UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    FORM 10-K

  |X|     ANNUAL  REPORT  PURSUANT  TO  SECTION  13 OR 15(d)  OF THE  SECURITIES
          EXCHANGE ACT OF 1934 
          For the fiscal year ended December 31, 1997

  |_|     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
          EXCHANGE ACT OF 1934
          For the transition period from _________________ to ________________
                                         

                         Commission File Number: 0-23110

                            DIGITAL LINK CORPORATION
             (Exact name of registrant as specified in its charter)

               California                                    77-0067742
    (State or other jurisdiction of                        (IRS Employer
     incorporation or organization)                    Identification Number)

           217 Humboldt Court                                  94089
             Sunnyvale, CA                                   (Zip Code)
 (Address of principal executive offices)

Registrant's telephone number, including area code:  (408) 745-6200

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  Common Stock, 
                                                             no par value
                                                             (Title of class)

Indicate  by check  mark  whether  the  registrant:  (1) has filed  all  reports
required to be filed by Sections 13 or 15(d) of the  Securities  Exchange Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|

The  aggregate  market value of the voting stock held by  non-affiliates  of the
registrant as of March 25, 1998, was approximately $13,823,068.00.

The number of shares  outstanding of the  registrant's  Common Stock as of March
25, 1998, was 9,314,006 shares.

                      DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the definitive proxy statement (the "Definitive Proxy Statement") to
be filed with the Securities and Exchange  Commission  relative to the Company's
annual  meeting of  shareholders  to be held May 20,  1998 are  incorporated  by
reference in Part III of this Form 10-K.

================================================================================


<PAGE>


                            DIGITAL LINK CORPORATION

                           ANNUAL REPORT ON FORM 10-K

                      For the Year Ended December 31, 1997


                                TABLE OF CONTENTS


Form 10-K
Item No.                       Name of Item                                Page

PART I  
 Item 1.  Business..........................................................  3
 Item 2.  Properties........................................................ 10
 Item 3.  Legal Proceedings................................................. 10
 Item 4.  Submission of Matters to a Vote of Security Holders............... 10

PART II
 Item 5.  Market for Registrant's Common Equity and Related Stockholder
               Matters...................................................... 11
 Item 6.  Selected Financial Data........................................... 11
 Item 7.  Management's Discussion and Analysis of Financial Condition and
               Results of Operations........................................ 12
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk........ 23
 Item 8.  Financial Statements and Supplementary Data....................... 24
 Item 9.  Changes in and Disagreements with Accountants on Accounting and 
               Financial Disclosures........................................ 42

PART III
 Item 10. Directors and Executive Officers of the Registrant................ 42
 Item 11. Executive Compensation............................................ 42
 Item 12. Security Ownership of Certain Beneficial Owners and Management.... 42
 Item 13. Certain Relationships and Related Transactions.................... 42

