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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________________
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002, OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _____________ .
000-21669
(Commission File Number)
___________________________
DIGITAL LIGHTWAVE, INC.
(Exact name of Registrant as specified in its charter)
___________________________
DELAWARE 95-4313013
(State or other jurisdiction of ) (I.R.S. Employer Identification No.)
incorporation or organization)
15550 LIGHTWAVE DRIVE 33760
CLEARWATER, FLORIDA (Zip Code)
(Address of principal executive offices)
(727) 442-6677
(Registrant's telephone number, including area code)
___________________________
Indicate by check mark whether Registrant (1) has filed all reports
required to be filed by Section 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 report(s)), 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
August 12, 2002 was 31,371,681.
#
DIGITAL LIGHTWAVE, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED JUNE 30, 2002
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements:
Consolidated Condensed Balance Sheets-June 30, 2002
(Unaudited) and December 31, 2001.......................... 1
Consolidated Condensed Statements of Operations (Unaudited)
Three Months Ended June 30, 2002 and June 30, 2001......... 2
Consolidated Condensed Statements of Operations (Unaudited)
Six Months Ended June 30, 2002 and June 30, 2001........... 3
Consolidated Condensed Statements of Cash Flows (Unaudited)
Six Months Ended June 30, 2002 and June 30, 2001........... 4
Notes to Consolidated Condensed Financial Statements
(Unaudited)................................................ 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................... 21
Item 4. Submission of Matters to a Vote of Security Holders........ 22
Item 5. Other Information ......................................... 22
Item 6. Exhibits and Reports on Form 8-K........................... 23
SIGNATURES........................................................... 24
EXHIBIT INDEX........................................................ 25
#
PART I
FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
DIGITAL LIGHTWAVE, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
JUNE 30, DECEMBER 31,
2002 2001
-------------- --------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 16,114 $ 51,044
Restricted cash and cash equivalents 12,839 --
Short-term investments 14,690 --
Accounts receivable, less allowance of $1,483 and $5,900, respectively 7,143 7,638
Inventories, net 15,457 16,565
Prepaid expenses and other current assets 3,151 895
------------- -------------
Total current assets 69,394 76,142
Property and equipment, net 10,947 9,917
Other assets 209 203
------------- -------------
Total assets $ 80,550 $ 86,262
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 7,920 $ 7,287
Accrued litigation charge 4,650 4,100
Notes payable 361 --
------------- -------------
Total current liabilities 12,931 11,387
Revolving credit facility 10,000 --
Other long-term liabilities 815 809
------------- -------------
Total liabilities 23,746 12,196
------------- -------------
Stockholders' equity:
Preferred stock, $.0001 par value; authorized 20,000,000
shares; no shares issued or outstanding -- --
Common stock, $.0001 par value; authorized 200,000,000
shares; issued and outstanding 31,371,681 and
31,269,723 shares in 2002 and 2001, respectively 3 3
Additional paid-in capital 80,817 80,511
Accumulated deficit (24,020) (6,448)
Accumulated other comprehensive income 4 --
------------- -------------
Total stockholders' equity 56,804 74,066
------------- -------------
Total liabilities and stockholders' equity $ 80,550 $ 86,262
============= =============
The accompanying notes are an integral part of these consolidated condensed
financial statements.
#
DIGITAL LIGHTWAVE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER-SHARE DATA)
THREE MONTHS ENDED
JUNE 30,
--------------------
2002 2001
------------ ------------
Net sales $ 4,214 $ 34,517
Cost of goods sold 8,370 10,423
------------ ------------
Gross profit (loss) (4,156) 24,094
------------ ------------
Operating expenses:
Engineering and development 3,461 3,773
Sales and marketing 2,331 4,866
General and administrative 1,695 2,383
Litigation charge 550 -
------------ ------------
Total operating expenses 8,037 11,022
------------ ------------
Operating income (loss) (12,193) 13,072
Other income, net 168 444
------------ ------------
Income (loss) before income taxes (12,025) 13,516
Provision for income taxes - 4,193
------------ ------------
Net income (loss) $ (12,025) $ 9,323
============ ============
Per share of common stock:
Basic net income (loss) per share $ (0.38) $ 0.30
============ ============
Diluted net income (loss) per share $ (0.38) $ 0.28
============= ============
Weighted average common shares outstanding 31,356,470 30,851,260
============= ============
Weighted average common and common equivalent shares outstanding 31,356,470 32,731,565
============= ============
The accompanying notes are an integral part of these consolidated condensed
financial statements.
#
DIGITAL LIGHTWAVE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER-SHARE DATA)
SIX MONTHS ENDED
JUNE 30,
--------------------
2002 2001
------------ ------------
Net sales $ 10,513 $ 68,935
Cost of goods sold 11,913 20,922
------------ ------------
Gross profit (loss) (1,400) 48,013
------------ ------------
Operating expenses:
Engineering and development 6,793 7,411
Sales and marketing 4,789 9,891
General and administrative 3,082 3,943
Restructuring charge 1,300 -
Litigation charge 550 -
------------ ------------
Total operating expenses 16,514 21,245
------------ ------------
Operating income (loss) (17,914) 26,768
Other income, net 342 854
------------ ------------
Income (loss) before income taxes (17,572) 27,622
Provision for income taxes - 5,320
------------ ------------
Net income (loss) $ (17,572) $ 22,302
============ ============
Per share of common stock:
Basic net income (loss) per share $ (0.56) $ 0.73
============ ============
Diluted net income (loss) per share $ (0.56) $ 0.69
============ ============
Weighted average common shares outstanding 31,332,766 30,691,928
============ ============
Weighted average common and common equivalent shares outstanding 31,332,766 32,444,532
============ ============
The accompanying notes are an integral part of these consolidated condensed
financial statements.
#
DIGITAL LIGHTWAVE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
--------------------
2002 2001
Cash flows from operating activities: ---------- ----------
Net income (loss) $ (17,572) $ 22,302
Adjustments to reconcile net income to cash (used in) provided
by operating activities:
Depreciation and amortization 1,762 1,603
Loss on disposal of property 41 12
Provision for uncollectible accounts -- 252
Provision for excess and obsolete inventory 6,000 --
Income tax benefit from stock options -- 5,320
Restructuring charges 1,300 --
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 495 (10,811)
Increase in inventories (7,079) (2,443)
Increase in prepaid expenses and other assets (2,115) (426)
Decrease in accounts payable and accrued expenses (261) (2,125)
Increase in accrued litigation charge 550 --
---------- ----------
Net cash (used in) provided by operating activities (16,879) 13,684
---------- ----------
Cash flows from investing activities:
Purchases of short-term investments (14,690) --
Increase in restricted cash and cash equivalents (12,839) --
Purchases of property and equipment (749) (1,160)
Increase in notes receivable (175) (200)
---------- ----------
Net cash used in investing activities (28,453) (1,360)
---------- ----------
Cash flows from financing activities:
Proceeds from notes payable 811 --
Principal payments on notes payable (451) --
Borrowing under revolving credit facility 10,000 --
Proceeds from sale of common stock 306 2,832
Payments received from lease receivables -- 33
Principal payments on capital lease obligations (268) (268)
---------- ----------
Net cash provided by financing activities 10,398 2,597
---------- ----------
Net (decrease) increase in cash and cash equivalents (34,934) 14,921
Effect of translation adjustment 4 --
Cash and cash equivalents at beginning of period 51,044 30,481
---------- ----------
Cash and cash equivalents at end of period $ 16,114 $ 45,402
========== ==========
Other supplemental disclosures:
Cash paid for interest $ 19 $ 34
Fixed assets capitalized from inventory $ 2,186 $ 753
The accompanying notes are an integral part of these consolidated condensed
financial statements.
#
DIGITAL LIGHTWAVE, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial statements of
Digital Lightwave, Inc. and its subsidiaries (the "Company", "Digital
Lightwave", "us," "we," "our," etc.) have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, these statements include all adjustments,
consisting of normal and recurring adjustments, considered necessary for a fair
presentation of results for such periods. The results of operations for the
six month period ended June 30, 2002 are not necessarily indicative of
results which may be achieved for the full fiscal year or for any future
period. The unaudited interim financial statements should be read in
conjunction with the financial statements and notes thereto contained in
Digital Lightwave's Form 10-K for the period ended December 31, 2001.
2. NEW SUBSIDIARIES AND BRANCH OFFICES
During the second quarter of 2002, two new subsidiaries were formed.
