FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-23110
DIGITAL LINK CORPORATION
(Exact name of registrant as specified in its charter)
California 77-0067742
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
217 Humboldt Court, Sunnyvale, California 94089
(Address of principal executive offices, including zip code)
(408) 745-6200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Sections 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
The number of shares outstanding of the registrant's common stock
at August 6, 1996 was 9,158,940
DIGITAL LINK CORPORATION
INDEX TO FORM 10-Q
Page
PART I - FINANCIAL INFORMATION:
ITEM 1 - Financial Statements
Consolidated Balance Sheets as of June 30, 3
1996 and December 31, 1995
Consolidated Statements of Income for the 4
quarters and six months ended June 30, 1996
and June 30, 1995
Consolidated Statements of Cash Flows for the 5
six months ended June 30, 1996 and June 30, 1995
Notes to Consolidated Financial Statements 6
ITEM 2 - Management's Discussion and Analysis of 9
Financial Condition and Results of
Operations
PART II - OTHER INFORMATION
ITEM 1 - Legal Proceedings 18
ITEM 2 - Changes in Securities 18
ITEM 3 - Defaults Upon Senior Securities 18
ITEM 4 - Submission of Matters to a Vote of 18
Security Holder
ITEM 5 - Other Information 19
ITEM 6 - Exhibits and Reports on Form 8-K 19
SIGNATURE(S) 20
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share amounts)
June 30, December 31,
1996 1995
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,090 $ 2,639
Short-term marketable securities 13,454 16,726
Accounts receivable, net 5,832 7,690
Inventories, net 4,733 4,603
Prepaid and other current assets 3,190 2,807
Total current assets 29,299 34,465
Property and equipment at cost, net 1,752 1,608
Long-term marketable securities 24,836 18,244
Other assets 446 438
TOTAL ASSETS $ 56,333 $ 54,755
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,016 $ 1,371
Accrued payroll expense 1,349 1,433
Other accrued expenses 3,116 2,751
Income taxes payable 1,694 1,427
Total current liabilities 7,175 6,982
SHAREHOLDERS' EQUITY:
Common stock, no par value:
Authorized: 25,000,000 shares;
Issued and outstanding: 9,126,340
shares in 1996 and 9,000,500 shares
in 1995 29,691 29,283
Unrealized gain on marketable securities 124 555
Retained earnings 19,343 17,935
Total shareholders' equity 49,158 47,773
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 56,333 $ 54,755
The accompanying notes are an integral part of these consolidated
financial statements.
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
FOR THE QUARTERS AND SIX MONTHS ENDED
JUNE 30, 1996 AND 1995
(Amounts in thousands, except per share amounts)
Quarter Ended Six Months Ended
June 30, June 30,
1996 1995 1996 1995
Net sales $12,026 $11,409 $22,228 $21,824
Cost of sales 4,838 4,212 9,203 7,784
Gross profit 7,188 7,197 13,025 14,040
EXPENSES:
Research and development 2,335 2,314 4,386 4,518
Selling, general and
administrative 4,145 3,413 7,728 6,850
Total expenses 6,480 5,728 12,114 11,368
Operating income 708 1,469 911 2,672
Other income 574 534 1,207 1,132
Income before provision for
income taxes 1,282 2,003 2,118 3,804
Provision for income taxes 430 621 710 1,179
NET INCOME $ 852 $1,382 $1,408 $2,625
NET INCOME PER SHARE $ 0.09 $ 0.15 $ 0.15 $ 0.28
Shares used in computing per
share amounts 9,449 9,482 9,401 9,463
The accompanying notes are an integral part of these consolidated
financial statements.
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND 1995
(Amounts in thousands)
Six Months Ended
June 30,
1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 1,408 $ 2,625
Adjustments to reconcile net income to
net cash flows provided by
operating activities:
Depreciation and amortization 598 752
Provision (reduction in provision) for
doubtful accounts (162) 44
Provision for excess and obsolete
inventories 180 152
Changes in assets and liabilities:
Accounts receivable 2,020 527
Increase in inventories (310) (771)
Prepaid and other assets (391) (611)
Accounts payable (355) 910
Accrued payroll and other accrued
expenses 282 (660)
Income taxes payable 267 1,300
Net cash flows provided by
operating activities 3,537 4,268
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (24,641) (23,167)
Maturities of marketable securities 20,890 15,872
Acquisition of property and equipment (743) (903)
Net cash flows used in investing
activities (4,494) (8,198)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock
options and employee stock
purchases 408 316
Net cash flows provided by
financing activities 408 316
Net (decrease) in cash and cash
equivalents (549) (3,614)
Cash and cash equivalents at beginning
of year 2,639 4,638
Cash and cash equivalents at end of
period $ 2,090 $ 1,024
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for income
taxes $ 438 $ 343
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Unrealized gain (loss) on securities
carried at market $ (431) $ 369
The accompanying notes are an integral part of these consolidated
financial statements.
