995:
Year Ended December 31,
-----------------------
1997 1996 1995
---- ---- ----
Net sales ........................................ 100.0% 100.0% 100.0%
Cost of sales .................................... 44.1 41.2 37.8
------ ------ ------
Gross profit ............................. 55.9 58.8 62.2
------ ------ ------
Expenses:
Research and development .................... 16.7 19.4 20.1
Selling, general and administrative ......... 33.3 31.0 31.5
Purchased research and development .......... 5.5 0 0
------ ------ ------
Total expenses ........................... 55.5 50.4 51.6
------ ------ ------
Operating income ......................... 0.4 8.4 10.6
Other income ..................................... 3.8 4.8 5.1
------ ------ ------
Income before provision for income taxes . 4.2 13.2 15.7
Provision for income taxes ....................... 1.3 4.1 4.9
------ ------ ------
Net income ............................... 2.9% 9.1% 10.8%
====== ====== ======
Net Sales
Net sales increased 27.0% to $66.0 million in 1997 from $52.1 million in
1996. The increase in 1997 was primarily attributable to an increase in unit
sales of broadband (i.e., transmission rates in excess of T1/E1) products and to
a lesser extent, an increase in unit sales of narrowband (i.e., transmission
rates up to T1/E1) products. This increase was offset in part by decreased
average selling prices on certain narrowband and broadband products as a result
of price reductions made in the first half of 1997. Net sales increased 17% to
$52.1 million in 1996 from $44.3 million in 1995. The increase in 1996 was
primarily attributable to an increase in unit sales of both narrowband products
in the Encore product family and domestic broadband products. These increases
were offset in part by decreased unit sales of the Company's SMDS access
products primarily sold in Europe and decreased average selling prices on
certain of the Company's narrowband and broadband products as a result of price
reductions made throughout 1996. The Company believes that the decrease in unit
sales of the Company's SMDS access products in Europe in 1996 was due in part to
delays in the further deployment of SMDS networks due to technical problems
within the networks and market confusion in Europe among Frame Relay, SMDS and
ATM technologies, which began in late 1995.
During the fourth quarter of 1997, the Company experienced decreased demand
from certain domestic carrier customers which resulted in significantly lower
than anticipated levels of net sales and a net loss for the quarter. The Company
anticipates that this market condition will continue through at least the first
half of 1998, which will result in lower levels of net sales as compared to net
sales in the first half of 1997. However, actual results could vary from the
foregoing forward looking statements as a result of 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
described throughout this Form 10-K.
In 1997, narrowband sales in absolute dollars increased by 15% and
decreased as a percentage of net sales to 55% as compared to 61% in 1996.
Broadband sales increased in absolute dollars by 45% and increased as a
percentage of net sales to 45% in 1997 as compared to 39% in 1996. Broadband
sales as a percentage of net sales increased from 1996 to 1997 primarily as a
result higher broadband sales to certain domestic carrier customers and ISPs. In
1997, narrowband sales increased primarily as a result of increased sales to
ISPs and Frame Relay networks. In 1996, narrowband sales in absolute dollars
increased by 28% and increased as a percentage of net sales to 61% as compared
to 56% in 1995. Broadband sales increased in absolute dollars by 5% and
decreased as a percentage of net sales to 39% in 1996 as compared to 44% in
1995. In 1996, narrowband sales increased primarily as a result of increased
sales to ISPs and Frame Relay networks. Narrowband sales increased as a
percentage of net sales from 1995 to 1996 primarily as a result of lower
broadband sales of SMDS products in Europe. Broadband sales in absolute dollars
increased in 1996 primarily as a result of higher sales to certain domestic
carriers and ISPs, which were offset, in part by lower SMDS sales in Europe.
Broadband sales as a percentage of net sales decreased from 1995 to 1996
primarily as a result of lower SMDS sales in Europe, which were slightly offset
by higher broadband sales to certain domestic carrier customers and ISPs.
International sales (including sales in Canada) represented approximately
17%, 17% and 28% of net sales in 1997, 1996 and 1995, respectively. The decrease
in international sales as a percentage of net sales from 1995 to 1996 was
primarily related to the decline in sales of the Company's SMDS products, as
described above. 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.
In 1997, 1996 and 1995, net sales to MCI represented approximately 20%, 13%
and 12%, respectively, of the Company's net sales. In addition, net sales to BBN
Planet Corporation during 1996 was 13% of the Company's net sales and net sales
to Siemens during 1995 was 11%. A significant portion of the Company's business
is derived from substantial orders placed by large end users and telephone
companies, and the timing of such orders could cause material fluctuations in
the Company's business and operating results. For example, in the quarter ended
December 31, 1997, the Company experienced a shortfall in revenues as compared
to its expectations, which was due primarily to lower than expected revenues
from certain domestic carriers.
Gross Profit
Gross profit increased by 21% in 1997 to $36.9 million from $30.6
million for 1996. Gross margin decreased to 55.9% of net sales in 1997 as
compared to 58.8% in 1996. This decrease in gross margin is primarily due to 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.
Gross profit increased 11% to $30.6 million in 1996 from $27.6 million in
1995, while gross margin decreased to 58.8% from 62.2%. This decrease in gross
margin in 1995 was primarily due to the above referenced price reductions, and
to a lesser extent, a shift in the mix of products sold to include more
narrowband products, which generally have lower gross margins than broadband
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 at
least through the end of 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 increased 9% to $11.0 million in 1997 from $10.1 million
in 1996. This increase is primarily attributable to higher personnel related
expenses offset by a decrease in consulting fees related to the Company's DL7100
product. R&D expenses increased 13% to $10.1 million in 1996 from $8.9 million
in 1995. This increase is primarily attributable to higher consulting fees
related to the Company's DL7100 product, offset by a decrease in professional
services, personnel related expenses and material costs for prototype products.
As a percentage of net sales, R&D expenses were 16.7% in 1997 as compared to
19.4% in 1996. 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 1998 will increase in absolute
dollars and may increase as a percentage of net sales as compared to 1997, as a
result in part of an increase in personnel related costs due to the Company's
acquisition of Performance Telecom. See "--Purchased Research and Development"
below. 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 1998.
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 entertainment. SG&A expenses increased 36% in 1997 to $22.0
million from $16.2 million in 1996. This increase is primarily attributable to
higher personnel related expenses and, to a lesser extent, consulting expenses.
SG&A expenses increased 16% for 1996 to $16.2 million from $14.0 million for
1995. This increase in absolute dollars was primarily a result of higher
personnel related expenses, primarily within the sales and marketing
organization, and higher evaluation product and promotional expenses. As a
percentage of net sales, SG&A expenses increased to 33.4% for 1997 as compared
to 31.0% for 1996. This increase as a percentage of net sales was primarily a
result of a higher rate of growth in personnel related expenses compared to the
rate of growth in net sales over the same period. As a percentage of net sales,
SG&A expenses decreased slightly to 31.0% for 1996 as compared to 31.5% for the
prior year. The decrease as a percentage of net sales was primarily the result
of operating efficiencies from higher net sales during 1996. The Company
believes SG&A expenses as a percentage of net sales will be higher for at least
the first half of 1998 compared to 1997 as a result of anticipated lower levels
of net sales for 1998 as compared to 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 are 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
In connection with its acquisition of certain assets and in-process
technology for $5 million in cash from Performance Telecom, for which
technological feasibility had not been achieved, the Company incurred an expense
of $3.7 million related to purchased research and development in the third
quarter of 1997. Such in-process technology was valued, along with other
acquired assets, in accordance with valuation techniques commonly used in the
technology industry and was expensed upon acquisition in accordance with
Financial Accounting Standard No. 2, "Accounting for Research and Development
Costs." This technology enables network service providers to offer applications
such as Internet access, interactive video services, remote data access and
multimedia applications at multi-megabit-per-second speeds over standard
voice-grade copper lines. The Company intends to integrate the acquired
technologies into its existing products, but there can be no assurance that such
integration will be completed in the expected time or at the expected cost.
