UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-23110
DIGITAL LINK CORPORATION
(Exact name of registrant as specified in its charter)
California 77-0067742
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
217 Humboldt Court, Sunnyvale, CA 94089
(Address of principal executive offices,
including zip code)
(408) 745-6200
Registrant's telephone number, including area code
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
The number of shares outstanding of the registrant's Common Stock as of May 13,
1999, was 8,068,766 shares.
<PAGE>
DIGITAL LINK CORPORATION
INDEX TO FORM 10-Q
Page
PART I - FINANCIAL INFORMATION:
ITEM 1 - Financial Statements
Consolidated Balance Sheets as of March 31, 1999 and December 31, 3
1998
Consolidated Statements of Income and Comprehensive Income (Loss) 4
for the three months ended March 31, 1999 and March 31, 1998
Consolidated Statements of Cash Flows for the three months ended 5
March 31, 1999 and March 31, 1998
Notes to Consolidated Financial Statements 6
ITEM 2 - Management's Discussion and Analysis of Financial Condition and 10
Results of Operations
ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk 17
PART II - OTHER INFORMATION
ITEM 1 - Legal Proceedings 18
ITEM 2 - Changes in Securities and Use of Proceeds 18
ITEM 3 - Defaults Upon Senior Securities 18
ITEM 4 - Submission of Matters to a Vote of Security Holders 18
ITEM 5 - Other Information 18
ITEM 6 - Exhibits and Reports on Form 8-K 18
SIGNATURE(S) 19
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PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. Financial Statements
- ------- --------------------
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share amounts)
- -----------------------------------------------------------------------------
March 31, December 31,
1999 1998
----------- ------------
(Unaudited)
ASSETS
- ------
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents ............................................. $ 3,312 $ 296
Short-term marketable securities ...................................... 3,089 15,738
Accounts receivable, less allowance for doubtful accounts of $455 at
3/31/99 and $540 at 12/31/98 .......................................... 4,877 4,767
Inventories, net ...................................................... 4,038 4,306
Prepaid and other current assets ...................................... 1,088 998
Income taxes receivable ............................................... 2,501 2,501
Deferred income taxes ................................................. 3,069 3,069
-------- --------
Total current assets ......................................... 21,974 31,675
Property and equipment, net ........................................... 2,454 2,582
Long-term marketable securities ....................................... 28,889 18,696
Deferred income taxes ................................................. 1,560 1,560
Other assets .......................................................... 376 393
-------- --------
TOTAL ASSETS ................................................. $ 55,253 $ 54,906
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable ...................................................... $ 4,150 $ 2,365
Accrued payroll and related expenses .................................. 2,061 2,168
Other accrued expenses ................................................ 4,674 4,764
Income taxes payable .................................................. 529 243
-------- --------
Total current liabilities .................................... 11,414 9,540
-------- --------
CONTINGENCIES (Note 4)
SHAREHOLDERS' EQUITY:
Preferred stock, no par value:
Authorized: 5,000,000 shares;
Issued and outstanding: None
Common stock, no par value:
Authorized: 25,000,000 shares;
Issued and outstanding: 8,127,622 shares at 3/31/99 and 8,490,472
shares at 12/31/98 .................................................... 31,894 33,311
Accumulated other comprehensive income (loss) ......................... (66) 52
Retained earnings ..................................................... 12,011 12,003
-------- --------
Total shareholders' equity ................................... 43,839 45,366
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................... $ 55,253 $ 54,906
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
FOR THE THREE MONTHS ENDED
MARCH 31, 1999 AND 1998
(Amounts in thousands, except per share amounts)
- -------------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------------------
1999 1998
---- ----
REVENUES:
Net sales ..................................... $ 15,232 $ 14,519
Cost of sales ................................. 7,298 7,204
-------- --------
Gross profit ........................... 7,934 7,315
-------- --------
EXPENSES:
Research and development ...................... 2,581 2,822
Selling, general and administrative ........... 4,613 5,023
-------- --------
Total operating expenses ............... 7,194 7,845
-------- --------
Operating income (loss) ................ 740 (530)
Other income .................................. 476 601
-------- --------
Income before provision for income taxes 1,216 71
Provision for income taxes .................... 304 22
-------- --------
NET INCOME ............................. $ 912 $ 49
======== ========
COMPREHENSIVE INCOME (LOSS) ................... $ 794 $ (26)
======== ========
EARNINGS PER SHARE (Basic)
Net income per share .......................... $ 0.11 $ 0.01
======== ========
Shares used in computing per share amounts .... 8,297 9,383
======== ========
EARNINGS PER SHARE (Diluted)