PART IV
 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.. 43

            Signatures...................................................... 45



<PAGE>


                                     PART I
ITEM 1.  BUSINESS

     Except  for the  historical  statements  contained  herein,  this Form 10-K
contains  forward  looking  statements  within the meaning of Section 27A of the
Securities  Act of 1933, as amended ("the  "Securities  Act") and Section 21E of
the  Securities  Exchange Act of 1934, as amended (the  "Exchange  Act").  These
forward looking  statements  involve a number of risks,  known and unknown,  and
uncertainties,  such as the loss of, or  difference  in actual from  anticipated
levels  of  purchases  from,  the  Company's  major  customers,  the  impact  of
competitive  products and pricing and other risks which are described throughout
this Form 10-K,  including under the sections titled  "Products and Technology,"
"Customers  and  End  Users,"  "Research  and   Development,"   "Manufacturing,"
"Competition,"   "Intellectual   Property  and  Other  Proprietary  Rights"  and
"Employees" in Item 1 hereof and within "Management's Discussion and Analysis of
Financial Condition and Results of Operations," including under the title "Other
Factors That May Affect Future Operating  Results," in Item 7 of this Form 10-K.
The actual  results  that Digital Link  Corporation  (the  "Company" or "Digital
Link") achieves may differ materially from any forward looking statements due to
such risks and uncertainties.
     When  used in this  Form  10-K  words  such as  "believes,"  "anticipates,"
"expects,"  "intends," and similar  expressions are intended to identify forward
looking  statements,  but  are not  the  exclusive  means  of  identifying  such
statements.  Readers  are urged to  carefully  review and  consider  the various
disclosures  made by the  Company in this  report and in the  Company's  reports
filed  with the  Securities  and  Exchange  Commission  that  attempt  to advise
interested  parties  of the risks and  factors  that may  affect  the  Company's
business.
     Due  to  all   the   foregoing   factors,   the   Company   believes   that
period-to-period  comparisons of its results of operations  are not  necessarily
meaningful and should not be relied upon as an indication of future performance.
Similarly,  past performances are not necessarily  indicative of future results.
It is likely that, in some future quarters, the Company's operating results will
be below the expectations of stock market analysts and investors. In such event,
the price of the  Company's  Common Stock would likely be  materially  adversely
affected.  Consequently,  the purchase or holding of the Company's  Common Stock
involves an extremely high degree of risk.

Overview

     The Company  designs,  manufactures,  markets and supports a broad range of
high speed digital access products,  ranging from 56 Kbps to 155 Mbps for global
wide  area  networks  ("WANs").  The  Company's  products  are  used by  service
providers  as   infrastructure   equipment  and  by  business   enterprises  for
connectivity  to WAN  services,  such as leased  lines,  Frame  Relay,  Switched
Multimegabit Data Service ("SMDS") and Asynchronous  Transfer Mode ("ATM").  The
Company's  products  allow  local  area  network  ("LAN")-based  internetworking
devices,  such as routers, to access WANs and also integrate data with digitized
voice and video traffic for more  efficient  line  utilization.  Digital  Link's
products are used both in the customer premise equipment ("CPE") environment and
in the networks of interexchange  carriers ("IXCs"),  Internet service providers
("ISPs") and telephone companies. The Company believes it is a leader in the WAN
access  products  market  because of its broad range of products and its diverse
sales  channels.  The Company  markets and sells its products in North  America,
Europe,  South  America  and Asia  primarily  through  its direct  sales  force,
value-added resellers ("VARs") and original equipment manufacturers ("OEMs").
     The Company was incorporated in California in 1985. Its principal executive
offices are located at 217 Humboldt Court,  Sunnyvale,  California 94089 and its
telephone number is (408) 745-6200.


<PAGE>


Industry Background

     The growing reliance on enterprise-wide  networks to facilitate the sharing
of information  has created an environment in which the linkage of multiple LANs
over wide area networks is critical to daily operations.  Two types of WANs have
developed to satisfy  internetworking  needs:  private WANs, which are generally
based on dedicated leased lines; and public WANs, which are based on centralized
switching networks that route data to the proper  destination.  In private WANs,
the  functions  of  switching,  routing and  multiplexing  are  performed on the
organization's premises utilizing  customer-owned  equipment and dedicated lines
leased from  telephone  companies and IXCs. As an  alternative  to private WANs,
telephone  companies,  ISPs and IXCs offer public WAN services.  Companies  that
provide  products for  connecting  LAN-based  data networks to WANs must support
both private and public WANs,  including public WANs based on Frame Relay,  SMDS
and ATM technologies.
     In order for LANs to be interconnected to WANs, an interface is required to
condition LAN-based data to a format appropriate for transmission over WANs. The
Company  believes  equipment  providers  addressing  the WAN access  market must
develop product solutions  flexible enough to respond to the changing  standards
and network requirements associated with emerging WAN technologies, forge strong
relationships with telephone  companies and ISPs implementing these services and
actively participate in standards development.