DIGITAL LINK CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been
prepared by the Company without audit in accordance with
generally accepted accounting principles for interim
financial information and pursuant to rules and regulations
of the Securities and Exchange Commission. In the opinion
of management, all adjustments (consisting of only normal
recurring adjustments) considered necessary for a fair
representation have been included. These financial
statements should be read in conjunction with the Company's
consolidated financial statements and notes thereto
contained in the Company's Annual Report on Form 10-K, which
was filed with the Securities and Exchange Commission on
March 28, 1996.
The year-end balance sheet at December 31, 1995 was derived
from audited financial statements, but does not include all
disclosures required by generally accepted accounting
principles.
Operating results for the six months ended June 30, 1996 may
not necessarily be indicative of the results to be expected
for any other interim period or for the full year.
2. COMPUTATION OF NET INCOME PER SHARE
Net income per share is computed using the weighted average
number of common and dilutive common equivalent shares
outstanding during the period. Dilutive common equivalent
shares consist of stock options using the treasury stock
method for all periods presented.
3. INVENTORIES
Inventories are valued at the lower of cost (determined
using the first-in, first-out method) or market.
Inventories consisted of (in thousands):
June 30, 1996 December 31, 1995
(Unaudited)
Raw materials $ 2,123 $ 1,838
Work-in-process 1,783 1,965
Finished goods 827 800
$ 4,733 $ 4,603
4. CONTINGENCY
Certain third parties have expressed their belief that
certain of the Company's products may infringe patents held
by them and have suggested that the Company acquire licenses
to such patents. The Company believes that licenses, to the
extent required, will be available; however, no assurance
can be given that the terms of any offered licenses would be
favorable to the Company. Management, after review and
consultation with counsel, believes that the ultimate
resolution of these allegations are uncertain and there can
be no assurance that these assertions will be resolved
without costly litigation or in a manner that is not adverse
to the Company. Accordingly, while the Company has accrued
certain amounts for these matters, the ultimate resolution
of these matters could result in payments in excess of the
amounts accrued in the accompanying financial statements and
require royalty payments in the future which could adversely
impact gross margins.
In April 1996, a class action complaint was filed against
the Company and certain of its officers and directors in the
Superior Court of the State of California, alleging
violations of the California Corporations Code and
California Civil Code. The class period covers from
September 12, 1994 through December 29, 1995, and the
allegations include claims that the defendants concealed
and/or misrepresented material adverse information about the
Company and that the individual defendants sold shares of
the Company's stock based upon material nonpublic
information. The complaint seeks damages in an unspecified
amount. The Company believes that the action is without
merit and intends to defend against it vigorously.
Litigation is subject to inherent uncertainties and, thus,
there can be no assurance that this suit will be resolved
favorably to the Company or will not have a material adverse
effect on the Company's financial condition and results of
operations. Accordingly, no provision for any liability
that may result upon adjudication has been made on the
accompanying financial statements.
5. CHANGE IN DEPRECIATION METHOD
Effective January 1, 1996, the Company adopted the straight-
line method of depreciation for all property and equipment
placed in service after that date. Property and equipment
placed in service prior to January 1, 1996 continue to be
depreciated using the double-declining balance method. The
estimated useful lives under either method ranges from 3 to
5 years. Management believes that the change from the
double-declining balance method to the straight-line method
provides a better matching of costs and revenues over the
lives of its property and equipment and conforms to
predominant industry practice. Use of the straight-line
method of depreciation on assets placed in service in 1996
versus the double-declining balance method resulted in no
material difference on the pre-tax income or net income in
the first half of 1996.