Other Income
Other income includes primarily interest income and purchase discounts.
Other income remained flat at $2.5 million in both 1997 and 1996. Other income
increased 9% to $2.5 million in 1996 from $2.3 million in 1995. This increase
was primarily a result of higher interest income due to higher rates of return
on marketable securities.
Provision for Income Taxes
The Company's effective tax rate decreased to 30.5% in 1997 compared to
31.4% in 1996. This decrease is due primarily to increases in foreign sales
corporation tax benefit and nontaxable municipal interest. The Company's
effective rate increased to 31.4% in 1996 compared to 31.0% in 1995. This
increase is due primarily to lower foreign sales which resulted in lower foreign
sales corporation tax benefit.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("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.
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.
During October 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-2 ("SOP 97-2"), "Software Revenue Recognition."
The Company will be studying the implications of these Statements, but the
impact of their implementation on the financial statements of the Company has
not yet been determined.
Quarterly Results of Operations
The following table sets forth certain unaudited quarterly financial
information for each of the Company's last eight quarters. The Company believes
this information reflects all adjustments, consisting only of normal recurring
adjustments, that the Company's management considers necessary for a fair
representation of this information in accordance with generally accepted
accounting principles. Quarterly results are not necessarily indicative of
future results of operations.
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended
-------------------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
(in thousands, except per share data 1996 1996 1996 1996 1997 1997 1997 1997
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales ............................ $ 10,203 $ 12,026 $ 14,127 $ 15,722 $ 16,038 $ 17,033 $ 18,529 $ 14,408
Cost of sales ........................ 4,366 4,838 5,666 6,587 6,816 6,856 7,948 7,458
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit .................... 5,837 7,188 8,461 9,135 9,222 10,177 10,581 6,950
-------- -------- -------- -------- -------- -------- -------- --------
Expenses:
Research and development .......... 2,050 2,335 2,749 2,986 3,032 2,594 2,603 2,776
Selling, general and .............. 3,584 4,145 4,206 4,215 4,916 5,768 5,858 5,477
administrative
Purchased research & development . 0 0 0 0 0 0 3,651 0
-------- -------- -------- -------- -------- -------- -------- --------
Total expenses ................. 5,634 6,480 6,955 7,201 7,948 8,362 12,112 8,253
-------- -------- -------- -------- -------- -------- -------- --------
Operating income ................ 203 708 1,506 1,934 1,274 1,815 (1,531) (1,303)
Other income ......................... 633 574 625 663 641 638 646 599
-------- -------- -------- -------- -------- -------- -------- --------
Income before provision for
income taxes ................. 836 1,282 2,131 2,597 1,915 2,453 (885) (704)
Provision for income taxes ........... 280 430 650 789 583 748 (270) (214)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) ............... $ 556 $ 852 $ 1,481 $ 1,808 $ 1,332 $ 1,705 $ (615) $ (490)
======== ======== ======== ======== ======== ======== ======== ========
Earnings per share (basic)
- --------------------------
Net income (loss) per share .......... $ 0.06 $ 0.09 $ 0.16 $ 0.20 $ 0.14 $ 0.19 $ (0.07) $ (0.05)
======== ======== ======== ======== ======== ======== ======== ========
Shares used in computing per
share amounts ....................... 9,007 9,082 9,149 9,187 9,190 9,188 9,240 9,375
======== ======== ======== ======== ======== ======== ======== ========
Earnings per share (diluted)
- ----------------------------
Net income (loss) per share .......... $ 0.06 $ 0.09 $ 0.16 $ 0.19 $ 0.14 $ 0.18 $ (0.07) $ (0.05)
======== ======== ======== ======== ======== ======== ======== ========
Shares used in computing per
share amounts ........................ 9,352 9,449 9,451 9,659 9,577 9,506 9,240 9,375
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
The Company acquired certain assets of Performance Telecom in September
1997, incurring a one-time charge of $3.7 million for purchased research and
development. As a result, the Company incurred a net loss in the third quarter
of 1997.
A significant portion of the Company's business is derived from substantial
orders placed by large end-users and telephone companies. The timing of such
orders can, in general, cause material fluctuations in the Company's operating
results and was of particular significance in the fourth quarter of 1997 where
weaker than expected demand from certain domestic carrier customers together
with expense levels geared in expectation of higher revenue levels combined to
produce a net loss.
The Company has in the past hired more of its SG&A personnel primarily
within the sales and marketing organizations, and incurred increased expenses
related to trade shows and other promotional activities, during the first half
of the year. In the first half of 1997, the Company increased its sales
organization personnel in anticipation of increased revenue opportunities.
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. For example, periodically throughout 1996 and in the first half of
1997, the Company reduced the prices on some of its access products to address
competitive pricing pressures, which adversely affected the Company's gross
margins during 1996 and 1997. The Company anticipates that this increased
pricing pressure will continue at least through 1998. In addition, the mix of
products sold may continue to change to include a higher percentage of
narrowband products that generally have lower gross margins and would therefore
adversely affect the Company's overall gross margins. Other factors that may
cause fluctuations in the Company's operating results include the loss of, or
difference in actual from anticipated levels of purchases from, the Company's
major customers, seasonal capital spending patterns of large domestic customers,
changes in sales volumes through the Company's distribution channels, 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.
Liquidity and Capital Resources
With the exception of $1.0 million that the Company received from the sale
of Preferred Stock in 1987, through 1993 the Company financed its operations and
capital equipment requirements primarily from cash flows from operations. In
early 1994, the Company sold approximately 1,937,500 shares of common stock at a
price per share of $14.00 in its initial public offering. The Company has added
the net proceeds of that offering to working capital, where such proceeds are
available to support general corporate purposes.
The Company's working capital increased to $28.9 million at December 31,
1997 from $28.5 million at December 31, 1996 and $27.5 million at December 31,
1995. The Company's cash, cash equivalents and long and short-term marketable
securities decreased to $42.4 million at December 31, 1997 from $44.0 million at
December 31, 1996 and $37.6 million at December 31, 1995. Net cash provided by
operating activities was $5.8 million, $6.4 million and $4.6 million in 1997,
1996 and 1995, respectively. The Company paid $5 million for certain assets of
Performance Telecom in the third quarter of 1997, accounting for much of the
decline in cash, cash equivalents and long and short-term marketable securities
at the end of 1997. The decline in net cash provided by operating activities
from 1996 to 1997 was largely due to a shortfall in the fourth quarter of 1997
in net sales as discussed under "--Results of Operations -- Net Sales" and
"Quarterly Results of Operations," and the related decline in net income for
1997. In addition, investments were made in inventory during 1997 in
anticipation of higher levels of net sales that did not materialize. In 1996,
net cash provided by operating activities was primarily a result of net income,
a decrease in accounts receivable and an increase in accounts payable and
accrued payroll and other accrued expenses, offset to some extent by increased
inventories. To date, the Company has not experienced any material inventory
obsolescence as a result of new product development, but there can be no
assurance that future product development efforts will not render Company
products obsolete. Leasehold improvements and capital equipment additions were
$2.3 million in 1997, $1.3 million in 1996, and $1.4 million in 1995. Net cash
used in financing activities amounted to $10,000 in 1997 as compared to net cash
provided by financing activities of $812,000 and $852,000 in 1996 and 1995
respectively, primarily from the proceeds of employee stock options and
purchases. The use of cash in financing activities in 1997 was due primarily to
the Company's repurchase of $2.4 million of its Common Stock, offset by the
proceeds from the exercise of stock options and employee stock purchases.