Digital Lightwave Asia Pacific Pty, Ltd. is based in Australia and provides
sales and sales support in the Asia Pacific region. Digital Lightwave Latino
Americana Ltda. is based in Brazil and provides sales and sales support
in Latin America. All significant intercompany transactions and balances are
eliminated in consolidation. The translation adjustment that results when
converting the financial statements of these subsidiaries from their local
currencies to US dollars is recorded as a component of other comprehensive
income.
During the second quarter of 2002, four new offices were established. The
offices are located in Australia, China, Taiwan and Brazil and will provide
sales and sales support for those respective countries. The offices in
Australia, China and Taiwan will be managed by Digital Lightwave Asia Pacific
Pty, Ltd. and the office in Brazil will be managed by Digital Lightwave Latino
Americana Ltda.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
SHORT-TERM INVESTMENTS
The Company's short-term investments consist of highly liquid debt
instruments with strong credit ratings and remaining maturities of less than
one year. Commercial paper investments with a maturity greater than three
months, but less than one year at the time of purchase are considered to be
short-term investments. The Company classifies its existing short-term
investments as available-for-sale in accordance with Statement of Financial
Accounting Standards No, 115, "Accounting For Certain Investments In Debt And
Equity Securities." These securities are carried at fair market value, with
unrealized gains and losses reported in stockholders' equity as a component of
other comprehensive income. Gains or losses on securities sold are recorded as
other income (loss) in the consolidated statement of operations based on the
specific identification method.
ACCOUNTS RECEIVABLE
The balance in accounts receivable includes approximately $7.4 million in
trade receivables, $1.5 million in the allowance for doubtful accounts, $0.8
million in a receivable from Jabil Circuit, Inc. and approximately $0.4
million in other miscellaneous receivables.
The reduction in the allowance for doubtful accounts was primarily
attributable to the write-off of uncollectible balances and the repossession of
approximately $3.5 million in product that was previously deemed uncollectible
and included in the allowance for doubtful accounts. The repossessed products
were taken from customers in financial difficulty through the collection
efforts of the Company. Since these balances were previously reserved, the
original cost of the repossessed units was charged against the allowance for
doubtful accounts when the units were returned to inventory.
#
INVENTORY
Inventories are stated at the lower of cost (first-in, first-out) or market.
The Company records a provision for excess and obsolete inventory whenever such
an impairment has been identified.
REVENUE RECOGNITION
The Company derives its revenue from product sales. The Company recognizes
revenue from the sale of products when persuasive evidence of an arrangement
exists, the product has been delivered, the price is fixed and determinable and
collection of the resulting receivable is reasonably assured.
For all sales, the Company uses a binding purchase order as evidence that a
sales arrangement exists. Sales through international distributors are
evidenced by a master agreement governing the relationship with the
distributor. The Company either obtains an end-user purchase order documenting
the order placed with the distributor or proof of delivery to the end user as
evidence that a sales arrangement exists. For demonstration units sold to
distributors, the distributor's binding purchase order is evidence of a sales
arrangement.
For domestic sales, delivery generally occurs when product is delivered to a
common carrier. Demonstration units sold to international distributors are
considered delivered when the units are delivered to a common carrier. An
allowance is provided for sales returns based on historical experience.
For sales made under an OEM arrangement, delivery generally occurs when the
product is delivered to a common carrier. OEM sales are defined as sales of
the Company's products to a third party that will market the products under
their brand.
For trade-in sales, including both Company and competitor products, that have
a cash component of greater than 25% of the fair value of the sale, the Company
recognizes revenue based upon the fair value of what is sold or received,
whichever is more readily determinable, if the Company has demonstrated the
ability to sell its trade-in inventory for that particular product class.
Otherwise, the Company accounts for the trade-in sale as a nonmonetary
transaction and follows the guidance found in Accounting Principles Board
Opinion No. 29, "Accounting for Nonmonetary Transactions" and related
interpretations. Revenue and cost of sales are recorded based upon the cash
portion of the transaction. The remaining costs associated with the new units
are assigned to the units received on trade. When the trade-in units are
resold, revenue is recorded based upon the sales price and cost of goods sold
is charged with the value assigned to trade-in units from the original
transaction.
At the time of the transaction, the Company assesses whether the price
associated with its revenue transactions is fixed and determinable and whether
or not collection is reasonably assured. The Company assesses whether the price
is fixed and determinable based on the payment terms associated with the
transaction. Standard payment terms for domestic customers are 30 days from
the invoice date. Distributor contracts provide standard payment terms of 60
days from the invoice date. The Company does not offer extended payment terms.
The Company assesses collection based on a number of factors, including past
transaction history with the customer and the credit-worthiness of the
customer. Collateral is not requested from customers. If it is determined that
collection of an accounts receivable is not reasonably assured, the amount of
the accounts receivable is deferred and revenue recognized at the time
collection becomes reasonably assured.
Most sales arrangements do not generally include acceptance clauses. However,
if a sales arrangement includes an acceptance provision, acceptance occurs upon
the earlier of receipt of a written customer acceptance or expiration of the
acceptance period.
TRADE-IN REVENUE
For the quarter ended June 30, 2002 the Company recorded approximately $1.3
million in revenue from transactions that included a trade-in component. For
the six months ended June 30, 2002 the Company recorded approximately $2.0
million in revenue from transactions that included a trade-in component.
#
4. INVENTORIES
Inventories at June 30, 2002 and December 31, 2001 are summarized as
follows:
JUNE 30, DECEMBER 31,
2002 2001
---------- ----------
(IN THOUSANDS)
Raw materials $ 10,795 $ 9,341
Work-in-process 4,701 6,417
Finished goods 5,724 4,640
In transit 2,332 --
Provision for excess and obsolete inventory (8,095) (3,833)
---------- ----------
$ 15,457 $ 16,565
========== ==========
In December 2001, the Company signed a manufacturing service agreement with
Jabil Circuit, Inc. ("Jabil"), a leading provider of technology manufacturing
services with a customer base of industry-leading companies. Under the terms
of the agreement, Jabil will serve as the Company's primary contract
manufacturer for the Company's circuit board and product assembly and will also
provide engineering design services. Jabil's cumulative purchases from the
Company have been approximately $12.0 million through June 30, 2002. As of
June 30, 2002, the Company was committed to purchase $5.7 million of finished
goods from Jabil through 2002. Under the terms of the agreement, Jabil
will continue to purchase the Company's existing inventory to fulfill orders
until the Company's present inventory is depleted to safety stock levels.
At June 30, 2002 inventories included approximately $3.1 million of trade-in
products.
In June 2002, the Company recorded a $6.0 million provision for excess and
obsolete inventory. When evaluating the adequacy of the reserve for excess and
obsolete inventory the Company analyzes current and expected sales trends, the
amount of current parts on hand, the current market value of parts on hand and
the viability and technical obsolescence of products.
5. COMPUTATION OF NET INCOME (LOSS) PER SHARE
Basic income (loss) per share is based on the weighted average number of
common shares outstanding during the periods presented. For the three months
and six months ended June 30, 2002, diluted loss per share, which includes the
effect of incremental shares from common stock equivalents using the treasury
stock method, is not included in the calculation of net loss per share as the
inclusion of such equivalents would be anti-dilutive. The total incremental
shares from common stock equivalents were 119,215 and 168,916 for the three
months and six months ended June 30, 2002, respectively. The table below shows
the calculation of basic weighted average common shares outstanding and the
incremental number of shares arising from common stock equivalents under the
treasury stock method:
THREE MONTHS ENDED
JUNE 30,
--------------------------------
2002 2001
----------- -----------
Basic:
Weighted average common shares outstanding 31,356,470 30,851,260
Total basic 31,356,470 30,851,260
Diluted:
Incremental shares for common stock equivalents -- 1,880,305
Total dilutive 31,356,470 32,731,565
#
SIX MONTHS ENDED
JUNE 30,
--------------------------------
2002 2001
----------- -----------
Basic:
Weighted average common shares outstanding 31,332,766 30,691,928
Total basic 31,332,766 30,691,928
Diluted:
Incremental shares for common stock equivalents -- 1,752,604
Total dilutive 31,332,766 32,444,532
6. LEGAL PROCEEDINGS
On November 23, 1999, Seth P. Joseph, a former officer and director of the
Company commenced arbitration proceedings against the Company alleging breach
of his employment agreement and stock option agreements, violation of the
Florida Whistleblower statute and breach of an indemnification agreement and
the Company bylaws. As relief, Mr. Joseph sought $500,000, attorneys' fees,
interest and stock options for 656,666 shares of the Company's common stock
exercisable at a price of $5.25 per share. The Company filed an answer denying
Mr. Joseph's allegations and alleging multiple affirmative defenses and
counterclaims. The Company's counterclaims against Mr. Joseph sought repayment
of loans totaling approximately $113,000 plus interest. Mr. Joseph
subsequently dismissed without prejudice all of his claims other than his claim
under the Whistleblower Statute. The arbitration hearing on Mr. Joseph's
Whistleblower claim and the Company's counterclaims concluded on October 5,
2001. The parties submitted proposed findings to the arbitrator on October 17,
2001. As part of his proposed findings, Mr. Joseph sought an award of $48
million and attorneys' fees and costs. On November 9, 2001, the Company was
notified of the arbitrator's decision which awarded Mr. Joseph the sum of
approximately $3.7 million and attorneys' fees and costs. On December 20,
2001, the arbitrator issued a corrected award and awarded Mr. Joseph the sum of
$3.9 million and attorneys' fees and costs in amounts yet to be determined. On
January 23, 2002, Mr. Joseph filed a motion seeking the award of $1.1 million
in attorneys' fees, costs and interest thereon. On July 18, 2002, the
arbitrator issued an award to Mr. Joseph of $575,000 for attorneys' fees,
$165,000 for costs, $10,000 for a portion of the arbitrator fees, plus interest
from November 1, 2001 until paid.