6. RECENT ACCOUNTING PRONOUNCEMENT
During October 1995, the Financial Accounting Standards
Board issued Statement No. 123 (SFAS No. 123), "Accounting
for Stock-Based Compensation," which establishes a fair
value based method of accounting for stock-based
compensation plans. The Company intends to continue to
account for employee stock options under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." SFAS 123 is
effective for fiscal years beginning after December 15, 1995
and will require certain additional disclosures in the
financial statements for the year ending December 31, 1996.
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.
These forward looking statements involve a number of risks and
uncertainties, such as the impact of competitive products and
pricing, the Company's timely development of new products,
including its W/ATM GateWay product, and their acceptance by the
market, delays in the deployment of and confusion regarding
various evolving technologies, such as SMDS, ATM and Frame Relay,
the loss of, or differences in actual from anticipated levels of
purchases from the Company's major customers, and other risks
which are described throughout the Company's reports filed with
the Securities and Exchange Commission, including its Form 10-K
for the year ended December 31, 1995, and within this
"Management's Discussion and Analysis of Financial Condition and
Results of Operations," including under the title "Other Factors
That May Affect Future Operating Results." The actual results
that the Company achieves may differ materially from any forward
looking statements due to such risks and uncertainties. The
Company has identified by an asterisk (*) various paragraphs
within this "Management's Discussion and Analysis of Financial
Condition and Results of Operations," which contain such forward
looking statements. Actual results could differ materially from
such forward looking statements as a result of the factors
discussed in such paragraphs and those factors discussed in the
sections referenced above and in other sections of this and other
documents filed with the Securities and Exchange Commission. In
addition, when used in this Form 10-Q, words such as "believes,"
"anticipates," "expects," "intends" and similar expressions are
intended to identify forward looking statements, but are not the
exclusive means of identifying such statements. The Company
undertakes no obligation to revise any forward looking statements
in order to reflect events or circumstances that may arise after
the date of this report.
Net Sales
Net sales for the second quarter of 1996 increased 5% to
$12,026,000 from $11,409,000 for the same period of the prior
year. This increase in net sales over the prior year's second
quarter was primarily attributable to an increase in unit sales
of both inverse multiplexer and domestic broadband (i.e.,
transmission rates greater than T1/E1) products primarily sold to
certain domestic carriers and Internet Service Providers (ISP's),
offset by lower unit sales of its broadband SMDS access products,
primarily sold in Europe. Net sales for the six months ended
June 30, 1996 increased 2% to $22,228,000 from $21,824,000 for
the same period of the prior year. This increase was primarily
attributable to an increase in unit sales of both narrowband
(i.e., transmission rates up to T1/E1) products in the Encore
product family and domestic broadband products. This increase
was offset in part by decreased unit sales of the Company's
broadband SMDS access products primarily sold in Europe.
*The Company believes that the decrease in sales of broadband
SMDS access products is due in part to delays in Europe, and in
particular in the United Kingdom, in the further deployment of
SMDS networks due to technical problems within the networks and
to market confusion among Frame Relay, SMDS and ATM technologies.
The Company anticipates that these market conditions will
continue through at least the remainder of 1996, which would
result in lower levels of annual sales of its broadband SMDS
access products in 1996 as compared to annual sales in 1995.
Narrowband sales in absolute dollars increased by 4% and remained
relatively flat as a percentage of net sales at 54% in the second
quarter of 1996 as compared to 55% in the second quarter of 1995.
Broadband sales increased in absolute dollars by 7% and remain
relatively flat as a percentage of net sales at 46% in the second
quarter of 1996 as compared to 45% in the second quarter of 1995.
Narrowband sales and broadband sales as a percentage of net sales
remained relatively flat notwithstanding lower sales in Europe of
broadband products which were offset by higher broadband sales to
certain domestic carrier customers and ISP's, as discussed above.
*International sales represented 15% of net sales in the second
quarter of 1996 as compared to 31% in the second quarter of 1995,
and 14% of net sales for the six months ended June 30, 1996 as
compared to 35% for the same period of the prior year. The
decreases for the quarter and six month periods ending June 30,
1996 were primarily due to a decrease in unit sales of SMDS
products in Europe. For the reasons discussed above, the Company
anticipates that international sales will remain at similar
levels during the remainder of 1996, as compared to 1995, which
would result in a decrease in international sales as a percentage
of net sales for 1996. 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.