In October 1996, the Company's Board of Directors announced the
authorization for the Company to repurchase 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, at which
time the stock will be retired. No time limit was set for completion of the
program. The Company purchased 142,000 shares of common stock under this program
in 1997 at a cost of $2,422,000.
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 this "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.
Operating Results May Fluctuate; Absence of Significant Backlog
The Company believes that the loss of, or difference in actual from
anticipated levels of purchases from, the Company's major customers could in the
future affect operating results. Other factors that may cause fluctuations in
the Company's operating results include, but are not limited to, seasonal
capital spending patterns of large domestic customers, changes in the product
mix sold toward narrowband products that yield lower gross margins, completion
of the build out of carrier and ISP infrastructures, the timing of new product
announcements and introductions by the Company and its competitors, changes in
sales volumes through the Company's distribution channels, 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 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's industry has in the last
several years been characterized by declining prices on existing products,
therefore continual improvement of manufacturing efficiencies and enhancements
to existing products are required to maintain gross margins.
Market for the Company's Products is Highly Competitive
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 suppliers of internetworking
equipment, such as routers, and telephone equipment, such as switches, which are
including a direct WAN interface in certain of their products. An increased
reliance by customers on such suppliers for WAN access would 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 at least through 1998.
Company Depends on Key Personnel
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 key management
personnel have only recently joined the Company and certain personnel have only
limited experience in the Company's industry. In February 1998, Alan I. Fraser,
the Company's President and Chief Executive Officer, resigned to pursue other
interests. Vinita Gupta, Chairman of the Board, assumed the responsibilities of
President and Chief Executive Officer upon Mr. Fraser's departure, and the
Company recently began searching for an individual to succeed Ms. Gupta as
President and Chief Executive Officer. In addition, the Company is searching for
a Vice President, Sales. The current availability of qualified sales and
engineering personnel is quite limited, and competition among companies for such
personnel is intense. The Company is currently attempting to hire a number of
sales and engineering personnel and has experienced delays in filling such
positions. There can be no assurance that the Company will be successful in
attracting and retaining skilled personnel to hold these important positions.
Company Must Respond to Technological Change
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 (formerly known as the W/ATM GateWay 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.
Risks of Company's Involvement With Products for Emerging Markets
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 that required some software to be redesigned. This became
available for revenue shipments in the second half of 1997. The Company has
experienced very limited customer interest to date of this product in the
marketplace. The Company does not anticipate that the DL7100 revenue will become
a significant portion of the Company's revenue until at least 1999. 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 market for ATM
infrastructure products will continue to develop, the DL7100 will meet the needs
of the emerging ATM market or any other market or, that products currently
available or under development by competitors would not directly compete with
the DL7100 product. The occurrence of any of these events would have a material
adverse affect on the Company's business and operating results.
Risks Associated with Acquisitions
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 affect on the Company's
business, financial condition and results of operations.
Year 2000 Compliance
The Company has assessed and continues to assess the impact of the Year
2000 issue on its operations, including the development of cost estimates for,
and the extent of programming changes required to address, this issue. Although
final cost estimates have yet to be determined, it is anticipated that these
Year 2000 costs will not be material to the Company expenses during 1998 and
1999. The Company doe 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.
Legal Proceedings
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 of these 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 that the individual defendants sold shares of the Company's
stock based upon material nonpublic information. The complaints seek unspecified
monetary damages. To date, the Superior Court has dismissed portions of
plaintiff's state court complaint without leave to amend. The Superior Court
also dismissed five of the individual defendants without leave to amend and
another individual defendant with leave to amend. The Superior Court also denied
motions to dismiss filed by the Company and two other individual defendants with
respect to the remaining portions of the complaint. Plaintiff has filed a third
amended complaint that names the Company and three individual defendants.
Discovery to date has been limited in the state court action, and the Superior
Court has not set a trial date. The Company also moved to dismiss the federal
complaint. On September 11, 1997, the Court granted the Company's motion to
dismiss. The Court granted plaintiff leave to file, and plaintiff has filed, an
amended complaint. The Company has moved to dismiss the amended complaint. There
has been no discovery in the federal action, and no trial date has been set.
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. No
provision for any liability that may result upon adjudication has been made in
the accompanying financial statements.
Risk of Third Party Claims of Infringement
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. The
Company does not believe that there is merit to Larscom's claim. Management,
after review and consultation with counsel, believes that the ultimate
resolution of both 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 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. 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.
Possible Adverse Changes in Future Market Price
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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The quarterly supplementary data is included as part of Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The financial statements required by this item are set forth below.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page
Report of Independent Accountants ........................................ 25
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1997 and 1996 ........ 26
Consolidated Statements of Income for each of the three years in the
period ended December 31, 1997 ...................................... 27
Consolidated Statements of Shareholders' Equity for each of the three
years in the period ended December 31, 1997 ......................... 28
Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 1997 .................................. 29
Notes to Consolidated Financial Statements .......................... 30
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Digital Link Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Digital
Link Corporation and Subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Digital Link
Corporation and Subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
San Jose, California
January 20, 1998
<PAGE>
<TABLE>
<CAPTION>
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
December 31,
------------
1997 1996
---- ----
Current assets:
<S> <C> <C>
Cash and cash equivalents ..................................... $ 2,504 $ 2,043
Short-term marketable securities .............................. 18,026 19,585
Accounts receivable, less allowance for doubtful accounts of
$517 in 1997 and $465 in 1996 ................................. 5,193 6,490
Inventories, net .............................................. 8,163 5,920
Prepaid and other current assets .............................. 1,433 1,131
Deferred income taxes ......................................... 2,304 2,285
------- -------
Total current assets ................................. 37,623 37,454
Property and equipment, net ............................................ 3,325 2,147
Long-term marketable securities ........................................ 21,899 22,420
Deferred income taxes .................................................. 2,062 418
Other assets ........................................................... 1,147 294
------- -------
Total assets ................................ $66,056 $62,733
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable .............................................. $ 2,407 $ 2,300
Accrued payroll and related expense ........................... 2,344 1,648
Other accrued expenses ........................................ 3,785 3,442
Income taxes payable .......................................... 186 1,541
------- -------
Total current liabilities ............................ 8,722 8,931
Commitments and contingencies (Note 3)
Shareholders' equity:
Preferred stock, no par value:
Authorized: 5,000,000 shares;
Issued and outstanding: none in 1997 and 1996
Common stock, no par value:
Authorized: 25,000,000 shares;
Issued and outstanding: 9,427,306 shares in 1997 and
9,218,150 shares in 1996 ................................. 34,609 30,913
Unrealized gain on marketable securities ...................... 107 257
Retained earnings ............................................. 22,618 22,632
------- -------
Total shareholders' equity ........................... 57,334 53,802
------- -------