Products and Technology

     WAN Access and DL7100 Products

     The Company's principal products offer 56/64Kbps, T1/E1 and T3/E3 access to
public and private WANs using  Internet,  Frame Relay,  SMDS and ATM technology.
The  Company's  products  range from simple  desktop or  rack-mounted  units for
smaller sites to intelligent multi-processor systems that support multiple lines
and integrate  data with  digitized  voice and video for larger and more complex
sites.  Enterprises use these products to enable internetworking  equipment such
as routers to access WANs.  The  Company's  products may also be used within the
networks  of  telephone  companies,  ISPs and IXCs to  provide  access  to their
backbone  networks.  The list prices of the Company's  products  generally range
from $300 to $40,000.
     The  Company's   access   products  are   classified  as  Digital   Service
Units/Channel  Service  Units  ("DSUs/CSUs"),  access  multiplexers  and inverse
multiplexers.  The Company's DSUs/CSUs generally provide the interface between a
single data port and a single WAN line, and its access  multiplexers are used to
multiplex  multiple  data,  voice or  video  ports  over one or more WAN  lines.
Digital Link's inverse  multiplexers  break down  high-speed  data from a single
source for transmission over multiple T1 WAN lines.
     The Company  introduced its first T1 access  products in 1985. In 1993, the
Company  introduced  the second  generation  of its T1/E1 access  products  with
certain  enhanced  features.  Known as the Encore  product line,  these products
provide  interfaces  to Ethernet  and Token Ring  LAN-based  data  traffic  from
internetworking  devices and connects  them to  dedicated  or Frame  Relay-based
56Kbps and T1/E1 lines.  Recently, the Company released a T1 access product that
includes improved network management capabilities such as in-band management and
integrated  performance  monitoring ("IPM").  This product in conjunction with a
marketing agreement with NetScout Systems, Inc. will allow the Company to market
a comprehensive enterprise management solution.
     In 1993,  the  Company  introduced  the  DL3800 T1 inverse  multiplexer  in
response to marketplace demand for a method of transporting  information at data
rates faster than T1 without the expense and availability issues associated with
T3 lines.  The DL3800  accepts  data from a single  high-speed  data  device and
prepares it for  transmission  over as many as eight T1 lines. In June 1996, the
Company introduced an international  version of its inverse  multiplexer product
line.
     The Company  introduced its first T3 access products in 1990. The Company's
T3/E3 DSUs and multiplexers  include the DL3100 T3/E3 Access  Multiplexer  which
connects  networking  equipment to T3/E3 lines and is  available  with single or
multiple ports. In May 1995, the Company introduced the DL3900 multiplexer shelf
that allows customers to reduce the shelf space needed when installing  multiple
inverse  multiplexers  in the  same  location.  It  houses  both T1 and  inverse
multiplexer  modules and T3 access multiplexer  modules to provide  connectivity
between central and DL3100 or DL3800 units at remote sites.
     The Company's SMDS and ATM access products  consist of DSUs/CSUs and DL7100
access concentrators.  In 1991, the Company began shipping the DL200, which is a
DSU/CSU used to access public SMDS  networks  that operate over T1/E1 lines.  In
1992,  the Company  began  shipping  the  DL3200,  which is a DSU used to access
public SMDS and ATM networks  that  operate over T3/E3 lines.  The DL3200 is now
being used as a tool to facilitate the migration from SMDS to ATM networks.
     In support of the ATM  infrastructure  and to complement the large capacity
ATM switches necessary for such an infrastructure, the Company has developed its
DL7100 product  (formerly known as the W/ATM GateWay Product) to connect non-ATM
traffic  and slower  speed ATM traffic to these  high-speed  ATM  switches.  The
DL7100 is a high-capacity  system that  multiplexes  and switches  voice,  data,
video,  low-speed  cell and  Frame  Relay  for ATM  transmissions.  The  Company
recently added inverse  multiplexing  for ATM ("IMA")  capability to the DL7100,
which  allows  service  providers  to save costs by  aggregating  ATM cells onto
multiple T1 lines,  rather than through a single,  higher-priced  T3 trunk.  The
Company  believes that its IMA  capability is the first in the industry to fully
conform to the ATM Forum's  latest  approved  multiplexing  specifications.  The
Company has experienced very limited customer  interest to date for this product
and is continuing  development to enhance its  functionality.  See "Management's
Discussion  and Analysis of Financial  Conditions  and Results of  Operations --
Other  Factors That May Affect  Future  Operating  Results -- Risks of Company's
Involvement with Products for Emerging Markets" in Item 7 of this Form 10-K.
     The Company believes that network  reliability and management are among the
most important  factors  considered by users when selecting a network  equipment
supplier.  In order to  maximize  network  reliability,  the  Company  has built
monitoring  and  diagnostic  tools into all of its  products.  In addition,  the
Company offers access products via Simple Network Management  Protocol ("SNMP"),
a standards-based  network management  system.  SNMP provides a set of processes
and  procedures  to manage all elements of a network,  allowing a user to manage
and control the entire network with one management system.
     The Company also provides an  SNMP-based  graphical  user  interface in its
WANview  technology  solutions.  WANview network management systems help service
providers  achieve  high levels of service,  increased  network  efficiency  and
reliability  for improved  operations  because they can configure,  maintain and
test the Company's products.  The Company's  Management Access Processor ("MAP")
allows  customers  to manage  Digital Link  products  via a direct  Ethernet LAN
interface.   This   cost-effective   interface   provides  a  management  access
alternative independent of routers or terminal servers.
     The  markets  for  the  Company's   products  are  characterized  by  rapid
technological advances,  product obsolescence,  changes in customer requirements
and evolving  regulatory  requirements  and industry  standards.  The  Company's
future prospects will depend in part on its ability to enhance the functionality
of its existing WAN access products in a timely manner and to identify,  develop
and achieve market  acceptance of new products that address new technologies and
meet market requirements. Any failure by the Company to anticipate or to respond
adequately to  technological  developments in its industry,  changes in customer
requirements,  or changes in regulatory  requirements or industry standards,  or
any significant delays in the development, introduction or shipment of products,
could have a material  adverse  affect on the  Company's  business and operating
results.  See "Management's  Discussion and Analysis of Financial  Condition and
Results of Operations -- Other Factors That May Affect Future Operating  Results
-- Company Must Respond to Technological Change" in Item 7 of this Form 10-K. In
addition,  customers  could  refrain  from  purchasing  the  Company's  existing
products  in  anticipation  of new product  introductions  by the Company or its
competitors.