*During the second quarter of 1996, sales to MCI and BBN Planet
Corporation accounted for 20% and 15%, respectively, of the
Company's net sales. During the first six months of 1996, BBN
Planet Corporation and MCI accounted for 21% and 16%,
respectively of the Company's net sales. The Company anticipates
that sales to BBN Planet Corporation will decrease as a
percentage of net sales and may decrease in absolute dollars in
the second half of 1996 as a result of fluctuations in activities
associated with the build out of its Internet infrastructure. A
significant portion of the Company's business is derived from
substantial orders placed by large end users and telephone
companies, and the timing of such orders could cause material
fluctuations in the Company's business and operating results.
For example, in the fourth quarter of 1995, the Company had lower
operating results than expected due in part to a weaker than
expected demand from certain domestic carrier customers, as well
as the slow down of sales of its SMDS access products.
During the second quarter of 1996, net sales through direct
sales, value added resellers (VAR's), and OEM's were 60%, 28%,
and 12%, respectively compared to 41%, 39%, and 20% in the second
quarter of 1995. Net sales through direct sales, VAR's, and
OEM's for the first half of 1996 were 63%, 28%, and 9%,
respectively compared to 44%, 32%, and 24% in the first half of
1995. These increases, in the percentage of direct sales, were
as a result of selling directly to BBN Planet Corporation during
1996 compared to 1995 when BBN was sold through a VAR. The
decreases, in the percentage of OEM sales, were a result of a
slowdown in SMDS access products primarily sold in Europe.
Gross Profit
Gross profit decreased slightly in the second quarter of 1996 to
$7,188,000 from $7,197,000 for the same period of the prior year.
Gross margin decreased to 59.8% of net sales in the second
quarter of 1996 as compared to 63.1% in the second quarter of
1995. This decrease in gross margin was primarily due to price
reductions made since the second half of 1995 with respect to
some of the Company's access products. Gross profit decreased 7%
in the six months ended June 30, 1996 to $13,025,000 from
$14,040,000 for the same period of the prior year. Gross margin
decreased to 58.6% of net sales for the first six months of 1996
as compared to 64.3% for the same period of the prior year. This
decrease as a percentage of net sales reflects the above
referenced price reductions and a shift in the mix of products
sold to include more narrowband products, which generally have
lower gross margins than broadband products.
*Gross margins may vary significantly from quarter to quarter
depending on factors such as competitive pricing pressures,
changes in the mix of products sold and the channels through
which they are distributed, the timing of orders and the timing
of new product introductions by the Company. 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 1995, and the first half of 1996, the Company reduced
the prices on some of its access products to address competitive
pricing pressures, which adversely affected the Company's gross
margins during 1995 and 1996.
Research and Development
*Research and development ("R&D") expenses increased 1% to
$2,335,000 in the second quarter of 1996 from $2,314,000 in the
second quarter of 1995. This slight increase was due primarily
to an increase in consulting fees primarily related to the
Company's W/ATM GateWay product, offset by a decrease in
personnel-related expenses, material costs for prototype products
and professional services. As a percentage of net sales, R&D
expenses were 19.4% in the second quarter of 1996 as compared to
20.3% in the second quarter of 1995. This decrease as a
percentage of net sales primarily reflects higher sales volumes
during the second quarter of 1996. R&D expenses decreased 3% to
$4,386,000 in the six months ended June 30, 1996 from $4,518,000
for the same period of the prior year. As a percentage of net
sales, R&D expenses decreased to 19.7% for the first six months
of 1996 as compared to 20.7% for the same period of the prior
year. The absolute dollar decrease for the six-month period is
attributable to lower material costs for prototype products,
lower professional services and personnel-related expenses,
offset by higher consulting fees primarily related to its W/ATM
GateWay product. The Company anticipates that its R&D expenses
in the second half of 1996, especially consulting expenses
related to its W/ATM GateWay product, will increase in absolute
dollars and may increase as a percentage of net sales subject to,
among other factors set forth or referenced in "Net Sales" above
and "Other Factors That May Affect Future Operating Results"
below, the Company's ability to accelerate or defer operating
expenses, achieve revenue levels and hire new personnel during
the remainder of 1996.
*All of the Company's R&D expenditures to date have been expensed
as incurred. In the future, the Company may be required to
capitalize a portion of its software development costs pursuant
to Statement of Financial Accounting Standards No. 86,
"Accounting for Costs of Computer Software to be Sold, Leased or
Otherwise Marketed."