Total liabilities and shareholders' equity .. $66,056 $62,733
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
- --------------------------------------------------------------------------------
Year Ended December 31,
-----------------------
1997 1996 1995
---- ---- ----
Net sales ...................................... $66,008 $52,078 $44,344
Cost of sales .................................. 29,078 21,457 16,769
------- ------- -------
Gross profit ............................ 36,930 30,621 27,575
------- ------- -------
Expenses:
Research and development ................... 11,005 10,120 8,922
Selling, general and administrative ........ 22,019 16,150 13,958
Purchased research and development ......... 3,651 -- --
------- ------- -------
Total expenses .......................... 36,675 26,270 22,880
------- ------- -------
Operating income ........................ 255 4,351 4,695
Other income ................................... 2,524 2,495 2,281
------- ------- -------
Income before provision for income taxes 2,779 6,846 6,976
Provision for income taxes ..................... 847 2,149 2,162
------- ------- -------
Net income .............................. $ 1,932 $ 4,697 $ 4,814
======= ======= =======
Earnings per share (basic)
- --------------------------
Net income per share ........................... $ 0.21 $ 0.52 $ 0.55
======= ======= =======
Shares used in computing per share amounts ..... 9,249 9,107 8,783
======= ======= =======
Earnings per share (diluted)
- ----------------------------
Net income per share ........................... $ 0.20 $ 0.50 $ 0.51
======= ======= =======
Shares used in computing per share amounts ..... 9,600 9,478 9,467
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Unrealized
Gain
(Loss) on
Preferred Stock Common Stock Marketable Retained
Shares Amount Shares Amounts Securities Earnings Total
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, December 31, 1994 .................... -- -- 8,628 $ 27,162 (72) $ 13,121 $ 40,211
-------- -------- -------- -------- -------- -------- --------
Issuance of common stock in connection with:
Stock option plan ........................ -- -- 356 600 -- -- 600
Stock purchase plan ...................... -- -- 16 252 -- -- 252
Tax benefit related to disqualifying
dispositions from exercise of stock
options .................................. -- -- -- 1,269 -- -- 1,269
Unrealized loss on marketable
securities ............................... -- -- -- -- 627 -- 627
Net income ................................. -- -- -- -- -- 4,814 4,814
-------- -------- -------- -------- -------- -------- --------
Balances, December 31, 1995 .................... -- -- 9,000 29,283 555 17,935 47,773
Issuance of common stock in connection with:
Stock option plan ........................ -- -- 199 546 -- -- 546
Stock purchase plan ...................... -- -- 19 266 -- -- 266
Tax benefit related to disqualifying
dispositions from exercise of stock
options .................................. -- -- -- 818 -- -- 818
Unrealized loss on marketable
securities ............................... -- -- -- -- (298) -- (298)
Net income ................................. -- -- -- -- -- 4,697 4,697
-------- -------- -------- -------- -------- -------- --------
Balances, December 31, 1996 ................. -- -- 9,218 30,913 257 22,632 53,802
Issuance of common stock in connection with:
Stock option plan ........................ -- -- 311 1,885 -- -- 1,885
Stock purchase plan ...................... -- -- 40 527 -- -- 527
Repurchase of common stock ............... -- -- (142) (476) -- (1,946) (2,422)
Tax benefit related to disqualifying
dispositions from exercise of stock
options .................................. -- -- -- 1,760 -- -- 1,760
Unrealized loss on marketable
securities ............................... -- -- -- -- (150) -- (150)
Net income ................................. -- -- -- -- -- 1,932 1,932
-------- -------- -------- -------- -------- -------- --------
Balances, December 31, 1997 .................... -- -- 9,427 $ 34,609 $ 107 $ 22,618 $ 57,334
======== ======== ======== ======== ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
<PAGE>
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
<S> <C> <C> <C>
Net income ...................................................... $ 1,932 $ 4,697 $ 4,814
Adjustments to reconcile net income to net cash flows
provided by operating activities:
Depreciation and amortization ................................ 1,224 752 1,720
Amortization of goodwill ..................................... 28 -- --
Provision (reduction in allowance) for doubtful accounts ..... 66 (383) 434
Provision (reduction in allowance) for excess and obsolete
inventories ................................................ 555 457 (160)
R&D write-off on acquisition ................................. 3,651 -- --
Deferred income taxes ........................................ (1,663) (482) (213)
Changes in assets and liabilities:
Accounts receivable ....................................... 1,686 1,583 (405)
Inventories ............................................... (2,315) (1,774) (1,819)
Prepaid and other current assets .......................... (284) (402) (148)
Accounts payable .......................................... 107 1,136 (656)
Accrued payroll and other accrued expenses ................ 421 700 (407)
Income taxes payable ...................................... 405 114 1,427
------- -------- --------
Net cash flows provided by operating activities ....... 5,813 6,398 4,587
------- -------- --------
Cash flows from investing activities:
Purchases of marketable securities .............................. (22,740) (34,915) (32,008)
Maturities of marketable securities ............................. 24,670 24,391 13,168
Sales of marketable securities .................................. -- 4,008 12,816
Acquisition of Performance Telecom Corporation assets ........... (5,000) -- --
Acquisition of property and equipment ........................... (2,272) (1,290) (1,414)
-------- -------- --------
Net cash flows used in investing activities ........... (5,342) (7,806) (7,438)
-------- -------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options and employee stock ...... 2,412 812 852
purchases
Repurchase of common stock ...................................... (2,422) -- --
-------- -------- --------
Net cash flows provided by (used in) financing activities (10) 812 852
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents ....................................... 461 (596) (1,999)
Cash and cash equivalents at beginning of year ..................... 2,043 2,639 4,638
-------- -------- --------
Cash and cash equivalents at end of year ........................... $ 2,504 $ 2,043 $ 2,639
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes ...................... $ 2,377 $ 1,727 $ 662
-------- -------- --------
Cash received during the year for income taxes .................. $ 85 $ 27 $ 1,137
======== ======== ========
Supplemental schedule of noncash investing and financing activities:
Unrealized gain (loss) on securities carried at market .......... $ (150) $ (298) $ 627
======== ======== ========
Tax benefit related to disqualifying dispositions from exercise
of stock option ............................................ $ 1,760 $ 818 $ 1,269
======== ======== ========
</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. Business and Summary of Significant Accounting Policies:
Basis of Consolidation:
The consolidated financial statements include the accounts of Digital Link
Corporation and its wholly owned subsidiaries (the "Company"). All significant
intercompany balances and transactions have been eliminated.
Cash, Cash Equivalents and Marketable Securities:
The Company considers all highly liquid investments with maturities of
three months or less at the time of purchase and money market funds to be cash
equivalents. The Company has deposited its cash and money market funds at one
major bank and two investment firms. Cash equivalents are stated at cost plus
accrued interest, which approximates market.
All marketable securities are deemed by management to be available for sale
and are reported at fair value with net unrealized gains or losses reported as a
separate component in shareholders' equity. Realized gains and losses on the
sale of marketable securities are computed on the specific identification basis.
Available for sale marketable securities with maturities less than one year from
the balance sheet date are classified as current and those with maturities
greater than one year from the balance sheet date are classified as long-term.
Revenue Recognition:
Product revenues are recognized upon shipment of the product if remaining
obligations are insignificant and collections of the resulting receivable is
probable. The Company records estimated product returns and accrues for future
warranty costs, anticipated retroactive price adjustments and insignificant
vendor obligations at the time of product shipment. Warranty costs to date
generally have not been significant. Maintenance and support revenues, which are
not significant, are recognized over the terms of the related agreements.
Inventories:
Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market.
Property and Equipment:
Property and equipment is stated at cost. Effective January 1, 1996, the
Company adopted the straight-line method of depreciation for all property and
equipment placed in service after that date. Property and equipment placed in
service prior to January 1, 1996 continues to be depreciated using the
double-declining balance method. The estimated useful lives under either method
range from three to five years. When property and equipment are retired or
otherwise disposed of, the cost and related accumulated depreciation are removed
from the accounts and the resulting gain or loss is included in income.
<PAGE>
Fair Value:
The fair value of cash equivalents and marketable securities is disclosed
in relevant notes to the financial statements. For all other financial
instruments, the carrying amount approximates fair value.
Concentration of Credit Risk:
Financial instruments which potentially subject the Company to
concentration of credit risk consist principally of investments in marketable
securities and accounts receivable.