Customers and End Users

     Digital  Link's  customers  and end users are  diverse and  represent  many
industries.  End users of private WANs that  incorporate  the  Company's  access
products, as well as telephone companies,  ISPs and IXCs that either incorporate
the Company's  products  within their public  networks or purchase the Company's
access products for resale to end users,  include major interexchange  carriers,
the  Regional  Bell   Operating   Companies   ("RBOCs"),   major   domestic  and
international  carriers,   industrial,   electronics  and  other  companies  and
governments, universities and utilities.
     The Company sells a majority of its products to a relatively limited number
of end users,  VARs and telephone  companies,  certain of whom individually have
historically  represented more than 10% of the Company's net sales. There can be
no assurance that the Company's  current customers will continue to place orders
with the  Company or that the  Company  will be able to obtain  orders  from new
customers.  A  significant  portion of the  Company's  business is derived  from
substantial  orders placed by large end users and telephone  companies,  and the
timing  of such  orders  could  cause  material  fluctuations  in the  Company's
business and operating  results.  See  "Management's  Discussion and Analysis of
Financial  Condition  and Results of  Operations -- Results of Operations -- Net
Sales," " -- Quarterly  Results of  Operations"  and " -- Other Factors That May
Affect Future Operating Results -- Operating  Results May Fluctuate;  Absence of
Significant Backlog" in Item 7 of this Form 10-K.

Sales and Marketing

     The Company primarily markets its products  worldwide directly to large end
users,  ISPs, IXCs and RBOCs and indirectly  primarily through a network of VARs
and OEMs to accommodate specific markets and customer support requirements.  The
Company's  sales  force  focuses  on (i) U.S.  end users and ISPs,  (ii) U.S.  &
Canadian  IXCs and  telephone  companies  ("carriers")  and (iii)  international
customers.  Each of these focus areas  include  one or more  field-based  system
engineers to provide  technical  sales  support.  In addition,  the Digital Link
sales organization  receives support from various groups within the Company such
as the marketing  department,  which is  responsible,  among other  things,  for
product marketing, customer service, and marketing communications.