Net income per share .......................... $ 0.11 $ 0.01
======== ========
Shares used in computing per share amounts .... 8,343 9,436
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
<TABLE>
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DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(Amounts in thousands)
- -------------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------------
1999 1998
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 912 $ 49
Adjustments to reconcile net income to net cash flows provided
by operating activities:
Depreciation and amortization ............................. 378 456
Provision for doubtful accounts ........................... 0 18
Provision for excess and obsolete inventories ............. 356 33
Accounts receivable ................................. (110) (1,627)
Inventories ......................................... (88) 1,146
Prepaid and other assets ............................ (74) (10)
Accounts payable .................................... 1,785 1,103
Accrued payroll and other accrued expenses .......... (197) (275)
Income taxes payable ................................ 286 981
-------- --------
Net cash flows provided by operating activities . 3,248 1,874
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities ........................... (13,808) (9,487)
Maturities of marketable securities .......................... 16,147 14,700
Acquisition of property and equipment ........................ (250) (384)
-------- --------
Net cash flows provided by investing activities . 2,089 4,829
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options ...................... 43 42
Repurchase of common stock ................................... (2,364) (1,425)
-------- --------
Net cash used in financing activities ........... (2,321) (1,383)
-------- --------
Net increase in cash and cash equivalents .. 3,016 5,322
Cash and cash equivalents at beginning of year ............... 296 2,504
-------- --------
Cash and cash equivalents at end of period ................... $ 3,312 $ 7,824
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
DIGITAL LINK CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared
by the Company without audit in accordance with generally accepted
accounting principles for interim financial information and pursuant to
rules and regulations of the Securities and Exchange Commission. In the
opinion of management, all adjustments (consisting of only normal
recurring adjustments) considered necessary for a fair representation
have been included. These financial statements should be read in
conjunction with the Company's consolidated financial statements and
notes thereto contained in the Company's Annual Report on Form 10-K,
which was filed with the Securities and Exchange Commission on March
29, 1999.
The year-end balance sheet at December 31, 1998 was derived from
audited financial statements, but does not include all disclosures
required by generally accepted accounting principles.
Operating results for the three months ended March 31, 1999 may not
necessarily be indicative of the results to be expected for any other
interim period or for the full year.
2. COMPUTATION OF NET INCOME PER SHARE
Basic and diluted net income per share is computed in accordance with
Statement of Financial Accounting Standards No. 128 ("SFAS No. 128").
Quarter Ended
March 31, March 31,
1999 1998
---- ----
Basic (in thousands, except per share data)
- -----
Weighted average common shares outstanding
for the period ........................... 8,297 9,383
Shares used in computing per share amounts 8,297 9,383
====== ======
Net income ............................... $ 912 $ 49
------ ------
Net income per share ..................... $ 0.11 $ 0.01
====== ======
<PAGE>
Quarter Ended
March 31, March 31,
1999 1998
---- ----
Diluted (in thousands, except per share data)
- -------
Weighted average number of shares outstanding for
the period ............................................. 8,297 9,383
Common equivalent shares from conversion of stock
options under treasury stock method .................... 46 53
------ ------
Shares used in computing per share amounts ............. 8,343 9,436
====== ======
Net income ............................................. $ 912 $ 49
------ -----
Net income per share ................................... $ 0.11 $ 0.01
====== ======
3. INVENTORIES
Inventories are valued at the lower of cost (determined using the
first-in, first-out method) or market. Inventories consisted of (in
thousands):
March 31, 1999 December 31, 1998
-------------- -----------------
(Unaudited)
Raw materials $1,271 $1,349
Work-in-process 1,242 1,456
Finished goods 1,525 1,501
----- -----
$4,038 $4,306
====== ======
4. CONTINGENCIES
Certain third parties have expressed their belief that certain of the
Company's products may infringe patents held by them and have suggested
that the Company acquire licenses to such patents. The Company believes
that licenses, to the extent required, will be available; however, no
assurance can be given that the terms of any offered licenses would be
favorable to the Company. Management, after review and consultation
with counsel, believes that the ultimate resolution of these matters is
uncertain and there can be no assurance that these assertions will be
resolved without costly litigation or in a manner that is not adverse
to the Company. While the Company has accrued approximately $950,000
for these matters deemed probable in prior years, it is currently
unable to estimate the ultimate range of loss regarding these matters.