The Company currently places its investments with three high credit
qualified financial institutions. With respect to accounts receivable, the
Company's customer base is dispersed across many different geographic areas.
While its customers are dispersed across many industries, a substantial portion
of its sales are from ISPs and domestic carriers. The Company performs ongoing
credit evaluations of its customers, generally does not require collateral and
maintains an allowance for potential credit losses. At December 31, 1997, there
were three customers with balances individually in excess of 5% of total
accounts receivable versus six customers at December 31, 1996. Jointly, these
customers accounted for 23% of total accounts receivable at December 31, 1997
versus 46% at December 31, 1996.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from these estimates.
Computation of Net Income per Share:
Basic and diluted income per share is computed in accordance with the
Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"). All per
share amounts have been restated in accordance with SFAS. 128. The weighted
average shares used in the computations for 1997, 1996 and 1995, were 9,249,000,
9,107,000 and 8,783,000. The Company adopted SFAS 128 for the year ended
December 31, 1997.
1997 1996 1995
---- ---- ----
Basic
- -----
Weighted-average common shares outstanding
for the period ........................... 9,249 9,107 8,783
Shares used in computing per share amounts .... 9,249 9,107 8,783
------ ------ ------
Net income .................................... $1,932 $4,697 $4,814
====== ====== ======
Net income per share .......................... $ 0.21 $ 0.52 $ 0.55
====== ====== ======
<PAGE>
1997 1996 1995
---- ---- ----
Diluted
- -------
Weighted-average common shares outstanding
for the period .............................. 9,249 9,107 8,783
Common equivalent shares from conversion of
stock options under treasury stock method ... 351 371 684
------ ------- -------
Shares used in computing per share amounts ....... 9,600 9,478 9,467
------ ------- -------
Net income ....................................... $1,932 $4,697 $4,814
====== ====== ======
Net income per share ............................. $ 0.20 $ 0.50 $ 0.51
====== ====== ======
Advertising Costs:
Costs related to advertising and promotion of products is charged to
advertising expense as incurred. Advertising expense was $1,750,000, $1,408,000
and $931,000 for 1997, 1996 and 1995, respectively.
Research and Development Costs:
Costs related to research, design and development of products are charged
to research and development expenses as incurred. Software development costs are
capitalized beginning when a product's technological feasibility has been
established and ending when a product is available for general release to
customers provided that research and development activities for the related
hardware portion of the product have been completed. Generally, the Company's
products include hardware and software components that are developed
concurrently. As a result, the Company has not capitalized any software
development costs since such costs have not been significant.
Foreign Currency Translation:
The Company's foreign subsidiaries use the United States dollar as their
functional currency. Resulting foreign transaction gains and losses, which have
been insignificant, are included in the results of operations.
Accounting for Income Taxes:
The Company's provision for income taxes comprises its estimated tax
liability currently payable and the change in its deferred income taxes.
Deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.
Stock-Based Compensation:
The Company accounts for employee stock options under APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and provides pro forma disclosure in
Note 4 to the financial statements as if the measurement provisions of SFAS No.
123 ("SFAS 123") "Accounting for Stock-Based Compensation," had been adopted.
<PAGE>
Recent Pronouncements:
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.
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.
During October 1997, the American Institute of Certified Public Accountants
issued SOP 97-2, "Software Revenue Recognition." The Company will be studying
the implications of these Statements, but the impact of their implementation on
the financial statements of the Company has not yet been determined.
Balance Sheet Reclassifications:
Certain balance sheet items have been reclassified in 1996 in order to
conform to the 1997 presentation.
2. Balance Sheet Detail:
Marketable Securities:
<TABLE>
<CAPTION>
December 31,
1997 1996
---- ----
(in thousands)
Market Market
Cost Value Cost Value
Debt securities:
<S> <C> <C> <C> <C>
U.S. government corporations and .......... $24,689 $24,679 $21,829 $22,050
agencies
U.S. treasury bills ....................... -- -- 2,007 2,007
State and municipal securities ............ 15,129 15,246 15,361 15,387
Other ..................................... -- -- 2,551 2,561
------- ------- ------- -------
$39,818 $39,925 $41,748 $42,005
======= ======= ======= =======
</TABLE>
Gross unrealized gains and unrealized losses for marketable securities were
$136,000 and $29,000, respectively, at December 31, 1997 and $288,000 and
$31,000, respectively, at December 31, 1996.
At December 31, 1997, scheduled maturities of marketable securities within
one year are $18,026,000 (cost $17,947,000) and for one year to five years are
$21,899,000 (cost $21,871,000).
<PAGE>
Inventories, net:
December 31,
1997 1996
---- ----
(in thousands)
Raw materials ..................... $2,952 $2,255
Work in progress .................. 2,275 2,301
Finished goods .................... 2,936 1,364
------ ------
$8,163 $5,920
====== ======
The Company's products are concentrated in a single segment in the
telecommunications industry that is highly competitive and rapidly changing.
Significant technological changes in the industry segment could affect operating
results adversely. The Company's inventories include high technology parts and
components that may be specialized in nature or subject to rapid technological
obsolescence. While the Company has programs to minimize the required
inventories on hand and considers technological obsolescence in estimating the
required allowance to reduce recorded amounts to market values, such estimates
could change in the future. In addition, certain semiconductor devices and
components and subassemblies are presently available only from single sources,
and certain other components are presently available or acquired only from a
limited number of sources.
Property and Equipment, net:
December 31,
1997 1996
---- ----
(in thousands)
Manufacturing and development equipment ............. $ 9,328 $ 6,442
Furniture and fixtures .............................. 520 1,043
Leasehold improvements .............................. 215 201
-------- --------
10,063 7,686
-------- --------
Less accumulated depreciation and amortization ...... (6,738) (5,539)
-------- --------
$ 3,325 $2,147
======== ========
Other Accrued Expenses:
December 31,
1997 1996
---- ----
(in thousands)
Product warranty ................................ $1,029 $ 795
Deferred product revenue ........................ 123 99
Other ........................................... 2,633 2,548
------ ------
$3,785 $3,442
====== ======
<PAGE>
3. Commitments and Contingencies:
Commitments:
The Company leases its headquarters facility under an operating lease.
Under the terms of the lease agreement, the Company is responsible for
insurance, maintenance and property taxes.
Future minimum lease payments under the lease are as follows at December
31, 1997 (in thousands):
1998 $1,021
1999 1,072
2000 1,126
2001 1,182
2002 1,241
2003 1,019
-----
Total minimum lease payments $6,661
======
Rent expense was $883,000, $619,000 and $510,000 for 1997, 1996 and 1995,
respectively.
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 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. 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 adversly 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 of these 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 that the individual defendants sold shares of the Company's
stock based upon material nonpublic information. The complaints seek unspecified
monetary damages. To date, the Superior Court has dismissed portions of
plaintiff's state court complaint without leave to amend. The Superior Court
also dismissed five of the individual defendants without leave to amend and
another individual defendant with leave to amend. The Superior Court also denied
motions to dismiss filed by the Company and two other individual defendants with
respect to the remaining portions of the complaint. Plaintiff has filed a third
amended complaint that names the Company and three individual defendants.
Discovery to date has been limited in the state court action, and the Superior
Court has not set a trial date. The Company also moved to dismiss the federal
complaint. On September 11, 1997, the Court granted the Company's motion to
dismiss. The Court granted plaintiff leave to file, and plaintiff has filed, an
amended complaint. The Company has moved to dismiss the amended complaint. There
has been no discovery in the federal action, and no trial date has been set. 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. No provision for
any liability that may result upon adjudication has been made on the
accompanying financial statements.