     U.S. End Users and ISPs

     Sales to U.S. end users are  generally  made through the  Company's  direct
sales force and indirectly through VARs. Thus, the U.S. end users sales group is
primarily responsible for developing and maintaining relationships with selected
end users and for  supporting  the sales  activities of its VARs.  The Company's
agreements  with its VARs  generally  have  terms of 12 months,  are  subject to
renewal by mutual  agreement and provide for discounts  from the Company's  list
prices for products  based on the expected  annual sales volumes and require the
Company to provide sales and application  engineering support. The U.S. end user
sales group operates through the Company's headquarters in Sunnyvale, California
and twelve other sales offices.



<PAGE>


     Carriers

     Digital Link's carrier sales force focuses on developing relationships with
carriers in the U.S.  and Canada and on  understanding  the  network  deployment
strategies of these carriers. Products sold to carriers may be used (i) within a
carrier's network in conjunction with the provision of their services,  (ii) for
resale in conjunction with a carrier's  provision of services to an end user, or
(iii) to satisfy the needs of a carrier's management  information systems, where
the  carrier  is an end user of the  products.  The  Company  has  entered  into
agreements with certain  carriers in the United States to purchase its products.
However,  these  agreements do not obligate the carriers to purchase any minimum
quantity of the Company's products.

     International Customers

     Sales to  international  customers  are  primarily  made  through  OEMs and
selected VARs.  International VARs authorized to sell the Company's products are
located in several countries within Europe,  South America and Asia. Support for
the Company's  products sold  internationally  is provided by the Company or its
authorized  VARs.  The Company  currently has offices in the United  Kingdom and
Germany.

Customer Support

     The Company believes that a high level of continuing service and support is
integral to its objective of developing and maintaining long-term  relationships
with its customers. The Company's customer support personnel are responsible for
servicing the Company's  products and provide  installation,  technical training
and post-sales  support  (primarily over the telephone).  The Company's products
generally  have a  warranty  of at  least 2 years  and some  CPE  products  have
lifetime  warranties.  The Company offers free  telephone  support during normal
business hours.  The Company also offers customers the option of entering into a
maintenance and support contract that can include telephone support seven days a
week and 24 hours a day,  emergency  replacement  programs and on-site  support.
Internationally,  the  Company  provides  customer  support  either  directly or
through full service VARs.