Therefore, it is reasonably possible that the ultimate resolution of
these matters could result in final settlement that could exceed or be
less than the amounts accrued and that the settlement of these matters
could be material to the Company's results of operations. Adjustment to
amounts accrued will take place in the period in which such matters are
resolved.
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
<PAGE>
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. Discovery to date has
been limited in the state court action, and the Superior Court has not
set a trial date. In the parallel Federal proceedings, the Court on
September 11, 1997 granted the Company's motion to dismiss the federal
complaint with leave to amend, and plaintiff has filed an amended
complaint. The Company has moved to dismiss the amended complaint, the
hearing on which is scheduled to take place in May, 1999. 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 effect 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.
5. RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting
for the Costs of Computer Software Developed or Obtained for Internal
Use." This standard requires companies to capitalize qualifying
computer software costs which are incurred during the application
development stage and amortize them over the software's estimated
useful life. SOP 98-1 is effective for fiscal years beginning after
December 15, 1998. The adoption of SOP 98-1 had no impact on the
Company's financial statements and related disclosures.
In April 1998, the AICPA issued Statement of Position 98-5 ("SOP
98-5"), "Reporting on the Costs of Start-Up Activities." This standard
requires companies to expense the costs of start-up activities and
organization costs as incurred. In general, SOP 98-5 is effective for
fiscal years beginning after December 15, 1998. The adoption of SOP
98-5 had no impact on the Company's results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes
new standards of accounting and reporting for derivative instruments
and hedging activities. SFAS 133 requires that all derivatives be
recognized at fair value in the statement of financial position, and
that the corresponding gains or losses be reported either in the
statement of operations or as a component of comprehensive income,
depending on the type of hedging relationship that exists. SFAS 133
will be effective for fiscal years beginning after June 15, 1999. The
Company does not currently hold derivative instruments or engage in
hedging activities.
<PAGE>
6. SUBSEQUENT EVENTS
During the period from April 1, 1999 through May 13, 1999, the Company
repurchased on the open market a total of 143,419 shares of common
stock at prices ranging from $7.0625 to $8.00 a share. This stock has
subsequently been retired.
<PAGE>
DIGITAL LINK CORPORATION
ITEM 2. Management's Discussion and Analysis of Financial Condition and
- ------- Results of Operations
---------------------
RESULTS OF OPERATIONS
Except for the historical statements contained herein, this Form 10-Q contains
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). These forward-looking
statements involve a number of risks, known and unknown, and uncertainties, such
as the loss of, or difference in actual from anticipated levels of purchases
from, the Company's major customers, the impact of competitive products and
pricing, the ability to retain and attract key personnel and other risks which
are described throughout the Company's reports filed with the Securities and
Exchange Commission ("SEC"), including its Form 10-K for the year ended December
31, 1998 and within "Management's Discussion and Analysis of Financial Condition
and Results of Operations," including under the title "Other Factors That May
Affect Future Operating Results." The actual results that the Company achieves
may differ materially from any forward-looking statements due to such risks and
uncertainties.
When used in this Form 10-Q words such as "believes," "anticipates," "expects,"
"intends," and similar expressions are intended to identify forward-looking
statements, but are not the exclusive means of identifying such statements.
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 SEC
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
possible, in some future quarters, that the Company's operating results will be
below the expectations of stock market analysts and investors. In such event,
the price of the Company's Common Stock would likely be materially adversely
affected. Consequently, the purchase or holding of the Company's Common Stock
involves an extremely high degree of risk.
Net Sales
Net sales for the first quarter of 1999 increased 5% to $15,232,000 from
$14,519,000 for the same period of the prior year. This increase in net sales
was primarily attributable to an increase in unit sales of broadband (i.e.,
transmission rates in excess of T1/E1) products due to higher sales to certain
domestic carrier customers. The Company does not believe that the percentage
change in net sales in the first quarter of 1999 as compared to the same period
of the prior year is necessarily indicative of the percentage change in net
sales to be expected for the entire fiscal year.