On December 3, 2001, the Company filed a petition to vacate or modify the
arbitration award in the Circuit Court of the Sixth Judicial Circuit, Pinellas
County, Florida, in an action entitled Digital Lightwave, Inc. v. Seth P.
Joseph, Case No. 01-9010C1-21. The Company filed an amended petition on
December 26, 2001, following the corrected arbitration award. Subsequently,
Mr. Joseph filed a cross-motion to confirm the arbitration award. Oral
argument on the Company's petition and Mr. Joseph's cross-motion was heard by
the Court on February 27, 2002. On March 26, 2002, the Court denied the
Company's petition to vacate the arbitration award, granted Mr. Joseph's cross-
motion to confirm the award, and entered a judgment in favor of Mr. Joseph in
the amount of $4.0 million including interest. The Company is appealing the
decision and judgment of the Circuit Court. On April 4, 2002 the Company
posted a civil supersedeas bond in the amount of $4.8 million, which represents
the amount of the judgment plus two times the estimated interest, to secure a
stay of enforcement of the Circuit Court judgment pending the Company's appeal.
The Company has recorded an accrual of $4.7 million related to this arbitration
as of June 30, 2002. The Company believes its appeal is meritorious and
intends to pursue the appeal vigorously.
In January 2002, an employee terminated as part of the Company's October
2001 restructuring initiatives, filed a lawsuit claiming the Company wrongly
discharged the employee and has withheld payments due the employee. The suit
does not seek a specified amount of damages, but does claim that the 2001
compensation plan presented to the employee in October 2001 unfairly lowered
the employee's salary. The plaintiff seeks attorneys' fees, interest and
punitive damages. The Company has responded to the complaint and denied the
substantive allegations therein. The Company intends to defend against these
claims vigorously.
In March 2002, a former employee filed a lawsuit claiming the Company
breached the employee's severance agreement by paying the employee less than
the agreement provided. The suit seeks damages in excess of $100,000. The
Company has responded to the complaint and denied the substantive allegations
therein. The Company intends to vigorously defend the action.
The Company from time to time is involved in various other lawsuits and
actions by third parties arising in the ordinary course of business. The
Company is not aware of any additional pending litigation, claims or
assessments that could have a material adverse effect on the Company's
business, financial condition and results of operations.
7. RESTRUCTURING CHARGES
In October 2001, the Company's board of directors approved a reduction in
force of 38 employees and consultants across all departments and instituted
temporary executive salary reductions of up to 20%. The overall objective of
the initiative was to lower operating costs and improve efficiency. All
affected employees were terminated in October 2001 and given severance based
upon years of service with the Company. The Company recorded a restructuring
charge of $0.5 million in 2001 related to this cost reduction program. The
costs included in a restructuring charge for severance payments to employees
included in the reduction in force, legal costs associated with the cost
reduction program and remaining lease liabilities on the Company's facility in
New Jersey. In January 2002, the board of directors approved additional cost
reduction initiatives aimed at further reducing operating costs. These included
a second reduction in force of 46 employees and contractors and the outsourcing
of manufacturing and production. All affected employees were terminated in
January 2002 and given severance based upon years of service with the Company.
The Company recorded a restructuring charge of $1.3 million in the first
quarter of 2002.
The costs associated with both of these actions are expected to be paid by
January 2003. Activity associated with the restructuring charges during the
quarter ended June 30, 2002 was as follows:
Balance at March 31, 2002 Additions Payments/ Reductions Balance at June 30, 2002
-------- -------- -------- --------
(in thousands)
Severance $ 563 $ -- $ (36) $ 527
Legal and other expenses 113 -- (16) 97
Lease payments 86 -- (21) 65
-------- -------- -------- --------
$ 762 $ -- $ (73) $ 689
======== ======== ======== ========
8. COMMITMENTS
At June 30, 2002, the Company had outstanding non-cancelable purchase order
commitments to purchase certain inventory items totaling approximately $7.9
million, excluding the $5.7 million commitment to Jabil more fully described in
Note 4. The majority of the quantities under order are deliverable upon demand
by the Company or within thirty (30) days upon written notice of either party.
9. REVOLVING CREDIT FACILITY
In April 2002, the Company entered into a Revolving Credit and Security
Agreement ("the Agreement") with Wachovia Bank ("the Bank"). The terms of the
Agreement provide the Company with a $27.5 million line of credit at LIBOR plus
0.7% collateralized by the Company's cash and cash equivalents and short-term
investments. The advance rate varies between 80% and 95% and is dependent
upon the composition and maturity of the available collateral. An availability
fee of 0.10% per annum is payable quarterly based on the Average Available
Principal Balance (as defined in the Agreement) for such three months. The
Agreement has an initial term of three years. The Agreement may be terminated
by the Company at any time upon at least fifteen days prior written notice to
the Bank, and the Bank may terminate the Agreement at any time, without notice
upon or after the occurrence of an event of default. There were $10.0 million
in borrowings under the Agreement at June 30, 2002. Under the terms of the
Agreement, $12.8 million of the Company's cash and cash equivalents were
classified as restricted at June 30, 2002. This includes amounts borrowed
under the Agreement based upon an advance rate of 95% and approximately $2.2
million in letters of credit required by the leases for the Company's office
space. The Company plans to use the facility for short-term working capital
and general corporate purposes, including potential acquisitions of
complementary businesses and technologies. The Company's previous line of
credit with Congress Financial was terminated in April 2002 as part of this
transaction.
10. RELATED PARTY TRANSACTIONS
In April 2002, an officer of the Company borrowed $175,000 from the
Company. On April 12, 2002, this borrowing was combined with a previous note
of $200,000 plus accrued interest of approximately $16,000 into one note with a
principal balance of approximately $391,000. This note accrues interest at
8.0% with the principal and accrued interest thereon payable on demand or, if
earlier, from the proceeds of any sale of the officer's stock holdings or on
the date of termination of the officer's employment with the Company. This
note is collateralized by the officer's stock holdings in the Company, future
cash bonuses which may become payable and a second lien on the officer's
residence.
#
11. SUBSEQUENT EVENT
On August 9, 2002, the Board of Directors accepted the resignation of Dr.
Bryan Zwan as President and Chief Executive Officer of the Company. Dr. Zwan
will continue as the Company's Chairman of the Board and will concentrate on
developing the Company's strategy and technology, as well as potential mergers
and acquisitions. Also on August 9, 2002, the Board of Directors appointed the
Company's current Chief Operating Officer, Jim Green to the offices of
President and Chief Executive Officer. As President and Chief Executive
Officer Mr. Green will direct all of the Company's day to day operations and
serve as the Company's principal executive officer. On August 9, 2002, the
Board of Directors also promoted the Company's current Chief Financial Officer,
Mark Scott to the offices of Executive Vice President and Chief Financial
Officer.
#
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
The following discussion of our financial condition and results of operations
contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
These statements relate to future events or our future financial performance.