Research and Development

     The Company's  research and  development  efforts are focused on developing
new products,  core  technologies  and  enhancements to existing  products.  The
Company's  product  development  activities are based on customer  requirements,
marketplace needs and active  participation by the Company in industry standards
groups and forums.
     In 1997, 1996 and 1995, the Company's research and development expenditures
were $11.0 million,  $10.1 million,  and $8.9 million,  which represented 16.7%,
19.4% and 20.1%, respectively, of net sales. In addition, the Company incurred a
charge  for  purchased  research  and  development  of $3.7  million  in 1997 in
connection  with  its  acquisition  of  Performance  Telecom  Corporation.   The
Company's  research and  development  efforts in 1997  primarily  focused on the
continued  development  of  the  Company's  DL7100  product  as  well  as on the
expansion  of its Encore  product  family by  introducing  new  products and new
features,  including IPM, for existing Encore products. During 1998, the Company
expects that it will continue to devote  research and  development  resources to
the development of its DL7100 product and anticipates continuing to maintain its
focus on developing  new products and features  within its WAN access  business.
The Company  considers its research and  development  efforts to be vital to its
future success and anticipates that research and development  expenditure,  as a
percentage of net sales will remain significant for the foreseeable  future. See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations  --  Results  of  Operations   --  Research  and   Development"   and
"--Purchased Research and Development" in Item 7 of this Form 10-K.
     As  referenced   above,  the  Company's  product   development   activities
frequently   address  new  WAN  services  and  applications  based  on  emerging
technologies.  The Company  believes this  strategy has often  resulted in early
market penetration for products based on these technologies.  However,  industry
standards and requirements  are more likely to change in new markets,  which can
adversely  impact  the  Company's  business  and  operating  results.  Moreover,
technology and implementation approaches selected by the Company may be rendered
obsolete  by such  changes,  and a new  market may not  become  widespread.  See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations -- Other Factors That May Affect Future Operating  Results -- Company
Must Respond to Technological Change" in Item 7 of this Form 10-K.
     The Company's  success will depend upon its ability to develop new products
that achieve market acceptance and to provide  enhancements to existing products
as required by the Company's  customers and the communications  marketplace.  In
order to meet the challenges of rapidly  changing  technologies and services and
new industry  standards  that can render  obsolete the Company's  products,  the
Company has invested and expects to continue to invest substantial  resources in
the  development  of new  products  and  technologies.  The Company is currently
developing  and may in the future  develop  products  with which the Company has
only limited  experience  and/or that are targeted at emerging market  segments.
There can be no assurance that the Company's  product  development  efforts will
result in  commercially  successful  products  or that  product  delays will not
result in missed market opportunities.
     As of December 31, 1997,  the  Company's  research  and  development  staff
consisted of 72 employees, of whom 68 were engineers,  and approximately half of
such engineers  were engaged  principally  in the  development of software.  The
Company  believes  its  ability to  attract  and  retain  qualified  development
personnel is essential to the success of its  development  programs.  The market
for  such  personnel  is  highly  competitive,  and  the  Company's  development
activities  could be  adversely  affected  if the  Company  is  unsuccessful  in
attracting and retaining skilled technical personnel.

Manufacturing

     The  Company's  manufacturing  operations  consist  primarily  of component
procurement and final assembly,  test and quality control of  subassemblies  and
systems.  The Company  uses local third party  contractors  to  manufacture  and
assemble printed circuit boards.  The manufacturing  process enables the Company
to configure the hardware and software in combinations to meet a wide variety of
customer requirements.  The Company performs "burn-in" procedures and functional
tests,  as  well  as  comprehensive   inspections  to  assure  the  quality  and
reliability of its products.
     The Company's  product designs are  proprietary  but generally  incorporate
industry standard hardware components.  However,  certain  semiconductor devices
and  components  and  subassemblies  are  presently  available  only from single
sources,  and certain other components are presently  available or acquired only
from a limited  number of sources.  To date, the Company has been able to obtain
adequate supplies of these components, as well as subassemblies from third party
contractors,  in a timely manner from existing sources or, when necessary,  from
alternative  sources,  or to redesign its products to accommodate an alternative
component.  The inability to obtain sufficient sole or limited source components
or subassemblies as required in the future, or to develop alternative sources or
redesign its  products if and as required in the future,  could result in delays
or reductions in product  shipments that could  materially  adversely affect the
Company's business and operating results or damage customer relationships.