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses increased
21% in the second quarter of 1996 to $4,145,000 from $3,413,000
for the same period of the prior year. As a percentage of net
sales, SG&A expenses were 34.5% in the second quarter of 1996 as
compared to 29.9% in the second quarter of 1995. SG&A expenses
increased 13% for the six months ended June 30, 1996 to
$7,728,000 from $6,850,000 for the same period of the prior year.
As a percentage of net sales, SG&A expenses were 34.8% for the
first six months of 1996 as compared to 31.4% for the same period
of the prior year. These increases were primarily due to higher
personnel-related expenses, primarily within the sales and
marketing organizations, an increase in promotional activities
and higher evaluation product expenses.
*The Company has in the past hired more of its SG&A personnel and
incurred increased expenses related to trade shows and other
promotional activities during the first half of the year.
Accordingly, SG&A expenses as a percentage of net sales are
generally higher during the first half of the year, and the
Company anticipates that this will be true for 1996. The Company
anticipates that its SG&A expenses will increase in absolute
dollars during the second half of 1996 as a result, in part, of
increases in legal expenses associated with its defense of the
recently filed class action lawsuit against the Company, but may
decrease as a percentage of net sales during the second half of
1996. However, any such decrease is subject to, among other
factors set forth or referenced in "Net Sales" above and "Other
Factors That May Affect Future Operating Results" below, the
Company's ability to accelerate or defer operating expenses and
achieve revenue levels during such periods.
Other Income
Other income increased 7% in the second quarter of 1996 to
$574,000 from $534,000 for the same period of the prior year.
For the six months ended June 30, 1996, other income increased 7%
to $1,207,000 from $1,132,000 for the same period of the prior
year. These increases were primarily due to higher interest
income from higher cash balances.
Provision for Income Taxes
The Company's effective tax rate increased to 33.5% for the
second quarter and first six months of 1996 compared to 31% for
the same periods in 1995. This increase was due primarily to the
prior use of the Company's R&D tax credit. The Company
anticipates that its effective tax rate during the remainder of
1996 will remain at levels similar to that experienced in the
first half of 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $22.1 million and cash, cash
equivalents and marketable securities of $40.4 million at June
30, 1996. Net cash provided by operating activities was $3.5
million for the first half of 1996 primarily as a result of a
decrease in accounts receivable and generation of net income
before depreciation and amortization, offset to some extent by an
increase in prepaid and other assets and inventories. This
compares to net cash provided by operating activities of $4.3
million for the first half of 1995 primarily as a result of net
income before depreciation and amortization and an increase in
income taxes payable. Cash used in investing activities during
the first half of 1996 was primarily from the purchases of
marketable securities. Leasehold improvements and capital
equipment additions were $743,000 in the first half of 1996 as
compared to $943,000 in the first half of 1995. Net cash
provided by financing activities was $408,000 in the first half
of 1996 from the exercise of stock options and issuance under the
employee stock purchase plan, as compared to $316,000 in the
first half of 1995.
*The Company believes that existing cash and cash flows from
operations will be sufficient to meet its anticipated cash
requirements for working capital and capital expenditures for at
least the next 12 months.
OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
As indicated above, there are a number of factors that may affect
the Company's future operating results.
*The Company believes that changes in the product mix sold toward
narrowband products that yield lower gross margins have in the
past and could in the future affect operating results. Other
factors that may cause fluctuations in the Company's operating
results include changes in sales volumes through the Company's
distribution channels, seasonal capital spending patterns of
large domestic customers, the gain or loss of significant
customers, the timing of new product introductions by the Company
and its competitors, market acceptance of new or enhanced
versions of the Company's products, availability and cost of
components from the Company's suppliers (some of which are in
short supply and are key to new product development), and
economic conditions generally or in various geographic areas. In
addition, the Company's expense levels are based in part on its
expectations of future revenue. The Company typically operates
with limited order backlog, and a substantial majority of its
revenues in each quarter result from orders booked in that
quarter. The Company has occasionally recognized a substantial
portion of its revenues in a given quarter from sales booked and
shipped in the last month of that quarter. If revenue levels are
below expectations, the Company may be unable to adjust spending
in a timely manner which could adversely affect operating
results.
*The market for the Company's products is highly competitive.