In some cases, you can identify forward-looking statements by terminology such
as may, will, should, expect, plan, anticipate, believe, estimate, predict,
potential or continue, the negative of terms like these or other comparable
terminology. These statements are only predictions. These statements involve
known and unknown risks and uncertainties and other factors that may cause
actual events or results to differ materially. In evaluating these statements,
you should specifically consider various risks and uncertainties, including
fluctuations in operating results, changes in the United States and worldwide
economy and fluctuations in capital expenditures within the telecommunications
industry, our dependence on a limited number of products and uncertainties of
the market for our current and planned products, technological change, our
dependence on growth of the Internet, competition, our dependence on a limited
number of major customers, our dependence on contract manufacturers and
suppliers, our products may not continue to meet changing regulatory and
industry standards, our ability to achieve sustained operating profitability,
our dependence on key personnel, the significant influence of our principal
stockholder, our dependence on proprietary technology, the volatility of our
market price, the sale of a significant number of our shares pursuant to future
sales contracts could depress the price of our stock, the effect that anti-
takeover provisions have on the price of our common stock and past and future
litigation risk, as outlined under the caption "Factors that May Affect Future
Results" set forth at the end of Item 1 in our Annual Report filed on Form 10-K
and such other risks and uncertainties contained from time to time in our other
filings with the SEC. All forward-looking statements included in this document
are based on information available to us on the date of filing, and we assume
no obligation to update any such forward-looking statements. We caution
investors that our business and financial performance are subject to
substantial risks and uncertainties.
OVERVIEW
Digital Lightwave, Inc. provides the global fiber-optic communications
industry with products and technology used to develop, install, maintain,
monitor and manage fiber optic-based networks. Telecommunications service
providers and equipment manufacturers deploy the Company's products to provide
quality assurance and ensure optimum performance of advanced optical
communications networks and network equipment. The Company's products are sold
worldwide to leading and emerging telecommunications service providers,
telecommunications equipment manufacturers, equipment leasing companies and
international distributors.
Fiber optics deliver increased network bandwidth for the transmission of
voice, video, audio, and data traffic over public and private networks,
including the Internet. The Company's products provide the capabilities to
cost-effectively deploy and manage fiber-optic networks to address increasing
demand for bandwidth. While the technology of optical networking is highly
advanced, the Company's products are used to verify that telecommunications
products and systems function and perform properly. Specific customer
applications of the Company's diagnostic equipment include the qualification of
products during manufacturing, the verification of service during network
installation and the monitoring and maintenance of deployed networks.
The Company's main two product lines are Network Information Computers
("NIC") and Network Access Agents ("NAA"). Network Information Computers are
portable instruments for the installation and maintenance testing of advanced,
high-speed networks and transmission equipment. The NIC product family
provides diagnostic capabilities for testing the performance of both optical
and legacy electrical networks with an array of communications standards and
transmission rates. NAAs are unattended, software-controlled, performance
monitoring and diagnostic systems permanently installed within optical-based
networks. NAAs embed the capabilities of our portable Network Information
Computers within a customer's network infrastructure, allowing centralized
remote network management.
The Company's portable NICs and network-embedded NAAs are software-based,
modular products that combine a multitude of test functions in a single
integrated solution, including SONET/SDH, T-carrier/PDH, ATM, and POS analysis.
The recent migration of these products to next-generation platforms has enabled
the accelerated introduction of new modules and product line enhancements. As a
result, customers utilizing these products are able to enjoy the advanced and
feature-rich functionality provided by these new enhancements while protecting
their original investment. These expanded diagnostic and management
capabilities are designed for communications service providers and equipment
manufacturers, enabling them to deploy advanced solutions to markets of their
current focus -- including both metropolitan and long-haul Dense Wavelength
Division Multiplexing (DWDM) and Internet Protocol (IP) networks.
During the first quarter of 2002, the Company announced new extensions of
its portable Network Information ComputerR NICR product family. These new
products include the NIC ONATM, which provides a single solution for multi-rate
SONET/SDH testing and optical spectrum analysis; the NIC GigETM for Gigabit
Ethernet network deployment; and the NIC 622MTM, an economical SONET/SDH
analyzer designed to meet emerging global market requirements. These
enhancements include:
* A Gigabit Ethernet (GigE) Module comprised of two fully independent
ports configurable for LX (single-mode fiber, 1310 nm) or SX (multi-
mode fiber, 850 nm) gigabit network topologies. This module enables
packet-level testing as well as the more traditional bit-error testing
on GigE traffic. With the integration of the GigE module into the NIC
or NAA, network providers can now test their high-speed optical network
and IP traffic with a single platform solution.
* An eight-port, comprehensive 10-Gbps solution for ultra-high-density
optical network test and turn-up. This new functionality increases the
port density to up to eight channels in a single portable NIC or to
over 16 channels in an NAA. This expanded port capacity greatly
decreases turn-up time and significantly lowers the cost of
provisioning high-speed networks.
* An Optical Spectrum Analyzer (OSA) module with both C & L band (1525 nm
to 1603 nm), which provides optical spectrum measurements and an
enhanced graphical touch-screen interface, including zoom, auto-scan,
and snapshot-graphic save functionality. When this module is integrated
into a NIC or NAA, network technicians can complete a full complement
of optical physical measurements, as well as perform a comprehensive
bit-error-rate analysis with a single solution.
* An Element Management System (EMS) for the integrated NAA platform,
which enables concurrent management of multiple NAAs within a network.
This new JavaTM-based EMS is a multi-user solution offering remote
dial-in, network-wide configuration control, test access, and security
to protect and manage test results. The new EMS was designed with an
intuitive graphical interface for easy system configuration and
testing.
In July 2002, the Company announced the new Lightwave (LW) series of
handheld and compact test equipment and accessories for measuring, maintaining
and documenting the physical layer performance of fiber-optic networks. This
new product family is designed to complement Digital Lightwave's Network
Information Computer NIC product family, providing technicians with a range of
fiber-optic analysis solutions from entry-level handheld units to multi-
functional high-speed test sets.
This new Lightwave (LW) series includes the following palm-sized products:
*LW OPM-6TM, an optical power meter with six wavelengths from 850nm to
1625nm and a dynamic range from +26dB to -50dB.
*LW DLSTM, a dual-laser source product with output measurements at both
1310nm and 1550nm for accurate and portable fiber testing.
*LW VLRTM, designed to allow for visual location of faults on either
single or multimode fiber-optic cables through the use of a "red laser"
or 650nm laser source.
*LW OSDTM, or Optical Signal Detection unit, which is designed to detect
optical signals without disrupting traffic during test and turn-up,
where specific fiber identification is critical.
*LW TSDTM, a dual talk set at 1550nm designed for providing full-duplex
voice communication over spare fibers.
*LW SFSTM, a safe-viewing fiber scope for use in inspecting connector
end-faces, which was designed to eliminate the direct optical path to
the installers' eyes. The LW SFS contains a miniature camera, state-of-
the-art displays and an NTSC video output for safe fiber inspection.
*LW LRLTM Series, designed for the global marketplace, where the
measurement of loss and return loss on high-speed digital or analog
fiber lines is critical. The LRL Series will include the LRL-D, a dual-
source 1330/1550nm wavelength unit; the LRL-DV, which is a dual-
wavelength unit incorporating talkset, as well; and the LRL-T, or the
triple wavelength solution at 1310, 1550, and 1625nm for a comprehensive
loss/return loss solution.
The ultra-compact units include:
*LW OTDRTM, a single-mode Optical Time Domain Reflectometer (OTDR),
providing a range designed to accept both 1310 and 1550nm sources. In
addition, trace analysis software enables complete fiber documentation
either on the unit itself or a personal computer, and supports various
trace manipulations, such as two-way averaging, trace overlay and
graphing.
*LW WPMTM, a small wavelength-selectable power meter designed for
automatic analysis of each channel, which provides information such as
channel center, power level and Optical Signal to Noise Ratio (OSNR)
either locally or remotely for analysis. Weighing just over 4 lbs., this
small unit was designed for the installation, maintenance and
troubleshooting of long-haul and metro DWDM applications.
The Company's net sales are generated from sales of its products less an
estimate for customer returns. We expect that the average selling price
(ASP) of our products will fluctuate based on a variety of factors, including
product configuration, potential volume discounts to customers, the timing of
new product introductions and enhancements and the introduction of competitive
products. Because the cost of goods sold tends to remain relatively stable for
any given product, fluctuations in the ASP may have a material adverse effect
on our business, financial condition and results of operations.
The Company primarily sells its products domestically through a direct sales
force to telecommunications service providers and network equipment
manufacturers. The Company primarily sells its products in Asia through the
direct sales force of its subsidiary Digital Lightwave Asia Pacific Pty, Ltd.
The Company primarily sells its products in Latin America through the direct
sales force of its subsidiary Digital Lightwave Latino Americana Ltda. The
Company primarily sells its products in Europe through distributor channels
located in Europe. Sales of our products have tended to be concentrated with a
few major customers and we expect sales will continue to be concentrated with a
few major customers in the future. For the six months ended June 30, 2002 our
largest customer, Test Equipment Remarketers, accounted for 11% of total sales.
No other customer accounted for more than 10%.