Broadband sales in absolute dollars increased by 16% and increased to 44% of net
sales in the first quarter of 1999 as compared to 40% in the first quarter of
1998. Narrowband sales decreased in absolute dollars by 3% and decreased as a
percentage of net sales to 56% in the first
<PAGE>
quarter of 1999 as compared to 60% in the first quarter of 1998. The changes in
narrowband sales and broadband sales as a percentage of net sales were primarily
due to higher sales of broadband products to certain domestic carrier customers.
International sales (including sales in Canada) represented 28% of net sales in
the first quarter of 1999 as compared to 19% in the first quarter of fiscal
1998. This increase was primarily due to an increase in unit sales in Europe of
the Company's narrowband and broadband products. International sales are subject
to inherent risks, including difficulties in homologating products in other
countries, difficulties in staffing and managing foreign operations, greater
difficulty in accounts receivable collection, unexpected changes in regulatory
requirements and tariffs, and potentially adverse tax consequences, which may in
the future contribute to fluctuations in the Company's business and operating
results.
Gross Profit
Gross profit increased 8% in the first quarter of 1999 to $7,934,000 from
$7,315,000 for the same period of the prior year. Gross margin increased to
52.1% of net sales in the first quarter of 1999 as compared to 50.4% in the
first quarter of 1998. This increase in gross margin is primarily a result of a
higher percentage of broadband products which generally have higher gross
margins, and to a lesser extent, increased sales volumes. Gross profits may vary
significantly from quarter to quarter depending on many factors including
competitive pricing pressures and changes in the mix of products sold. A
significant portion of the Company's business is very price competitive, which
has in the past and will in the future require the Company to lower its prices,
resulting in fluctuations in the Company's business and operating results. The
Company anticipates that this pricing pressure will continue for the foreseeable
future. In addition, the mix of products sold may 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 profits.
Research and Development
The primary types of expenses included in research and development ("R&D")
expenses are personnel, consulting, prototype materials and professional
services. R&D expenses decreased 9% to $2,581,000 in the first quarter of 1999
from $2,822,000 in the first quarter of 1998. This decrease is primarily due to
lower personnel-related expenses due to reduced headcount. As a percentage of
net sales, R&D expenses were 16.9% in the first quarter of 1999 as compared to
19.4% in the first quarter of 1998. This decrease as a percentage of net sales
was primarily the result of higher net sales and lower personnel-related
expenses due to reduced headcount in the first quarter of 1999 as compared to
the first quarter of 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."
<PAGE>
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 decreased 8% in the first quarter of 1999 to
$4,613,000 from $5,023,000 for the same period of the prior year. The decrease
in absolute dollars was primarily the result of lower personnel-related expenses
due to reduced headcount. As a percentage of net sales, SG&A expenses decreased
to 30.3% in the first quarter of fiscal 1999 as compared to 34.6% in the first
quarter of fiscal 1998. The decrease as a percentage of net sales was primarily
the result of higher sales volumes and lower personnel-related expenses due to
reduced headcount.
Other Income
Other income includes primarily interest income. Other income decreased 21% in
the first quarter of 1999 to $476,000 from $601,000 for the same period of the
prior year. This decrease was primarily due to lower interest income due to
lower interest rates.
Provision for Income Taxes
The Company's effective tax rate decreased to 25.0% for the first quarter of
1999 compared to 30.5% for the first quarter of 1998. The Company's 1999 tax
rate reflects the resolution of prior contingencies.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $3.2 million for the three months
ended March 31, 1999 and $1.9 million for the three months ended March 31, 1998.
Cash provided by operating activities for the three months ended March 31, 1999
resulted primarily from a net profit and an increase in accounts payable. Cash
provided by operating activities for the three months ended March 31, 1998 was
due primarily to reduction in inventories and an increase in accounts payable
and taxes payable, offset by a reduction in accounts receivable.
Net cash provided by investing activities was $2.1 million for the three months
ended March 31, 1999, compared to $4.8 million during the three months ended
March 31, 1998. The 1999 provision of cash resulted from the maturity of $16.1
million of marketable securities offset by the purchase of $13.8 million of
marketable securities and $250,000 of capital equipment. The net cash provided
by investing during the three months ended March 31, 1998 resulted from the
maturity of $14.7 million of marketable securities offset by the purchase of
$9.5 million of marketable securities and $384,000 of capital equipment.
