-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UM7kBZ8Hdxxpm6aCKFDcLJxdWmBv9+jaWjU3d04ZNN45vBhRoOA++T6wJK38t9Tv qtMObUxq7RhUS77x8mCLrA== 0000810467-99-000005.txt : 19990517 0000810467-99-000005.hdr.sgml : 19990517 ACCESSION NUMBER: 0000810467-99-000005 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIGITAL LINK CORP CENTRAL INDEX KEY: 0000810467 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER COMMUNICATIONS EQUIPMENT [3576] IRS NUMBER: 770067742 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-23110 FILM NUMBER: 99622946 BUSINESS ADDRESS: STREET 1: 217 HUMBOLDT COURT CITY: SUNNYVALE STATE: CA ZIP: 94089-1300 BUSINESS PHONE: 4087456200 MAIL ADDRESS: STREET 1: 217 HUMBOLDT COURT CITY: SUNNYVALE STATE: CA ZIP: 94089 10-Q 1 FORM 10-Q 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. 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
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: 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 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 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.
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: 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 ======== ========
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 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 ====== ====== 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 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. 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. 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 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." 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 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 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. 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 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. 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. 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. 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) EX-10 2 SEPARATION AGREEMENT 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. 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. 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 EX-27 3 FDS --
5 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. 0000810467 Digital Link Corporation 1 U.S. Dollars 3-Mos DEC-31-1999 JAN-01-1999 MAR-31-1999 1.000 3,312 3,089 4,877 455 4,038 1,088 11,981 9,527 55,253 11,414 0 0 0 31,894 11,945 55,253 15,232 15,232 7,298 14,492 (476) 0 0 1,216 304 912 0 0 0 912 0.11 0.11
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