The Company has not entered into long-term agreements or blanket purchase
orders for the sale of its products. It generally obtains purchase orders for
immediate shipment. The Company does not expect to carry substantial backlog
from quarter to quarter in the future. Our sales during a particular quarter
are highly dependent upon orders placed by customers during that quarter. Most
of our operating expenses are fixed and cannot be easily reduced in response to
decreased revenues. Variations in the timing of revenues could cause
significant variations in results of operations from quarter to quarter and
result in continuing quarterly losses. The deferral of any large order from one
quarter to another would negatively affect the results of operations for the
earlier quarter. The Company must obtain orders during each quarter for
shipment in that quarter to achieve revenue and profit objectives.
Reduced customer capital expenditures and the overall economic weakness
caused the Company to incur net operating losses beginning in the third quarter
of 2001. In October 2001 and January 2002, the Company took certain measures
to reduce its future operating costs. These measures included a reduction in
force, pay cuts for management and other expense reduction actions. The
Company can give no assurance as to whether its revenues will return to
previous levels, when it will generate positive cash flows from operations or
when it will return to profitability.
BUSINESS OUTLOOK
Prior to 2001, we had experienced sequential growth over a five-year period.
This growth was attributable primarily to the rapid expansion and substantial
installation of fiber optic networks fueled by an unprecedented demand for
bandwidth to accommodate exponentially increasing Internet traffic. We
participated in that growth as a leading supplier of products that are used in
the installation, maintenance and management of fiber optic communication
networks.
During 2001, our industry experienced a dramatic economic downturn that was
brought on by a significant decrease in network build-outs and capital spending
by the telecommunications carriers and equipment manufacturers. Our customers'
declining business resulted in a major decrease in sales of our products. We
do not anticipate a near-term recovery of the fiber optic test equipment market
and do not expect the overall capital spending by telecommunication carriers
and equipment factors will increase during 2002.
In January 2002, we announced a program for rescaling our business in
response to the current market environment. Specific actions taken as part of
our plan include:
Reducing Cost. We have taken immediate steps during the last two quarters
of 2001 and in January of 2002 to reduce costs. These initiatives included a
reduction in workforce and expenses that we expect will reduce expenses by
approximately $14 million on an annualized basis. With the successful
migration of our current product lines to next-generation platforms, we began
outsourcing manufacturing activities with Jabil Circuit, Inc. in January of
2002. We expect this to further reduce operating expenses associated with
manufacturing overhead and lower the carrying risks of inventory during
economically driven shifts in customer demand.
Growing Market Share. We are focused on maintaining market leadership with
our product lines. We have evaluated our sales efforts to identify
opportunities where our account presence can be improved and are working to
exploit those opportunities. We expect new applications for our installed
product base to be realized with use of new modular add-ons and enhancements.
During the second quarter, we established offices in Australia, Brazil, China,
and Taiwan. We also added approximately twenty international sales and support
representatives across Europe, Australia, Brazil, China, and Taiwan. We
believe that having a direct sales force in key markets will have a positive
impact on our ability to grow our market share.
Accelerating Product Development. We are escalating our efforts to bring
products currently under development to market faster. We are concentrating on
the products and technologies that we believe are most important to our
customers. We plan to introduce enhancements to our product lines to meet
growing international needs and global high-speed data service requirements.
During the second quarter of 2002, we added three new products to our NIC
product line. In July 2002, we expanded our product portfolio to include
handheld and other ultra-compact products. These products are expected to
complement our current product offerings and offer our customers a wide range
of options to meet their requirements for fiber-optic products.
Also, during the second quarter of 2002, we signed our first third-party
product agreements with Micron Optics, Inc. and Remote Management Systems Pty
Ltd. These agreements cover international, and in some cases domestic,
product distribution. We believe these third-party distribution agreements
will further complement our product portfolio and enable us to offer a broad
range of products to our customers.
Expanding into Additional Telecommunications Markets. We are identifying
and pursuing specific telecommunication market segments, both domestically and
internationally, that we believe will be synergistic with our current business
and create opportunities for growth.
We believe that the initiatives outlined will allow us to meet our current
customer needs, develop new opportunities and position the Company for a market
recovery.
CRITICAL ACCOUNTING POLICIES
We believe that the following accounting policies are critical in that they
are important to portrayal of the Company's financial conditions and results
and they require difficult, subjective and complex judgments that are often the
results of estimates that are inherently uncertain:
* Revenue recognition; and
* Estimating valuation allowances and accrued liabilities, specifically
sales returns and other allowances, the reserve for uncollectible
accounts, the reserve for excess and obsolete inventory and assessment
of the probability of the outcome of our current litigation.
Revenue Recognition
The Company derives its revenue from product sales. The Company recognizes
revenue from the sale of products when persuasive evidence of an arrangement
exists, the product has been delivered, the price is fixed and determinable and
collection of the resulting receivable is reasonably assured.
For all sales, the Company uses a binding purchase order as evidence that a
sales arrangement exists. Sales through international distributors are
evidenced by a master agreement governing the relationship with the
distributor. The Company either obtains an end-user purchase order documenting
the order placed with the distributor or proof of delivery to the end user as
evidence that a sales arrangement exists. For demonstration units sold to
distributors, the distributor's binding purchase order is evidence of a sales
arrangement.
For domestic sales, delivery generally occurs when product is delivered to a
common carrier. Demonstration units sold to international distributors are
considered delivered when the units are delivered to a common carrier. An
allowance is provided for sales returns based on historical experience.
For sales made under an OEM arrangement, delivery generally occurs when the
product is delivered to a common carrier. OEM sales are defined as sales of
the Company products to a third party that will market the products under their
brand.
For trade-in sales, including both Company and competitor products, that have
a cash component of greater than 25% of the fair value of the sale, the Company
recognizes revenue based upon the fair value of what is sold or received,
whichever is more readily determinable, if the Company has demonstrated the
ability to sell its trade-in inventory for that particular product class.
Otherwise, the Company accounts for the trade-in sale as a nonmonetary
transaction and follows the guidance found in Accounting Principles Board
Opinion No. 29, "Accounting for Nonmonetary Transactions" and related
interpretations. Revenue and cost of sales are recorded based upon the cash
portion of the transaction. The remaining costs associated with the new units
are assigned to the units received on trade. When the trade-in units are
resold, revenue is recorded based upon the sales price and cost of goods sold
is charged with the value assigned to trade-in units from the original
transaction.
At the time of the transaction, the Company assesses whether the price
associated with its revenue transactions is fixed and determinable and whether
or not collection is reasonably assured. The Company assesses whether the price
is fixed and determinable based on the payment terms associated with the
transaction. Standard payment terms for domestic customers are 30 days from
the invoice date. Distributor contracts provide standard payment terms of 60
days from the invoice date. The Company does not offer extended payment terms.
The Company assesses collection based on a number of factors, including past
transaction history with the customer and the credit-worthiness of the
customer. Collateral is not requested from customers. If it is determined that
collection of an accounts receivable is not reasonably assured, the amount of
the accounts receivable is deferred and revenue recognized at the time
collection becomes reasonably assured.
Most sales arrangements do not generally include acceptance clauses. However,
if a sales arrangement includes an acceptance provision, acceptance occurs upon
the earlier of receipt of a written customer acceptance or expiration of the
acceptance period.
Sales Returns and Other Allowances, Reserve for Uncollectible Accounts,
Reserve for Excess and Obsolete Inventory and Litigation
The preparation of financial statements requires us to make estimates and
assumptions that affect the reported amount of assets and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported period.
We estimate the amount of potential future product returns related to current
period product revenue. We consider many factors when making our estimates,
including analyzing historical returns, current economic trends, changes in
customer demand and acceptance of our products to evaluate the adequacy of the
sales returns and other allowances. Our estimate for the provision for sales
returns and other allowances as of June 30, 2002 was $0.6 million.
We also estimate the uncollectibility of our accounts receivables. We
consider many factors when making our estimates, including analyzing accounts
receivable and historical bad debts, customer concentrations, customer credit-
worthiness, current economic trends and changes in our customer payment terms
when evaluating the adequacy of the reserve for uncollectible accounts. Our
accounts receivable balance as of June 30, 2002 was $7.1 million, net of our
estimated reserve for uncollectible accounts of $1.5 million.
We estimate the amount of excess and obsolete inventory. We consider many
factors when making our estimates, including analyzing current and expected
sales trends, the amount of current parts on hand, the current market value of
parts on hand and the viability and technical obsolescence of our products when
evaluating the adequacy of the reserve for excess and obsolete inventory. Our
inventory balance was $15.5 million as of June 30, 2002, net of our estimated
reserve for excess and obsolete inventory of $8.1 million.