Financing activities consumed $2.3 million cash during the three months ended
March 31, 1999 and $1.4 million of cash during the same period in 1998. The use
of cash during both periods was primarily due to the Company's repurchase of
$2.4 million and $1.4 million, respectively, worth of its Common Stock, offset
by the proceeds from the exercise of stock options.
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
<PAGE>
transactions, at which time the stock will be retired. The Board authorized
additional repurchases of up to 1,000,000 shares in May 1998, 500,000 shares in
December 1998 and 500,000 shares in April 1999. No time limit was set for
completion of the repurchase programs. The Company purchased 372,000 shares of
common stock during the first three months of 1999, 1,372,000 shares in 1998 and
142,000 shares in 1997 under this program at a cost of $2,364,000, $9,364,000
and $2,422,000 for 1999, 1998 and 1997, respectively.
The Company believes that existing cash and cash flows from operations will be
sufficient to meet its anticipated cash requirements for working capital and
capital expenditures for at least the next 12 months.
OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
In addition to the factors set forth above in this "Management's Discussion and
Analysis of Financial Condition and Results of Operations," there are a number
of other factors that may affect the Company's future operating results. Most of
the following discussion consists of forward-looking statements and accompanying
risks.
The loss of, or difference in actual from anticipated levels of purchases from,
the Company's major customers have in the past adversely affected the Company
and could in the future adversely affect operating results. 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, including
the completion of the build out of carrier and network service providers'
infrastructures, could cause material fluctuations in the Company's business and
operating results. For example, in the fourth quarter of 1997 and in the second
quarter of 1998, the Company had lower operating results than expected due in
part to a weaker than expected demand from certain domestic carrier customers,
including MCI. In addition, none of the Company's customers are contractually
obligated to purchase any quantity of products in any particular period, and
product sales to major customers have varied widely from quarter to quarter and
year to year. There can be no assurance that the Company's current customers
will continue to place orders with the Company, that orders from existing
customers will continue at the levels of previous periods or that the Company
will be able to obtain orders from new customers. Other factors that may cause
fluctuations in the Company's operating results include, but are not limited to,
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, changes in the product mix sold toward narrowband products that yield
lower gross margins, seasonal capital spending patterns of large domestic
customers, changes in sales volumes through the Company's distribution channels,
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 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
<PAGE>
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. This 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 for
the foreseeable future.
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. It will
also depend on the Company's ability 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 effect on the Company's
business and operating results. There can be no assurance that the Company's
product development efforts will result in commercially successful products or
that product delays will not result in missed market opportunities. In addition,
customers could refrain from purchasing the Company's existing products in
anticipation of new product introductions by the Company or its competitors. New
products could also render certain of the Company's existing products obsolete.
Either of these events could materially adversely affect the Company's business
and operating results.
The Company 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. For example, in December 1998,
Lana Vaysburd was hired as Vice President, Engineering and in March 1999,
Sherman Silverman was hired as Vice President, Sales and Marketing, Worldwide.
In addition, in March 1998 Vinita Gupta was reappointed as the Company's interim
President and Chief Executive Officer, which position she accepted on a
full-time basis in January 1999. 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 utilizes management information systems and software technology that
may be affected by Year 2000 issues throughout its businesses. During 1998, the
Company began to implement plans for certain of its internal operating systems
to ensure these systems continue to meet its internal and external requirements.
The Year 2000 compliance efforts will encompass:
All Digital Link products. The cost of this effort is estimated to be
$250,000 and will be financed through working capital and the use of
internal engineering resources.
<PAGE>
All Digital Link major operational systems (including ASK MANMAN,
databases, spreadsheets, word processing, and CAD). The cost of these
initiatives is estimated to be $150,000. The Company has contracted with a
third party to perform the MANMAN compliance work and will use a
combination of consultants and internal resources to address the compliance
issues with other internal operational systems.
In addition, the Company has developed questionnaires and contacted key
suppliers and customers regarding their Year 2000 compliance to determine any
impact on its operations. The remaining initiatives to address vendor and
customer compliance are estimated to be complete by the end of June 1999. In
general, the Company's suppliers and customers have advised it that they have
developed or are in the process of developing plans to address Year 2000 issues.
The Company will continue to monitor and evaluate the progress of its suppliers
and customers on this critical matter. The Company is also reviewing its
non-information technology systems to determine the extent of any changes that
may be necessary and believes that there will be minimal changes necessary for
compliance.