4. Shareholders' Equity:
Stock Options Plan:
The Company has a 1992 Equity Incentive Plan ("Plan"), which succeeds the
Company's prior plan. All outstanding stock options issued under the prior plan
will continue to be governed by the terms and conditions of that plan, but no
additional stock options will be granted under that prior plan. During 1995, an
additional 500,000 shares were authorized for grant or sale to employees,
officers, directors and consultants of the Company under the Plan. During 1997,
an additional 800,000 shares were authorized for grant or sale to employees,
officers, directors and consultants of the Company under the Plan. The Plan
expires ten years after its adoption.
Options granted under the Plan may be either incentive stock options or
nonqualified stock options, as designated by the Board of Directors. The Plan
provides that the exercise price of options granted must be no less than the
fair market value of the Company's common stock at the date of grant. The Board
of Directors also has the authority to set exercise dates (no longer than ten
years from the date of grant), payment terms and other provisions for each
grant. Generally, options granted under the Plan through October 31, 1995 become
exercisable annually as to 20% and options granted on or after October 31, 1995
become exercisable as to 25% of the shares one year after the first vesting date
and thereafter with respect to an additional 2.084% at the end of each
succeeding month.
The Plan also provides for the award of common stock based on performance
and the sale of restricted stock to eligible persons at the fair market value of
the common stock of the Company at the date of sale or at discounts of up to
15%, as determined by the Board of Directors. All restricted stock awards under
this Plan are subject to a repurchase option that expires over a five year
period at the original issuance price. As of December 31, 1997, no restricted
stock awards have been issued under the Plan.
Directors Stock Options Plan:
In October 1994, the Company adopted the 1994 Directors Stock Option Plan
(the "Directors Plan"). The Company has reserved 200,000 shares of Common Stock
for issuance to directors of the Company who are not employees of the Company.
The Directors Plan expires ten years after its adoption.
Options granted under the Directors Plan are nonqualified stock options.
The Directors Plan provides that the exercise price of options granted shall be
the fair market value of the Company's common stock at the date of grant.
Options granted under the Directors Plan become exercisable ratably over four
years. The maximum term of these options granted is ten years from the date of
grant.
<PAGE>
Activity under the Plan and the Directors Plan during 1997, 1996 and 1995
is as follows:
<TABLE>
<CAPTION>
(in thousands, except per share amounts)
Outstanding Options
------------- ------------- ----------------- ------------- -------------
Weighted
Shares Number Price Average
available of per Aggregate Exercise
for grant Shares Share Price Price
---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, December 31, 1994 . 974 1,435 $0.33-$21.75 7,329 $ 5.11
Additional shares reserved 500 -- -- -- --
Options granted .......... (561) 561 $15.25-$28.25 10,882 $ 19.40
Options exercised ........ -- (356) $0.33-$15.12 (600) $ 1.69
Options cancelled ........ 178 (178) $0.67-$28.25 (1,798) $ 10.10
------- -------- -------
Balances, December 31, 1995 . 1,091 1,462 $0.60-$28.25 15,813 $ 10.82
Options granted .......... (984) 984 $10.125-$23.25 15,302 $ 15.55
Options exercised ........ -- (199) $0.60-$21.75 (546) $ 2.74
Options cancelled ........ 425 (425) $0.83-$28.25 (6,079) $ 14.30
------- -------- -------
Balances, December 31, 1996 . 532 1,822 $0.83-$28.25 24,490 $ 13.45
Additional shares reserved 800 -- -- -- --
Options granted .......... (540) 540 $13.25-$25.75 9,637 $ 17.86
Options exercised ........ -- (311) $12.50-$27.375 (1,885) $ 6.06
Options cancelled ........ 434 (434) $1.00-$28.25 (6,029) $ 13.91
------- -------- -------
Balances, December 31, 1997 . 1,226 1,617 $1.00-$28.25 26.213 $ 16.23
======= ======== =======
</TABLE>
The weighted-average fair value of those options granted in 1997 and 1996 was
$11.63 and $8.47, respectively. Options to purchase 481,000 shares, 350,000
shares, and 267,000 shares were exercisable with a weighted-average exercise
price of $14.65, $8.88, and $4.68, at December 31, 1997, 1996 and 1995,
respectively.
The following table summarizes information with respect to stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
(number of options in thousands)
Options Outstanding Options Exercisable
-------------------------------------------------------------------------------
Weighted
Average
Number Remaining Number Weighted
Outstanding at Weighted Exercisable at Average
December 31, Contractual Average December 31, Exercise
<S>
Range of Exercise Price 1997 Life (years) Exercise Price 1997 Price
- -------------------------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <C> <C> <C>
$ 1.00 - $ 1.67 36 4.12 $ 1.38 32 $ 1.35
$ 3.33 - $ 4.67 22 5.78 $ 3.90 11 $ 3.49
$ 8.50 - $ 9.25 67 6.54 $ 9.19 33 $ 9.19
$10.13 - $13.75 128 8.52 $11.85 34 $10.68
$14.00 - $16.00 758 8.49 $15.34 264 $15.35
$16.50 - $18.94 259 9.18 $17.97 39 $17.07
$20.13 - $24.00 324 8.65 $21.79 59 $22.68
$25.00 - $28.25 23 7.96 $27.06 9 $27.13
================= =================
$ 1.00 - $28.25 1,617 8.41 $16.23 481 $14.65
================= =================
</TABLE>
Employee Stock Purchase Plan:
In December 1993, the Company established the 1993 Employee Stock Purchase
Plan (the "Purchase Plan") under which 300,000 shares of Common Stock have been
reserved for issuance. Under the Purchase Plan, an eligible employee may
purchase shares of Common Stock from the Company through payroll deductions of
up to 10% of his or her base compensation, at a price per share equal to 85% of
the lesser of the fair market value of the Company's Common Stock as of the
first day or last day of each six-month offering period under the Purchase Plan.
The Company sold 40,000 shares, 19,000 shares, and 16,000 shares to employees in
1997, 1996, and 1995, respectively. The weighted-average fair value of those
purchase rights granted in 1997 and 1996 was $6.02 and $5.66, respectively.
Pro Forma Stock-Based Compensation:
The Company accounts for the fair value of its grants under the Plan, the
Directors Plan and the Purchase Plan, in accordance with APB 25. Accordingly, no
compensation expense has been recognized for these plans. Had compensation
expense been determined based on the fair value at the grant dates for awards
under these plans consistent with the method of SFAS 123, the Company's net
income would have been reduced to the pro forma amounts indicated below:
(Amounts in thousands, except per share data) 1997 1996 1995
---- ---- ----
Net income (loss)
As reported ........... $ 1,932 $ 4,697 $ 4,814
Pro forma ............. $ (338) $ 3,771 $ 4,462
Earnings per share (Basic)
As reported ........... $ 0.21 $ 0.52 $ 0.55
Pro forma ............. $ (0.04) $ 0.41 $ 0.51
Earnings per share (Diluted)
As reported ........... $ 0.20 $ 0.50 $ 0.51
Pro forma ............. $ (0.04) $ 0.40 $ 0.47
The fair value of each option is estimated on the date of grant using a
type of Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants under the Plan and the Directors Plan in 1997, 1996
and 1995:
1997 1996 1995
---- ---- ----
Dividend yield 0.00% 0.00% 0.00%
Expected life of option 4.50 years 4.50 years 4.50 years
Risk-free interest rate 5.74% 6.05% 6.05%
Expected volatility 80% 60% 60%
The Company has also estimated the fair value for the purchase rights
issued under the Purchase Plan using the Black-Scholes option-pricing model with
the following assumptions for grants in 1997, 1996 and 1995:
1997 1996 1995
---- ---- ----
Dividend yield 0.00% 0.00% 0.00%
Expected life of option 0.50 years 0.50 years 0.50 years
Risk-free interest rate 5.80% 5.34% 5.07%
Expected volatility 80% 60% 60%
The above pro forma disclosures are not likely to be representative of the
effects on reported net income for future years.