The Company expects competition to increase in the future from
existing competitors and from other companies that may enter the
Company's existing or future markets. The Company anticipates
that it will face competition from internetworking equipment and
other telecommunications equipment manufacturers, certain of whom
are including a direct WAN interface in their products. For
example, in 1995, the Company signed an OEM agreement with Cisco
Systems, Inc. ("Cisco") pursuant to which the Company supplies
DSU cards for inclusion in one of Cisco's key product lines.
Increased sales to Cisco or other internetworking equipment and
telecommunications equipment manufacturers could adversely affect
the Company's gross margins, as sales to OEMs generally have
higher discounts than sales to end users. Further,
internetworking equipment and telecommunications equipment
manufacturers are independently developing a direct WAN interface
for inclusion in their products, overall demand for the Company's
products would be reduced, which would have a material adverse
effect on the Company's business and operating results. As
discussed above, increased competition has also placed increasing
pressures on the pricing of the Company's products, which has
resulted in lower operating results. The Company anticipates
that this increased pricing pressure will continue during the
remainder of 1996.
*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 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.
For example, the Company has experienced decreased sales of its
SMDS and ATM access products, which the Company believes is due
in part to delays in the further deployment of SMDS networks due
to technical problems within the networks and to market confusion
in Europe among Frame Relay, SMDS and ATM technologies. There
can be no assurance that the Company's product development
efforts will result in commercially successful products or that
product delays will not result in missed market opportunities.
In addition, customers could refrain from purchasing the
Company's existing products in anticipation of new product
introductions by the Company or its competitors. New products
could also render certain of the Company's existing products
obsolete. Either of these events could materially adversely
affect the Company's business and operating results.
*The Company is currently developing and may in the future
develop products with which the Company has only limited
experience and/or that are targeted at emerging market segments,
including the Company's W/ATM GateWay product. The W/ATM GateWay
product has not been deployed to any end user customers, and the
Company has experienced delays in the development of this
product, in part related to technical problems which required
some software to be redesigned. The Company has entered into an
agreement with an OEM to market this product once its development
has been completed, but such agreement does not obligate the OEM
to purchase any minimum number of products. In addition, an
agreement with AT&T Network Systems to market the W/ATM GateWay
under that company's name expired in September 1995. According
to the Company's current plan, this product is not anticipated to
be available for customer evaluation before December of 1996.
Given its complexity, there can be no assurance that this product
will not encounter further technical or other difficulties which
could significantly delay its deployment or acceptance or could
result in the termination of the development program for this
product. There can be no assurance that markets for the W/ATM
GateWay will continue to develop, that the W/ATM GateWay will
meet the needs of the emerging ATM market or that products
currently under development by others will not be introduced that
would directly compete with the W/ATM GateWay product, any of
which could have a material adverse effect on the Company's
business, operating results or financial condition.
*The Company believes that its future success will depend in
large part upon the continued contributions of members of the
Company's senior management and other key personnel, and upon its
ability to attract and retain highly skilled managerial,
engineering, sales, marketing and operations personnel, the
competition for whom is intense. In October 1995, Daniel L.
Palmer, the Company's President and Chief Operating Officer,
resigned to pursue other interests. Vinita Gupta resumed the
duties of President upon Mr. Palmer's departure, and the Company
is currently searching for an individual to succeed Ms. Gupta as
President. There can be no assurance that the Company will be
successful in attracting and retaining skilled personnel to hold
this or other important positions. In addition, certain of the
Company's key management personnel have only recently joined the
Company.
*As discussed under "Legal Proceedings" in Part II hereof, in
April 1996, a class action complaint was filed against the
Company and certain of its officers and directors in the Superior
Court of the State of California alleging violations of the
California Corporations Code and California Civil Code. The
class period covers from September 12, 1994 through December
29,1995, and the allegations include claims that the defendants
concealed and/or misrepresented material adverse information
about the Company and that the individual defendants sold shares
of the Company's stock based upon material nonpublic information.
The complaint seeks damages in an unspecified amount. The
Company believes that the action is without merit and intends to
defend against it vigorously. However, litigation is subject to
inherent uncertainties and thus there can be no assurance that
this suit will be resolved favorably to the Company or will not
have a material adverse effect on the Company's financial
condition and results of operations.