To date, the Company has incurred approximately $300,000 in expenses related to
Year 2000 compliance of its products and internal operating systems. The Company
has achieved in excess of 95% of its products Year 2000 compliance and plans to
have the remaining products compliant by the end of May 1999. Currently, in
excess of 50% of the internal operating systems are Year 2000 compliant.
The Company plans to implement Year 2000 compliance to the remaining portion by
July 1999.
Based on the progress the Company has made in addressing its Year 2000 issues
and the Company's plan and timeline to complete its compliance program, the
Company does not foresee significant risks associated with its Year 2000
compliance at this time. As the Company's plan is to address its significant
Year 2000 issues prior to being affected by them, it has not developed a
comprehensive contingency plan. However, if the Company identifies significant
risks related to its Year 2000 compliance or its progress deviates from the
anticipated timeline, the Company will develop contingency plans as deemed
necessary at that time.
The Company is concerned that many enterprises and carriers will be devoting a
substantial portion of their information systems spending to addressing the Year
2000 issue. This expense may result in spending being diverted from networking
solutions in the near future. This diversion of information technology spending
could have a material adverse impact on the Company's future sales volume.
The foregoing statements are based upon management's best estimates at the
present time, which were derived utilizing numerous assumptions of future
events, including the continued availability of certain resources, third party
modification plans and other factors. There can be no guarantee that these
estimates will be achieved and actual results could differ materially from those
anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, the
nature and amount of programming required to upgrade or replace each of the
affected programs, the rate and magnitude of related labor and consulting costs
and the success of the Company's external customers and suppliers in addressing
the Year 2000 issue. The Company's evaluation is on going and it expects that
new and different
<PAGE>
information will become available to it as that evaluation continues.
Consequently, there is no guarantee that all material elements will be Year 2000
ready in time.
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. Discovery to date has been limited in the state court action,
and the Superior Court has not set a trial date. In the parallel Federal
proceedings, the Court on September 11, 1997 granted the Company's motion to
dismiss the federal complaint with leave to amend, and plaintiff has filed an
amended complaint. The Company has moved to dismiss the amended complaint, the
hearing on which is scheduled to take place in May, 1999. 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
effect 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.
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 DSU/CSUs, may
infringe upon patents held by it. The third party 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
has accrued approximately $950,000 for these matters deemed probable in prior
years, it is currently unable to estimate the ultimate range of loss regarding
these matters. Therefore, it is reasonably possible that the ultimate resolution
of these matters could result in final settlement that could exceed or be less
than the amounts accrued and that the settlement of these matters could be
material to the Company's results of operations. Adjustment to amounts accrued
will take place in the period in which such matters are resolved.
<PAGE>
There can be no assurance that other third parties will not assert infringement
claims against the Company in the future, that any such claims will not result
in costly litigation or that the Company will prevail in any such litigation or
be able to license any valid and infringed patents from third parties on
commercially reasonable terms.
The risks outlined herein are difficult for the Company to forecast, and these
or other factors can materially affect the Company's operating results and stock
price for one quarter or a series of quarters. Further, in recent years the
stock market has experienced extreme price and volume fluctuations that have
particularly affected the market prices of securities of many high technology
companies, for reasons frequently unrelated to the operating performance of the
specific companies. These fluctuations, as well as general economic, political
and market conditions, may materially adversely affect the market price of the
Company's common stock.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
- ------- ----------------------------------------------------------
The Company has limited exposure to financial market risks, including changes in
interest rates. The Company does not use derivative financial instruments in its
investment portfolio. The Company's investment portfolio is generally comprised
of municipal government securities that mature within three years. The Company
places investments in instruments that meet high credit quality standards. These
securities are subject to interest rate risk, and could decline in value if
interest rates increase. Due to the duration and conservative nature of the
Company's investment portfolio, the Company does not expect any material loss
with respect to its investment portfolio. The Company does not have any
significant foreign operations and thus is not materially exposed to foreign
currency fluctuations. The Company does not currently hedge against foreign
currency rate fluctuations.
<PAGE>
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 1. LEGAL PROCEEDINGS
- ------- -----------------
The Company and certain of its officers and directors are parties to various
lawsuits described in paragraphs two and three in Note 4 of Notes to
Consolidated Financial Statements in Part I of this Form 10-Q.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
- ------- -----------------------------------------
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- ------- -------------------------------
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
Not applicable.