5. Segments, Significant Customers, Suppliers and Foreign Revenues:
The Company operates in a single industry segment encompassing the design,
development, manufacture, marketing and support of high-speed digital access
products for wide area networks worldwide. The Company markets and sells its
products primarily in North America, Europe, South America and Asia, through a
direct sales force, VARs OEMs. In addition to twenty sales offices in the United
States, the Company opened its first international offices in the United Kingdom
and Germany during 1993.
In 1997, sales to one customer accounted for 20% of net sales. In 1996,
sales to two customers each accounted for 13% of net sales. In 1995, sales to
two customers accounted for 12% and 11% of net sales. The loss of any one or
more of the Company's major customers could materially adversely affect the
Company's business and operating results.
The Company's product designs are proprietary but generally incorporate
industry standard hardware components. However, certain semiconductor devices
and components and subassemblies are presently available only from single
sources, and certain other components are presently available or acquired only
from a limited number of sources. To date, the Company has been able to obtain
adequate supplies of these components, as well as subassemblies from third party
contractors, in a timely manner from existing sources or, when necessary, from
alternative sources. The inability to obtain sufficient sole or limited source
components or subassemblies as required in the future, or to develop alternative
sources or redesign its products if and as required in the future, could result
in delays or reductions in product shipments that could materially adversely
affect the Company's business and operating results or damage customer
relationships.
Outside of Europe, no geographic segment had sales in excess of 10% of
total sales. International sales in 1997, 1996, and 1995 were as follows:
1997 1996 1995
---- ---- ----
(in thousands)
Europe $ 5,888 $ 4,142 $ 7,524
Other $ 5,465 $ 4,524 $ 4,730
-------- -------- --------
Total international sales $ 11,353 $ 8,666 $12,254
======== ======== =======
6. Employee Benefit Plan:
The Company has a 401(k) profit sharing plan for its full time employees
who have attained the age of 21. Eligible employees may make voluntary
contributions to the Plan up to 18% of their annual compensation. The Company
makes a matching contribution equal to 50% of each employee's contributions. In
applying this matching contribution, however, only contributions up to 6% of the
employee's compensation will be considered. For 1997, 1996 and 1995, the Company
contributed $356,000, $191,000, and $184,000 respectively.
<PAGE>
7. Income Taxes:
The provision for income taxes comprises:
1997 1996 1995
---- ---- ----
(in thousands)
Current:
Federal $2,246 $2,376 $1,987
State 390 135 388
------ ------ ------
2,636 2,511 2,375
Deferred:
Federal (1,613) (295) (172)
State (176) (67) (41)
------- ------- -------
(1,789) (362) (213)
------- ------- --------
$ 847 $2,149 $2,162
====== ====== ======
The difference between the actual tax provision and the amount obtained by
applying the U.S. Federal statutory rate to income before provision for income
taxes is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Tax provision at federal statutory rate 34.0% 34.0% 34.0%
State taxes, net of federal tax benefit 6.6 5.4 6.1
Nontaxable municipal interest (6.3) (2.1) (1.1)
Foreign sales corporation (2.5) (0.6) (1.9)
Research and development tax credit (3.2) (6.3) (7.7)
Other 1.9 1.0 1.6
----- ---- -----
30.5% 31.4% 31.0%
==== ==== ====
</TABLE>
The components of the deferred tax asset are as follows:
December 31,
1997 1996
---- ----
(in thousands)
Deferred tax assets:
Allowance for doubtful accounts receivable $ 203 $ 184
Allowance for excess and obsolete inventories 885 577
Depreciation 379 418
Amortization of purchased research and
development 1,216 --
Accrual for warranty, royalties and other 1,483 1,524
Other 200 --
------ ------
Total deferred tax assets $4,366 $2,703
====== ======
The Company has not provided a valuation allowance on the deferred tax
assets as those amounts can be realized through carryback to prior years when
the Company paid income taxes or are expected to be realized from future
operations based upon the Company's history of profitable operations.
8. Acquisition:
In connection with its acquisition of certain assets and in-process
technology for $5 million in cash from Performance Telecom Corporation, for
which technological feasibility had not been achieved, the Company incurred an
expense of $3.7 million related to purchased research and development in the
third quarter of 1997. The financial statements include the results of
operations since September 30, 1997. This technology enables network service
providers to offer applications such as Internet access, interactive video
services, remote data access and multimedia applications at
multi-megabit-per-second speeds over standard voice-grade copper lines. Such
in-process technology was valued, along with other acquired assets, in
accordance with valuation techniques commonly used in the technology industry
and was expensed upon acquisition in accordance with Financial Accounting
Standard No. 2, "Accounting for Research and Development Costs." The Company
intends to integrate the acquired technologies into its existing products, but
there can be no assurance that such integration will be completed in the
expected time or at the expected cost. The acquired company's financial results
did not significantly impact Digital Link's 1997 results and, combined results,
pro forma basis would not have significantly impacted revenues or net income of
the Company.
9. Subsequent Event:
During the period from January 1, 1998 through March 25, 1998, the Company
repurchased on the open market a total of 131,000 shares of common stock at a
price ranging from $10.50 to $11.50 a share. This stock has subsequently been
retired.
On January 21, 1998, the Company's Board of Directors approved the
repricing of certain employee stock options. At the close of market on February
9, 1998 all employees, including executive officers, choosing to participate
were granted new options with an exercise price of $11.00 per share. All
employee options, except executive officers, retain their original vesting
schedules, but are subject to a one-year blackout period. All executive officer
options were issued with a new vesting schedule.
On February 25, 1998, the Company extended the term on the lease of its
headquarters facility for an additional period of six years, commencing on
October 16, 1997 and expiring on October 15, 2003. See Note 3 of Notes to
Consolidated Financial Statements.
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this Item is incorporated by reference from the
sections titled "Nominees" under "Proposal No. 1 - Election of Directors,"
"Executive Officers" and "Section 16(a) Beneficial Ownership Reporting
Compliance" from the Definitive Proxy Statement to be filed with the Securities
and Exchange Commission relative to the Company's annual meeting of shareholders
to be held on May 20, 1998 (the "Definitive Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
Information required by this Item is incorporated by reference from the
sections titled "Director Compensation" under "Proposal No. 1 - Election of
Directors" and "Executive Compensation" from the Definitive Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information required by this Item is incorporated by reference from
"Security Ownership of Certain Beneficial Owners and Management" from the
Definitive Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this Item is incorporated by reference from
"Certain Transactions" from the Definitive Proxy Statement.
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
The following financial statements and schedules are filed as part of this
report:
Page
(a)1. Financial Statements
See index in Part II, Item 8........................... 24
(a)2. and (d) Financial Statement Schedules
Report of Independent Accountants...................... 46
Schedule II - Valuation and Qualifying Accounts........ 47
All schedules not listed above are omitted because they are not applicable
or the required information is included in the financial statements or notes
thereto.