We estimate the amount of liability the Company may incur as a result of
pending litigation. Our estimate of legal liability is uncertain and is based
on the size of the outstanding claims and an assessment of the merits of the
claims. We accrued $4.7 million for liability resulting from pending
litigation as of June 30, 2002.
We make significant judgments and estimates and assumptions in connection
with establishing the amount of sales returns and other allowances, the
uncollectibility of our account receivables, the amount of excess and obsolete
inventory and the amount of liability related to pending litigation during any
accounting period. If we made different judgments or used different estimates
or assumptions for establishing such amounts, it is likely that the amount and
timing of our revenue for any period would be materially different.
RESULTS OF OPERATIONS
The following is a discussion of significant changes in the results of
operations of the Company which occurred in the quarter and six months ended
June 30, 2002 compared to the quarter and six months ended June 30, 2001. The
following sets forth certain financial data as a percent of net sales.
PERCENT OF NET SALES PERCENT OF NET SALES
FOR THE QUARTER ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------- ---------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net sales 100 % 100 % 100 % 100 %
Cost of goods sold (199) 30 (113) 30
---------- ---------- ---------- ----------
Gross profit (loss) (99) 70 (13) 70
---------- ---------- ---------- ----------
Engineering and development 82 11 65 11
Sales and marketing 55 14 46 14
General and administrative 40 7 29 6
Restructuring charges -- -- 12 --
Litigation charge 13 -- 5 --
---------- ---------- ---------- ----------
Total operating expenses 190 32 157 31
---------- ---------- ---------- ----------
Operating income (loss) (289) 38 (170) 39
Other income, net 4 1 3 1
---------- ---------- ---------- ----------
Income (loss) before income taxes (285) 39 (167) 40
Provision for income taxes -- (12) -- (8)
---------- ---------- ---------- ----------
Net income (loss) (285)% 27 % (167) % 32 %
========== ========== ========== ==========
Net Sales
Net sales for the quarter ended June 30, 2002 decreased $30.3 million, or
88%, to $4.2 million from $34.5 million for the quarter ended June 30, 2001.
The sales decrease relates to lower pricing and a significant decrease in
capital spending by telecommunications carriers and equipment manufacturers.
Sales to new customers during the quarter ended June 30, 2002 represented 33%
of sales or $1.4 million. International sales for the quarter ended June 30,
2002, were $1.3 million, or 31% of total sales as compared to $10.4 million, or
30% of total sales for the quarter ended June 30, 2001.
Net sales for the six months ended June 30, 2002 decreased $58.4 million, or
85%, to $10.5 million from $68.9 million for the year ago period ended June 30,
2001. The sales decrease relates to lower pricing and a significant decrease
in capital spending by telecommunications carriers and equipment manufacturers.
Sales to new customers during the six months ended June 30, 2002 represented
26% of sales or $2.7 million. International sales for the six months ended
June 30, 2002, were $4.0 million, or 38% of total sales, as compared to $14.9
million, or 22% of total sales for the six months ended June 30, 2001.
Cost of Goods Sold
Cost of goods sold for the quarter ended June 30, 2002 decreased by $2.0
million to $8.4 million as compared to $10.4 million for the quarter ended June
30, 2001. Cost of goods sold for the six months ended June 30, 2002 decreased
by $9.0 million to $11.9 million as compared to $20.9 million for the six
months ended June 30, 2001. The decrease in cost of goods sold was due to a
reduction in volume of units sold offset by a $6.0 million reserve for excess
inventory recorded in the quarter ended June 30, 2002 and a $0.5 million charge
related to the outsourcing of manufacturing operations recorded in the six
months ended June 30, 2002.
Gross Profit (Loss)
Gross profit (loss) for the quarter ended June 30, 2002 decreased by $28.3
million to a negative $4.2 million from $24.1 million for the quarter ended
June 30, 2001. Gross margin for the second quarter of 2002 decreased to a
negative 99% from 70% during the second quarter of 2001. The decrease in gross
profit was due to a $6.0 million reserve for excess inventory and a reduction
in volume of units sold at lower sales prices. Without the $6.0 million reserve
for excess inventory, gross margin for the three months ended June 30, 2002 was
44%.
Gross profit(loss) for the six months ended June 30, 2002 decreased by $49.4
million to a negative $1.4 million from $48.0 million for the six months ended
June 30, 2001. Gross margin for the six months ended June 30 2002 decreased to
a negative 13% from 70% during the six months ended June 30, 2001. The
decrease in gross profit was due to a $6.0 million reserve for excess
inventory, a $0.5 million charge related to the outsourcing of manufacturing
operations, and a reduction in volume of units sold at lower sales prices.
Without the $6.0 million reserve for excess inventory and the $0.5 million
charge related to the outsourcing of manufacturing operations, gross margin for
the six months ended June 30, 2002 was 49%.
Engineering and Development
Engineering and development expenses principally include salaries for
engineering and development personnel, depreciation of production assets,
outside consulting fees and other development expenses. Engineering and
development expenses for the quarter ended June 30, 2002 decreased by $0.3
million to $3.5 million from $3.8 million for the quarter ended June 30, 2001.
The dollar decrease was due to lower salary and other expenses as a result of
the Company's reduction in force initiatives implemented in October 2001 and
January 2002.
Engineering and development expenses for the six months ended June 30, 2002
decreased by $0.6 million to $6.8 million from $7.4 million for the six months
ended June 30, 2001. The dollar decrease was due to lower salary and other
expenses as a result of the Company's reduction in force initiatives
implemented in October 2001 and January 2002.
Sales and Marketing
Sales and marketing expenses principally include salaries, commissions,
travel, tradeshows, promotional materials and warranty expenses. Sales and
marketing expenses for the quarter ended June 30, 2002 decreased by $2.6
million to $2.3 million from $4.9 million for the quarter ended June 30, 2001.
The dollar decrease is directly related to lower commissions resulting from the
decreased sales activity, along with lower salary and other expenses as a
result of the Company's reduction in force initiatives implemented in October
2001 and January 2002.
Sales and marketing expenses for the six months ended June 30, 2002
decreased by $5.1 million to $4.8 million from $9.9 million for the six months
ended June 30, 2001. The dollar decrease is directly related to lower
commissions resulting from the decreased sales activity, along with lower
salary and other expenses as a result of the Company's reduction in force
initiatives implemented in October 2001 and January 2002
General and Administrative
General and administrative expenses principally include salaries,
professional fees, facility rentals, compensation and information systems
related to general management functions. General and administrative expenses
for the quarter ended June 30, 2002 decreased by $0.7 million to $1.7 million
from $2.4 million for the quarter ended June 30, 2001. The dollar decrease was
due to lower salary and other expenses as a result of the Company's reduction
in force initiatives implemented in October 2001 and January 2002.
General and administrative expenses for the six months ended June 30, 2002
decreased by $0.8 million to $3.1 million from $3.9 million for the six months
ended June 30, 2001. The dollar decrease was due to lower salary and other
expenses as a result of the Company's reduction in force initiatives
implemented in October 2001 and January 2002.
Restructuring Charges
In October 2001, the Company's board of directors approved a reduction in
force of 38 employees and consultants across all departments and instituted
temporary executive salary reductions of up to 20%. The overall objective of
the initiative was to lower operating costs and improve efficiency. All
affected employees were terminated in October 2001 and given severance based
upon years of service with the Company. The Company recorded a restructuring
charge of $500,000 in 2001 related to this cost reduction program. The costs
included in a restructuring charge for severance payments to employees included
in the reduction in force, legal costs associated with the cost reduction
program and remaining lease liabilities on the Company's facility in New
Jersey. In January 2002, the board of directors approved additional cost
reduction initiatives aimed at further reducing operating costs. These included
a second reduction in force of 46 employees and contractors and the outsourcing
of manufacturing and production. All affected employees were terminated in
January 2002 and given severance based upon years of service with the Company.
The Company recorded a restructuring charge of $1.3 million in the first
quarter of 2002.