ITEM 5. OTHER INFORMATION
- ------- -----------------
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------- --------------------------------
(a) Exhibits
10.24 Separation Agreement between Registrant and Kent A. Bossange
dated April 5, 1999.
27.01 Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended March
31, 1999.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIGITAL LINK CORPORATION
Date: May 13, 1999 s/ Stanley E. Kazmierczak
----------------------------
Stanley E. Kazmierczak
Vice President, Finance and Operations,
Chief Financial Officer and Secretary
(Duly Authorized Officer and Principal
Financial Officer)
Exhibit 10.24
April 5, 1999
Mr. Kent Bossange
19866 Seagull Way
Saratoga, CA 95070
Re: Separation Terms
Dear Kent,
This letter confirms the terms of your separation from your employment with
Digital Link Corporation.
1. Termination Date. Your employment with the Company is terminated effective
April 5, 1999.
2. Acknowledge of Payment of Wages. We herewith deliver to you a final paycheck
for all accrued wages, salary, bonuses, accrued but unused PTO and any similar
payments due and owing to you from the Company as of the termination date.
3. COBRA Coverage. Your health coverage expires April 30, 1999. You have the
option, at your own expense, to extend the health insurance coverage currently
provided by the Company for a period of 18 months from April 30, 1999, pursuant
to the terms and conditions of COBRA. You have 60 days from the termination date
to notify the Company in writing of your election to so continue your
continuation coverage. You will receive a packet, by certified mail, from the
Company providing additional information regarding your COBRA benefits.
4. Payment. In addition, it has been agreed that you will receive additional
compensation for 6 months of base pay as severance pay. You will receive a check
on a monthly basis beginning May 1, 1999. The Company will also pay an amount
equal to your current health insurance benefits for a period of 6 months
beginning May 1, 1999. These severance benefits are in addition to any amounts
due you from the Company and are given as consideration for the release set
forth below. All normal withholding will be applied to the 6 months of severance
pay.
5. Support. During the period from April 5, 1999 through October 6, 1999, you
will be available to consult on a mutually convenient basis to assist on issues
including, but not limited to, product information, customer issues, and
transitional support to Sherm Silverman. You will receive an additional $15,000
for your consultation services. All normal withholding will be applied to the
$15,000 payment.
If you choose to sign this agreement, you will then be given seven (7) days
after you sign the agreement to revoke it and the agreement will not be
effective until after this seven-day period has lapsed. You also acknowledge
that the Company will not begin your severance benefits until seven days from
the time you sign this agreement has expired.
6. Return of Company Property. You hereby represent and warrant to the Company
that you will return to the Company any and all property or data of the Company
of any type whatsoever that may have been in your possession or control by April
9, 1999.
<PAGE>
7. Proprietary Information. You hereby acknowledge that you are bound by the
attached Employee Invention Assignment and Confidentiality Agreement, dated June
9, 1995, that as a result of your employment with the Company you have had
access to the Proprietary Information (as defined in such agreement) of the
Company, that you will hold all such Proprietary Information in strictest
confidence and that you may not make any use of such Proprietary Information on
behalf of any third party. You further confirm that you have delivered to the
Company all documents and data of any nature containing or pertaining to such
Proprietary Information and that you have not take with you any such documents
or data or any reproduction thereof.
8. Waiver of Claims. The payments and agreements set forth in this Agreement are
in full satisfaction of any and all accrued salary, PTO pay, bonus pay,
profit-sharing, termination benefits or other compensation to which you may be
entitled by virtue of your employment with the Company or your termination of
employment. You hereby release and waive any and all claims you may have against
the Company or any of their officers, directors, employees, managers,
shareholders, partners, agents, attorneys, subsidiaries, successors, and
assigns, including without limitation claims for any additional compensation or
benefits arising out of the termination of your employment, any claims of
wrongful termination, breach of contract or discrimination under state or
federal law, and any claims you may have based on age or under the Age
Discrimination in Employment Act or Older Workers Benefit Protection Act. This
section 7 shall remain in full force and effect even if there is a breach of
this Agreement by either party.
You hereby expressly waive any benefits of Section 1542 of the Civil Code of the
State of California, or any other state law of similar effect, which provides as
follows:
"A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT
KNOW OR SUSPECT TO EXIST IN HER FAVOR AT THE TIME OF EXECUTING THE RELEASE,
WHICH IF KNOWN BY HER MUST HAVE MATERIALLY AFFECTED HER SETTLEMENT WITH THE
DEBTOR."