(a)3. and (c) Exhibits
3.01 Registrant's Amended and Restated Articles of Incorporation filed on
February 7, 1994. (1)
3.02 Registrant's Certificate of Correction of Amended and Restated
Articles of Incorporation filed on April 7, 1994. (1)
3.03 Registrant's Bylaws, as amended. (2)
4.01 Form of Specimen Certificate for Registrant's Common Stock. (3)
4.02 Registration Rights Agreement among Registrant, Vinita Gupta, Summit
Ventures L.P., SV Eurofund C.V. and Summit Investors, L.P. dated
December 23, 1987 and certain exhibits thereto. (3)
+10.01 Registrant's 1986 Stock Option Plan, as amended. (3)
+10.02 Form of Agreement for Registrant's 1986 Stock Option Plan. (1)
+10.03 Registrant's 1986 Stock Purchase Plan. (3)
+10.04 Form of Agreement for Registrant's 1986 Stock Purchase Plan, as
amended. (1)
+10.05 Registrant's 1992 Equity Incentive Plan, as amended. (8)
+10.06 Form of Agreement for Registrant's 1992 Equity Incentive Plan,
as amended. (1)
+10.07 Registrant's 1993 Employee Stock Purchase Plan. (3)
+10.08 Registrant's 1994 Directors Stock Option Plan. (1)
+10.09 Form of Agreement for Registrant's 1994 Directors Stock Option
Plan. (1)
10.10 Form of Indemnity Agreement entered into with each of Registrant's
directors. (3)
10.11 Lease Agreement between Registrant and John Hancock Mutual Life
Insurance Company dated June 17, 1992. (3)
10.12 Form of Patent License Agreement between Registrant and QPSX
Communications Ltd. dated December 1993. (3)
10.13* Software License Agreement between Registrant and Epilogue Technology
Corporation dated January 20, 1992. (3)
10.14 Stockholder Agreement among Registrant, Vinita Gupta, Narendra Gupta,
Summit Ventures, L.P., SV Eurofund C.V. and Summit Investors, L.P.
dated December 23, 1987. (3)
10.16 Original Equipment Manufacturer Agreement between Registrant and
Siemens Aktiengesellschaft dated April 7, 1995.(4)
+10.18 Employment Agreement between Registrant and Alan Fraser dated
September 5, 1996.(6)
+10.19 Security Agreement between Registrant and Alan Fraser dated
September 30, 1996.(6)
+10.20 Secured Promissory Note from Alan Fraser dated September 30, 1996. (6)
+10.21 Separation Agreement between Registrant and James Checco dated
November 19, 1996. (7)
21.01 List of Subsidiaries. (3)
23.01 Consent of Independent Accountants
27.01 Financial Data Schedule
- -----
* Confidential treatment has been obtained with respect to portions
of this exhibit.
(1) Filed as an exhibit to Registrant's Form 10-K for the year ended
December 31, 1994 and incorporated herein by reference.
(2) Filed as an exhibit to Registrant's Registration Statement on
Form S-8 (No. 33-95176) filed on July 31, 1995 and incorporated
herein by reference.
(3) Filed as an exhibit to Registrant's Form S-1 Registration Statement
(File No. 33-72642), which was declared effective January 31, 1994,
and incorporated herein by reference.
(4) Filed as an exhibit to Registrant's Form 10-Q for the quarter ended
June 30, 1995 and incorporated herein by reference.
(5) Filed as an exhibit to Registrant's Form 10-K for the year ended
December 31, 1995 and incorporated herein by reference.
(6) Filed as an exhibit to Registrant's Form 10-Q for the quarter ended
September 30, 1996 and incorporated herein by reference.
(7) Filed as an exhibit to Registrant's Form 10-K for the year ended
December 31, 1996 and incorporated herein by reference.
(8) 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.
+ Management contract or compensatory plan required to be filed as
an exhibit to this Form 10-K.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of
the period covered by this report.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
March 20, 1998 By: /s/ Stanley E. Kazmierczak
-------------------------------
Stanley E. Kazmierczak
Chief Financial Officer
Each person whose signature appears below constitutes and appoints Vinita
Gupta and Stanley E. Kazmierczak, jointly and severally, his or her true and
lawful attorneys-in-fact, each with the power of substitution, for him or her in
any and all capacities, to sign amendments to this Report on Form 10-K, and to
file the same, with all exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that said attorneys-in-fact, or his or her substitute or
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following person on behalf of the Registrant
and in the capacities and on the dates indicated.
Signature Title Date
Chairperson of the Board, Chief
/s/ Vinita Gupta Executive Officer and President
- ----------------------------- (Principal Executive Officer) March 20, 1998
Vinita Gupta
Chief Financial Officer
and Vice President, Finance
and Administration
(Principal Financial and
/s/ Stanley E. Kazmierczak Accounting Officer) March 20, 1998
- -----------------------------
Stanley E. Kazmierczak
/s/ Richard C. Alberding Director March 20, 1998
- -----------------------------
Richard C. Alberding
/s/ Gregory M. Avis Director March 20, 1998
- -----------------------------
Gregory M. Avis
/s/ Lance B. Boxer Director March 20, 1998
- -----------------------------
Lance Boxer
/s/ Alan I. Fraser Director March 20, 1998
- -----------------------------
Alan I. Fraser
/s/ Narendra K. Gupta Director March 20, 1998
- -----------------------------
Narendra K. Gupta
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Digital Link Corporation and Subsidiaries:
Our report on the consolidated financial statements of Digital Link
Corporation and Subsidiaries is included on page 25 of this Form 10-K. In
connection with our audits of such financial statements, we have also audited
the related financial statement schedule listed in the index on page 43 of this
Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
San Jose, California
January 20, 1998
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE II
DIGITAL LINK CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
For the Years Ended December 31, 1995, 1996
and 1997
(Amounts in thousands)
Balance at
Beginning Charged to Balance at
of Costs and Deductions End of
------------------------
Description the Period Expenses Description Amount the Period
------------ ----------------- -------------- --------- ------------
Balances for the year ended December 31, 1995:
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts receivable ..... $ 461 $ 434 $ 895
Allowance for excess and obsolete inventories ... 1,004 -- (a) $ 160 844
Balances for the year ended December 31, 1996:
Allowance for doubtful accounts receivable ...... 895 -- (b) 383
(a) 47 465
Allowance for excess and obsolete inventories ... 844 457 (a) 167 1,134
Balances for the year ended December 31, 1997
Allowance for doubtful accounts receivable ...... 465 66 (a) 14 517
Allowance for excess and obsolete inventories ... 1,134 555 (a) (23) 1,712
</TABLE>
(a) Write-offs & adjustments
(b) Credit to selling, general and administrative expenses
Exhibit 23.01
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements
of Digital Link Corporation and Subsidiaries on Form S-8 (File Nos. 33-74666,
33-95176 and 333-27855) of our reports dated January 20, 1998, on our audits of
the consolidated financial statements and financial statement schedule of
Digital Link Corporation and Subsidiaries as of December 31, 1997 and 1996, and
for the years ended December 31, 1997, 1996 and 1995 which reports are included
in this Annual Report on Form 10-K.
COOPERS & LYBRAND L.L.P.
San Jose, California
March 25, 1998
<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-K for the
period ending December 31, 1997, and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
<CIK> 0000810467
<NAME> Digital Link Corporation
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 2,504
<SECURITIES> 18,026
<RECEIVABLES> 5,193
<ALLOWANCES> 517
<INVENTORY> 8,163
<CURRENT-ASSETS> 37,623
<PP&E> 10,063
<DEPRECIATION> 6,738
<TOTAL-ASSETS> 66,056
<CURRENT-LIABILITIES> 8,722
<BONDS> 0
0
0
<COMMON> 34,609
<OTHER-SE> 22,725
<TOTAL-LIABILITY-AND-EQUITY> 66,056
<SALES> 66,008
<TOTAL-REVENUES> 66,008
<CGS> 29,078
<TOTAL-COSTS> 65,753
<OTHER-EXPENSES> (2,524)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,779
<INCOME-TAX> 847
<INCOME-CONTINUING> 1,932
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,932
<EPS-PRIMARY> 0.21
<EPS-DILUTED> 0.20
</TABLE>