*The telecommunications industry is characterized by the
existence of a large number of patents and frequent litigation
based on allegations of patent infringement. For example, a
third party has expressed its belief that certain of the
Company's products, including its CSU/DSUs, may infringe upon six
patents held by it and has suggested that the Company acquire a
license to such patents. The Company recently received further
notice from this third party reiterating its demand that the
Company obtain a license for these patents. There can be no
assurance that these assertions will be resolved without costly
litigation or in a manner that is not adverse to the Company.
The Company believes that a license, to the extent required, will
be available; however, no assurance can be given that the terms
of any offered license would be favorable to the Company. Should
a license be unavailable, the Company could be required to
discontinue the sale of or to redesign certain of its products.
In addition, Larscom, a competitor of the Company, has continued
to express its belief that the Company's inverse multiplexer
products may infringe a patent jointly owned by Larscom and a
third party and has suggested that the Company acquire a license
to the patent. There can be no assurance that other third
parties will not assert infringement claims against the Company
in the future, that any such claims will not result in costly
litigation or that the Company will prevail in such litigation or
be able to license any valid and infringed patents from third
parties on commercially reasonable terms. The Company's
management, after review and consultation with counsel, believes
that the ultimate resolution of these allegations are uncertain
and there can be no assurance that these assertions will be
resolved without costly litigation or in a manner that is not
adverse to the Company. Accordingly, while the Company has
accrued certain amounts for these matters, the ultimate
resolution of these matters could result in payments in excess of
the amounts accrued in the Company's financial statements and
require royalty payments in the future which could adversely
impact gross margins.
*The risks outlined herein are difficult for the Company to
forecast, and these or other factors can materially affect the
Company's operating results and stock price for one quarter or a
series of quarters. Further, in recent years the stock market
has experienced extreme price and volume fluctuations that have
particularly affected the market prices of securities of many
high technology companies, for reasons frequently unrelated to
the operating performance of the specific companies. These
fluctuations, as well as general economic, political and market
conditions, may materially adversely affect the market price of
the Company's common stock.
*During October 1995, the Financial Accounting Standards Board
issued Statement No. 123 (SFAS No. 123), "Accounting for Stock-
Based Compensation," which establishes a fair value based method
of accounting for stock-based compensation plans. The Company
intends to continue to account for employee stock options under
APB Opinion No. 25, "Accounting for Stock Issued to Employees."
SFAS 123 is effective for fiscal years beginning after December
15, 1995 and will require certain additional disclosures in the
financial statements for the year ending
December 31, 1996.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 22, 1996, a class action complaint was filed in the
Superior Court of the State of California, Santa Clara County
against the Company, certain of its officers and directors and
Bear Stearns & Co. Inc., alleging violations of the California
Corporations Code and California Civil Code. The class period
covers from September 12, 1994 through December 29, 1995, and the
allegations include claims that the defendants concealed and/or
misrepresented material adverse information about the Company and
that the individual defendants sold shares of the Company's stock
based upon material nonpublic information. The complaint seeks
damages in an unspecified amount, including compensatory and/or
punitive damages. The Company believes that the action is
without merit and intends to defend against it vigorously. On
July 22, 1996, the Company filed a Demurrer requesting dismissal
of this case. Nevertheless, litigation is subject to inherent
uncertainties and thus there can be no assurance that this suit
will be resolved favorably to the Company or will not have a
material adverse effect on the Company's financial condition and
results of operations.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 16, 1996, the Company held its annual meeting of
shareholders. At that meeting, the Company's five incumbent
directors were reelected to office by the following vote:
Votes
Name Votes for Withheld
Vinita Gupta 8,262,552 42,737
Richard C. Alberding 8,264,302 40,987
Gregory M. Avis 8,264,302 40,987
Narendra K. Gupta 8,264,302 40,987
Charles R. Moore 8,264,302 40,987
Also at that meeting, the shareholders ratified the selection of
Coopers & Lybrand as independent auditors for the company's
current fiscal year, with 8,282,300 votes for, 8,836 votes
against, and 14,153 votes abstaining.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
11.01 Statement of Computation of Net Income Per share.
27.01 Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter
ended June 30, 1996.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
DIGITAL LINK CORPORATION
Date: August 13, 1996 /s/ Vinita Gupta
Vinita Gupta
Chief Executive Officer
Date: August 13, 1996 /s/ Stanley E. Kazmierczak
Stanley E. Kazmierczak
Chief Financial Officer
EXHIBIT INDEX
Exhibits
11.01 Statement of Computation of Net Income Per Share.
27.01 Financial Data Schedule