The costs associated with both of these actions are expected to be paid by
January 2003. Activity associated with the restructuring charges during the
quarter ended June 30, 2002 was as follows:
Balance at March 31, 2002 Additions Payments/ Reductions Balance at June 30, 2002
-------- -------- -------- --------
(in thousands)
Severance $ 563 $ -- $ (36) $ 527
Legal and other expenses 113 -- (16) 97
Lease payments 86 -- (21) 65
-------- -------- -------- --------
$ 762 $ -- $ (73) $ 689
======== ======== ======== ========
Litigation Charge
On July 18, 2002, the arbitrator in the Seth Joseph arbitration case issued
an award to Mr. Joseph of $575,000 for attorneys' fees, $165,000 for costs,
$10,000 for a portion of the arbitrator fees, plus interest from November 1,
2001 until paid. The Company has recorded a litigation charge of $0.6 million
for the quarter and six months ended June 30, 2002 associated with the Seth
Joseph arbitration case and appeal thereof. There were no corresponding costs
during the quarter or six month period ended June 30, 2001
Other Income, net
Other income for the quarter ended June 30, 2002 decreased by $0.2 million
to $0.2 million from $0.4 million for the quarter ended June 30, 2001. Other
income for the six months ended June 30, 2002 decreased by $0.6 million to $0.3
million from $0.9 million for the six months ended June 30, 2001. This
primarily represents interest earned on invested cash balances partially offset
by fees related to a credit facility and interest expense on capital lease
obligations.
Provision for Income Taxes
No provision for income taxes was made for the three- and six-months ended
June 30, 2002 due to the Company's net loss of $12.0 million for the three
months ended June 30, 2002 and net loss of $17.6 million for the six months
ended June 30, 2002.
The provisions for income taxes for the three- and six-months ended June 30,
2001 reflect income taxes due at federal statutory rates and state income
taxes, net of federal benefit. The effective income tax rate for the quarter
ended June 30, 2001 was 31.0% and for the six months ended June 30, 2001 was
19.3%. The effective rates differ from the federal and state statutory rates
(net of federal benefit) due to the recognition of deferred tax assets for
which a full valuation allowance had previously been established. A valuation
allowance for deferred tax assets was recorded as a result of management's
belief it is more likely than not that future tax benefits will not be realized
as a result of current and future income. During the second quarter of 2001, a
research and experimentation credit was recognized resulting in a benefit of
$1.0 million which offset the otherwise recognized tax expense of $5.2 million
resulting in a net tax expense of $4.2 million or 31.0%. For the six months
ended June 30, 2001, the effect of this credit coupled with recognition during
first quarter of 2001 of the remaining deferred tax asset of $4.3 million
resulted in a benefit offsetting the otherwise recognized tax expense of $10.6
million producing a net tax expense of $5.3 million or 19.3%.
Net Income (Loss)
Net loss for the quarter ended June 30, 2002 was $12.0 million or $0.38 per
diluted share compared with net income of $9.3 million or $0.28 per diluted
share for the quarter ended June 30, 2001 for the reasons discussed above.
Net loss for the six months ended June 30, 2002 was $17.6 million or $0.56
per diluted share compared with net income of $22.3 million or $0.69 per
diluted share for the six months ended June 30, 2001 for the reasons discussed
above.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2002, the Company's unrestricted cash and cash equivalents
and short-term investments were approximately $30.8 million, a decrease of
$20.2 million from December 31, 2001. As of June 30, 2002, the Company's
working capital was approximately $56.5 million as compared to $64.8 million at
December 31, 2001. During 2001, the Company reported net income of $2.8 million
and cash flows from operations of $20.8 million. For the six months ended June
30, 2002 the Company reported a net loss of $17.6 million and cash used by
operations of $16.9 million. The Company had an accumulated deficit of $24.0
million at June 30, 2002.
Beginning in the third quarter of 2001 through the quarter ended June 30,
2002, the Company has experienced combined net losses of $37.1 million. The
Company expects to continue to incur operating losses through 2002. Management
has taken actions to increase net sales and significantly reduce cost of goods
sold, operating expenses and capital expenditures. These actions include
restructuring operations to more closely align operating costs with revenues.
The Company continues to consider various financing alternatives, including
other equity or debt issuances (the "Financing Sources"). The Company
anticipates that its existing cash and cash equivalents and anticipated cash
flow from operations together with funds provided from the revolving credit
facility with Wachovia Bank will be sufficient to fund the Company's working
capital and capital expenditure requirements for at least the next twelve
months. The anticipated cash flow from operations assumes the Company achieves
a level of sales that is sufficient to offset expected operating expenses. In
the event that these sales levels are not attained, the Company may be required
to use its cash reserves to fund operations or supplement its working capital
with additional funding or financing alternatives. There can be no assurance,
however, that the Company will achieve sufficient sales levels or that adequate
additional financing will be available when needed or if available on terms
acceptable to the Company.
Operating Activities
Net cash used by operating activities for the six months ending June 30,
2002 was $16.9 million. This was primarily the result of the net loss of $17.6
million, a decrease in accounts receivable of $0.5 million, a $7.1 million
increase in inventory, increases in prepaid and other assets of $2.1 million
and a decrease in accounts payable and accrued expenses of $0.3 million. These
were partially offset by non-cash expenses consisting primarily of a
restructuring charge of $1.3 million, depreciation and amortization of $1.8
million, $6.0 million provision for excess and obsolete inventory, and $0.6
million increase in accrued litigation charge.
Net cash provided by operating activities for the six months ending June 30,
2001 was $13.7 million. This was primarily the result of net income of $22.3
million, accompanied by non-cash expenses of income tax benefit from stock
option exercises of $5.3 million and depreciation and amortization of $1.6
million. This was partially offset by increases in accounts receivable of $10.8
million, inventory of $2.4 million and prepaid and other assets of $0.4 million
along with a decrease in accounts payable and accrued expenses of $2.1 million.
Investing Activities
Net cash used in investing activities for the six months ended June 30, 2002
was $28.5 million. This was the result of $14.7 million used to purchase
short-term investments, an increase of $12.8 million in restricted cash and
cash equivalents, $0.8 million for the purchase of property and equipment and a
$0.2 million increase in notes receivable.
Net cash used in investing activities for the six months ended June 30,
2001 was $1.4 million. This was the result of $1.2 million for the purchase of
property and equipment and a $0.2 million increase in notes receivable.
Financing Activities
Net cash provided by financing activities for the six months ended June 30,
2002 was $10.4 million. This was primarily the result of a $10.0 million
advance from a revolving credit facility, a $0.8 million advance against a note
payable and net proceeds of $0.3 million from employee exercises of stock
options. This was partially offset by principal payments of $0.3 on capital
lease obligations and principal payments of $0.4 million made on notes payable.
Net cash provided by financing activities for the six months ended June 30,
2001 was $2.6 million. This was primarily the result of $2.8 million in net
proceeds from employee exercises of stock options partially offset by $0.3
million of principal payments on capital lease obligations.
Revolving Credit Facility
In April 2002, the Company entered into a Revolving Credit and Security
Agreement ("the Agreement") with Wachovia Bank ("the Bank"). The terms of the
Agreement provide the Company with a $27.5 million line of credit at LIBOR plus
0.7% collateralized by the Company's cash and cash equivalents and short-term
investments. The advance rate varies between 80% and 95% and is dependent upon
the composition and maturity of the available collateral. An availability fee
of 0.10% per annum is payable quarterly based on the Average Available
Principal Balance (as defined in the Agreement) for such three months. The
Agreement has an initial term of three years. The Agreement may be terminated
by the Company at any time upon at least fifteen days prior written notice
o the Bank, and the Bank may terminate the Agreement at any time, without
notice upon or after the occurrence of an event of default. There were
$10.0 million in borrowings under the Agreement at June 30, 2002. Under the
terms of the Agreement, $12.8 million of the Company's cash and cash
equivalents were classified as restricted at June 30, 2002. This includes
amounts borrowed under the Agreement based upon an advance rate of 95% and
approximately $2.2 million in letters of credit required by the leases for the
Company's office space. The Company plans to use the facility for short-term
working capital and general corporate purposes, including potential
acquisitions of complementary businesses and technologies. The Company's
previous line of credit with Congress Financial was terminated in April 2002 as
part of this transaction.
Legal Proceedings
As discussed more fully in the Notes to the Consolidated Condensed Financial
Statements Note 6 - Legal Proceedings, the Company is currently appealing the
judgment of the Circuit Court of the Sixth Judicial Circuit, Pinellas County,
Florida, that awarded $3.9 million plus attorneys' fees to a former officer and
director of the Company. As of June 30, 2002 no amounts under this award have
been paid. On April 4, 2002 the Company posted a civil supersedeas bond in the
amount of $4.8 million to secure a stay of enforcement of the Circuit Court
judgment pending the Company's appeal. On July 18, 2002, the arbitrator issued
an award to Mr. Joseph of $575,000 for attorneys' fees, $165,000 for costs,
$10,000 for a portion of the arbitrator fees, plus interest from November 1,
2001 until paid.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are not exposed to fluctuations in currency exchange rates because the
majority of our sales and expenses are denominated in U.S. dollars. We are
exposed to the impact of interest rate changes on our short-term cash
investments, consisting of U.S. Treasury obligations and other investments in
institutions with the highest credit ratings, all of which have maturities of
three months or less. These short-term investments carry a degree of interest
rate risk. We believe that the impact of a 10% increase or decline in interest
rates would not be material to our investment income.