<PAGE>


Competition

     The market for the Company's  products is highly  competitive.  Many of the
Company's  customers  purchase  products from both the Company and the Company's
competitors.   The  Company  currently  competes  primarily  with  Adtran,  Inc.
("Adtran"),  Kentrox Industries,  Inc., a subsidiary of ADC  Telecommunications,
Inc. ("Kentrox"),  Larscom Inc. ("Larscom"),  Paradyne Corporation ("Paradyne"),
Verilink Corporation ("Verilink") and Visual Networks, Inc. ("Visual Networks").
Many of the Company's current and potential  competitors have greater financial,
research and development,  intellectual property,  marketing and other resources
than those of the Company and have  broader  product  lines and longer  standing
relationships with customers than the Company.
     The Company  expects  competition  to increase in the future from  existing
competitors  and from other  companies that may enter the Company's  existing or
future markets.  In addition,  the Company faces  competition  from suppliers of
internetworking  equipment,  such as routers, and telephone  equipment,  such as
switches,  which  are  including  direct  WAN  interfaces  in  certain  of their
products.  An increased  reliance by customers on such  suppliers for WAN access
would  reduce  demand for the  Company's  products,  which could have a material
adverse  affect on the  Company's  business  and  operating  results.  Increased
competition has also placed increasing pressures on the pricing of the Company's
products,  which has  resulted in lower  operating  results.  See  "Management's
Discussion  and Analysis of Financial  Condition  and Results of  Operations  --
Results of Operations -- Net Sales" and "-- Gross Profit" in Item 7 of this Form
10-K. The Company anticipates that this increased pricing pressure will continue
during 1998.
     The Company believes that its ability to compete  successfully depends on a
number of factors  both within and outside of its  control,  including,  but not
limited to,  price;  announcements  by the Company  and its  competitors;  rapid
development  of new  products and  features;  product  quality and  performance;
experienced sales,  marketing and service  organizations;  and evolving industry
standards.  There can be no assurance  that the Company will be able to continue
to compete successfully with its existing competitors or that it will be able to
compete successfully with new competitors.

Intellectual Property and Other Proprietary Rights

     The  telecommunications  industry is  characterized  by the  existence of a
large number of patents and frequent  litigation  based on allegations of patent
infringement.  The Company has been  contacted by two separate  parties who have
expressed their belief that certain of the Company's  products may infringe upon
patents held by these two parties. See "Management's  Discussion and Analysis of
Financial  Condition  and Results of Operations -- Other Factors That May Affect
Future Operating Results -- Risk of Third Party Claims of Infringement," in Item
7 of this Form 10-K.
     The Company  treats its software and hardware  designs as  proprietary  and
relies  primarily on a  combination  of  copyrights,  trademark and trade secret
laws,  and employee  and third party  nondisclosure  agreements,  to protect its
proprietary  information.  There  can  be  no  assurance  that  the  contractual
obligations to maintain the  confidentiality  of the Company's  trade secrets or
proprietary information will not be breached by employees, consultants, advisors
or others,  or that the Company's  trade secrets or proprietary  technology will
not otherwise  become known or be  independently  developed by competitors.  The
Company has one patent with the U.S. Patent and Trademark office for certain ATM
technology  that expires in September 2011.  However,  there can be no assurance
that such patent will prove to be important in the Company's product development
efforts.  Certain  technologies used in the Company's products are licensed from
third parties on a non-exclusive basis.



<PAGE>


Employees

     As of December 31,  1997,  the Company had 281  employees,  of whom 72 were
primarily  engaged in research  and  development,  112 in sales,  marketing  and
administration,  12 in customer  support and 85 in  manufacturing.  From time to
time,  Digital  Link  employs  contract  labor to  assist  with  its  short-term
personnel  needs.  The Company  believes that its future  success will depend in
large part upon the continued  contributions  of members of the Company's senior
management and other key  personnel,  and upon its ability to attract and retain
highly  skilled  managerial,   engineering,   sales,  marketing  and  operations
personnel,  the  competition  for whom is intense.  Certain of the Company's key
management  personnel  have  only  recently  joined  the  Company,  and  certain
personnel have only limited  experience in the Company's  industry.  In February
1998,  Alan I. Fraser,  the  Company's  President and Chief  Executive  Officer,
resigned to pursue other interests. Vinita Gupta, Chairman of the Board, assumed
the  responsibilities of President and Chief Executive Officer upon Mr. Fraser's
departure, and the Company recently began searching for an individual to succeed
Ms. Gupta as President and Chief Executive Officer. In addition,  the Company is
searching for a Vice  President,  Sales.  The current  availability of qualified
sales  and  engineering  personnel  is  quite  limited,  and  competition  among
companies for such personnel is intense.  The Company is currently attempting to
hire a number of sales and engineering  personnel and has experienced  delays in
filling  such  positions.  There can be no  assurance  that the Company  will be
successful in attracting and retaining skilled personnel to hold these important
positions. The Company expects to continue to experience growth in the number of
its  employees,  resulting  in  increased  responsibilities  for  the  Company's
management.  The  Company's  employees  are not  represented  by any  collective
bargaining organization,  and the Company has never experienced a work stoppage.
The Company believes that its employee relations are good.