9. Review of Severance Agreement You acknowledge your understanding that you may
take up to twenty-one (21) days to consider this Agreement and that you have
been advised to consult with an attorney prior to executing this Agreement. You
further acknowledge that you understand that you may revoke your agreement
within seven (7) days of your execution of this document and that the
consideration to be paid to you pursuant to paragraph 4 above for your agreement
will be paid only at the end of that seven (7) day revocation period.
10. Nondisparagement. You agree that you will not disparage the Company or its
products, services, agents, representatives, directors, officers, shareholder,
attorneys, employees, vendors, affiliates, successors or assigns, or any person
acting by, through, under or in concert with any of them, with any written or
oral statement.
11. Legal and Equitable Remedies. You agree that the Company shall have the
right to enforce this Agreement and any of its provisions by injunction,
specific performance or other equitable relief without prejudice to any other
rights or remedies the Company may have at law or in equity for breach of this
Agreement.
12. Attorney's Fees. If any action at law or in equity is brought to enforce the
terms of the Agreement, the prevailing party shall be entitled to recover its
reasonable attorneys' fees, costs and expenses from the other party, in addition
to any other relief to which such prevailing party may be entitled.
13. Confidentiality. The contents, terms and conditions of the Agreement shall
be kept confidential by you and shall not be disclosed except to your attorneys
or pursuant to subpoena or court order. Any breach of this confidentiality
provision shall be deemed a material breach of this Agreement.
<PAGE>
14. No Admission of Liability. This Agreements is not and shall not be construed
or contended by you to be an admission or evidence of any wrongdoing or
liability on the part of the Company, its representatives, heirs, executors,
attorneys, agents, partners, officers, shareholders, directors, employees,
subsidiaries, affiliates, divisions, successors or assigns. This Agreement shall
be afforded the maximum protection allowable under California Evidence Code
Section 1152 and/or any other state or Federal provisions of similar effect.
15. Entire Agreement. This Agreement constitutes the entire agreement between
you and the Company with respect to the subject material hereof and supersedes
all prior negotiations and agreements, whether written or oral, relating to such
subject matter. You acknowledge that neither the Company nor its agents or
attorneys, have made any promise, representation or warranty whatsoever, either
express or implied, written or oral, which is not contained in this Agreement
for the purpose of inducing you to execute the Agreement, and you acknowledge
that you have executed this Agreement in reliance only upon such promises,
representations and warranties as are contained herein.
16. Modification. It is expressly agreed that this Agreement may not be altered,
amended, modified, or otherwise changed in any respect except by another written
agreement that specifically refers to this Agreement, duly executed by
authorized representatives of each the parties hereto.
If this letter accurately sets forth the terms of your separation from the
Company, please sign the attached copy and return it to the undersigned
postmarked no later than April 28, 1999.
Very truly yours,
s/ Dianne Mastilock
Dianne Mastilock
Vice President, Human Resources
READ, UNDERSTOOD, AND AGREED
s/ Kent A. Bossange 04/07/99
- ------------------------ -----------
Signature Date
Kent A. Bossange
- -------------------------
Print Name
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet, consolidated statement of income and
consolidated statement of cash flows included in the Company's Form 10-Q
for the period ended March 31, 1999, 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> 3-Mos
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<EXCHANGE-RATE> 1.000
<CASH> 3,312
<SECURITIES> 3,089
<RECEIVABLES> 4,877
<ALLOWANCES> 455
<INVENTORY> 4,038
<CURRENT-ASSETS> 1,088
<PP&E> 11,981
<DEPRECIATION> 9,527
<TOTAL-ASSETS> 55,253
<CURRENT-LIABILITIES> 11,414
<BONDS> 0
0
0
<COMMON> 31,894
<OTHER-SE> 11,945
<TOTAL-LIABILITY-AND-EQUITY> 55,253
<SALES> 15,232
<TOTAL-REVENUES> 15,232
<CGS> 7,298
<TOTAL-COSTS> 14,492
<OTHER-EXPENSES> (476)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,216
<INCOME-TAX> 304
<INCOME-CONTINUING> 912
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 912
<EPS-PRIMARY> 0.11
<EPS-DILUTED> 0.11
</TABLE>