#
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On November 23, 1999, Seth P. Joseph, a former officer and director of the
Company commenced arbitration proceedings against the Company alleging breach
of his employment agreement and stock option agreements, violation of the
Florida Whistleblower statute and breach of an indemnification agreement and
the Company bylaws. As relief, Mr. Joseph sought $500,000, attorneys' fees,
interest and stock options for 656,666 shares of the Company's common stock
exercisable at a price of $5.25 per share. The Company filed an answer denying
Mr. Joseph's allegations and alleging multiple affirmative defenses and
counterclaims. The Company's counterclaims against Mr. Joseph sought repayment
of loans totaling approximately $113,000 plus interest. Mr. Joseph
subsequently dismissed without prejudice all of his claims other than his claim
under the Whistleblower Statute. The arbitration hearing on Mr. Joseph's
Whistleblower claim and the Company's counterclaims concluded on October 5,
2001. The parties submitted proposed findings to the arbitrator on October 17,
2001. As part of his proposed findings, Mr. Joseph sought an award of $48
million and attorneys' fees and costs. On November 9, 2001, the Company was
notified of the arbitrator's decision which awarded Mr. Joseph the sum of
approximately $3.7 million and attorneys' fees and costs. On December 20,
2001, the arbitrator issued a corrected award and awarded Mr. Joseph the sum of
$3.9 million and attorneys' fees and costs in amounts yet to be determined. On
January 23, 2002, Mr. Joseph filed a motion seeking the award of $1.1 million
in attorneys' fees, costs and interest thereon. On July 18, 2002, the
arbitrator issued an award to Mr. Joseph of $575,000 for attorneys' fees,
$165,000 for costs, $10,000 for a portion of the arbitrator fees, plus interest
from November 1, 2001 until paid.
On December 3, 2001, the Company filed a petition to vacate or modify the
arbitration award in the Circuit Court of the Sixth Judicial Circuit, Pinellas
County, Florida, in an action entitled Digital Lightwave, Inc. v. Seth P.
Joseph, Case No. 01-9010C1-21. The Company filed an amended petition on
December 26, 2001, following the corrected arbitration award. Subsequently,
Mr. Joseph filed a cross-motion to confirm the arbitration award. Oral
argument on the Company's petition and Mr. Joseph's cross-motion was heard by
the Court on February 27, 2002. On March 26, 2002, the Court denied the
Company's petition to vacate the arbitration award, granted Mr. Joseph's cross-
motion to confirm the award, and entered a judgment in favor of Mr. Joseph in
the amount of $4.0 million including interest. The Company is appealing the
decision and judgment of the Circuit Court. On April 4, 2002 the Company
posted a civil supersedeas bond in the amount of $4.8 million, which represents
the amount of the judgment plus two times the estimated interest, to secure a
stay of enforcement of the Circuit Court judgment pending the Company's appeal.
The Company has recorded an accrual of $4.7 million related to this arbitration
as of June 30, 2002. The Company believes its appeal is meritorious and
intends to pursue the appeal vigorously.
In January 2002, an employee terminated as part of the Company's October
2001 restructuring initiatives, filed a lawsuit claiming the Company wrongly
discharged the employee and has withheld payments due the employee. The suit
does not seek a specified amount of damages, but does claim that the 2001
compensation plan presented to the employee in October 2001 unfairly lowered
the employee's salary. The plaintiff seeks attorneys' fees, interest and
punitive damages. The Company has responded to the complaint and denied the
substantive allegations therein. The Company intends to defend against these
claims vigorously.
In March 2002, a former employee filed a lawsuit claiming the Company
breached the employee's severance agreement by paying the employee less than
the agreement provided. The suit seeks damages in excess of $100,000. The
Company has responded to the complaint and denied the substantive allegations
therein. The Company intends to vigorously defend the action.
The Company from time to time is involved in various other lawsuits and
actions by third parties arising in the ordinary course of business. The
Company is not aware of any additional pending litigation, claims or
assessments that could have a material adverse effect on the Company's
business, financial condition and results of operations.
#
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the annual meeting of stockholders of the Company held on May 20, 2002,
the stockholders voted on four proposals. The first was a proposal to re-elect
Dr. Bryan J. Zwan, Gerald A. Fallon, Dr. William F. Hamilton and Robert F.
Hussey as directors of the Company. The following table sets forth the votes in
such election:
DIRECTOR VOTES FOR VOTES WITHHELD
-------- -------- --------
Dr. Bryan J. Zwan 30,428,020 445,252
Gerald A. Fallon 30,461,008 412,264
Dr. William F. Hamilton 30,462,008 411,264
Robert F. Hussey 30,462,008 411,264
The second proposal was to approve three amendments to the Company's
Certificate of Incorporation and Bylaws to eliminate certain anti-takeover
provisions including:
PROPOSAL VOTES FOR VOTES ABSTENTIONS
AGAINST
---------- ---------- ------- ----------
(A) Article Eighth of the Certificate to eliminate the anti-takeover provisions; 13,748,443 277,926 19,488
(B) Article Sixth of the Certificate to eliminate restrictions on certain stockholder actions; 13,790,655 178,611 76,591
(C) Articles Fifth, Sixth, Seventh and Eighth of the Certificate to eliminate supermajority voting
requirements to amend certain provisions of the Bylaws and the Certificate; 13,783,622 220,344 41,891
The third proposal was to approve an amendment to the Digital Lightwave,
Inc. 1997 Employee Stock Purchase Plan to increase the number of shares of
Common Stock authorized for issuance thereunder by an additional 300,000
shares. The proposal received 13,673,360 affirmative votes, 341,398 votes
against and 31,099 abstentions.
The fourth proposal was to approve an amendment to the Digital Lightwave,
Inc. 2001 Stock Option Plan to increase the number of shares of Common Stock
authorized for issuance thereunder by an additional 3,000,000 shares. The
proposal received 13,192,689 affirmative votes, 833,227 votes against and
19,941 abstentions.
ITEM 5. OTHER INFORMATION
(a)On June 21, 2002, the Company filed the Amended and Restated Certificate
of Incorporation of the Company approved by the stockholders of the Company at
the annual meeting held on May 20, 2002, with the State of Delaware. On June
21, 2002, the Board of Directors of the Company approved the Amended and
Restated Bylaws of the Company approved by the stockholders of the Company at
the annual meeting held on May 20, 2002.
(b)On August 9, 2002, the Board of Directors accepted the resignation of Dr.
Bryan Zwan as President and Chief Executive Officer of the Company. Dr. Zwan
will continue as the Company's Chairman of the Board and will concentrate on
developing the Company's strategy and technology, as well as potential mergers
and acquisitions. Also on August 9, 2002, the Board of Directors appointed the
Company's current Chief Operating Officer, Jim Green to the offices of
President and Chief Executive Officer. As President and Chief Executive
Officer Mr. Green will direct all of the Company's day to day operations and
serve as the Company's principal executive officer. On August 9, 2002, the
Board of Directors also promoted the Company's current Chief Financial Officer,
Mark Scott to the offices of Executive Vice President and Chief Financial
Officer.
#
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
A list of exhibits is set forth in the Exhibit Index found on page 25 of
the report.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the period covered by this
Report.
#
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Digital Lightwave, Inc.
By: /s/ JAMES GREEN
James Green
Chief Executive Officer and
President
(Principal Executive Officer)
Date: August 14 , 2002
By: /s/ MARK E. SCOTT
Mark E. Scott
Executive Vice President, Finance,
Chief Financial Officer and
Secretary
(Principal Accounting Officer)
Date: August 14, 2002
#
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
3.02 + Amended and Restated Certificate of Incorporation, dated June 21, 2002
3.03 + Amended and Restated Bylaws, dated June 21, 2002
10.31*+ Amended and Restated Promissory Note between Jim Green and the Company
10.32*(1) Amendment to 1997 Employee Stock Purchase Plan
10.33*(2) Amendment to 2001 Stock Option Plan
99.1 + Written Statement of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
99.2 + Written Statement of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
______________
* Indicates management contract or compensatory plan or arrangement.
+ Indicates such exhibit is filed herewithin.
(1) Incorporated by reference to Appendix B to the Registrant's Proxy
Statement filed on April 22, 2002 for the 2002 Annual Meeting of
Stockholders held on May 20, 2002.
(2) Incorporated by reference to Appendix D to the Registrant's Proxy
Statement filed on April 22, 2002 for the 2002 Annual Meeting of
Stockholders held on May 20, 2002.
#