ITEM 2.  PROPERTIES

     The Company  leases its 60,030  square foot  principal  facility,  which is
located in  Sunnyvale,  California,  pursuant to a lease that expires in October
2003.  Digital Link also leases 11,500  square feet of space in  Rochester,  New
York,  as a research  and  development  facility.  The Company  maintains  sales
operations  in North  America  in Oak Brook,  Illinois;  Fort Lee,  New  Jersey;
Houston,  Texas;  Irving,  Texas; and Markham,  Ontario.  In Europe, the Company
leases  facilities  in London,  England,  Munich,  Germany  and near  Stuttgart,
Germany.  The Company believes that its existing facilities are adequate to meet
its current needs and that  suitable  additional  or  alternative  space will be
available in the future on commercially reasonable terms. See Note 3 of Notes to
Consolidated Financial Statements.

ITEM 3.  LEGAL PROCEEDINGS

     In April 1996, a class action  complaint  was filed against the Company and
certain of its officers and directors in Santa Clara Superior Court of the State
of  California,  alleging  violations of the  California  Corporations  Code and
California  Civil Code and in October 1996, a similar parallel lawsuit was filed
in the United  States  District  Court for the Northern  District of  California
alleging violations of federal securities laws. See "Management's Discussion and
Analysis of Financial  Condition and Results of Operations -- Other Factors That
May Affect Future  Operating  Results -- Legal  Proceedings,"  in Item 7 of this
Form 10-K.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Not Applicable.



<PAGE>



                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

     The Common  Stock of the  Company  began  trading  in the  over-the-counter
market on the  Nasdaq  National  Market on  February  1, 1994  under the  symbol
"DLNK." The following  table sets forth the high and low closing  prices for the
Company's  Common  Stock as  reported  on the  Nasdaq  National  Market for each
quarterly  period  since  January 1, 1996.  These  prices  reflect  inter-dealer
prices, without retail mark-up, markdown or commission,  and may not necessarily
represent actual transactions.

                                         1997                      1996
                                  High         Low            High        Low
                                  -------------------------------------------
1st Quarter...................   $24.25       $12.50         $14.13      $ 8.19
2nd Quarter...................   $21.75       $13.75         $22.00      $ 9.75
3rd Quarter...................   $27.38       $18.88         $18.25      $12.75
4th Quarter...................   $26.25       $ 9.41         $23.75      $16.50

     As of December 31, 1997,  there were 122 holders of record of the Company's
Common Stock and approximately 1,200 beneficial owners.
     The Company has never  declared or paid any cash  dividends  on its capital
stock.  The Company  currently  intends to retain any future earnings for use in
its business and,  therefore,  does not anticipate  paying any cash dividends in
the foreseeable future.

ITEM 6.  SELECTED FINANCIAL DATA

     The  following  selected  consolidated  financial  data  should  be read in
conjunction  with the  consolidated  financial  statements and the notes thereto
included  elsewhere  herein.  The consolidated  statement of income data for the
years ended December 31, 1997, 1996 and 1995, and the consolidated balance sheet
data at December  31,  1997 and 1996 are  derived  from,  and are  qualified  by
reference to, the audited  consolidated  financial statements included elsewhere
in this report and should be read in conjunction with those financial statements
and the notes thereto.  The consolidated  statement of income data for the years
ended  December  31, 1994 and 1993 and the  consolidated  balance  sheet data at
December 31, 1995, 1994 and 1993 are derived from audited  financial  statements
not included in this report.



<PAGE>

<TABLE>
<CAPTION>



                                                              Year Ended December 31,
                                                              -----------------------
                                                      
(in thousands, except per share data)              1997      1996      1995      1994      1993
                                                   ----      ----      ----      ----      ----

Statement of Income Data:
<S>                                               <C>       <C>       <C>       <C>       <C>    
Net sales .....................................   $66,008   $52,078   $44,344   $35,222   $22,509
Cost of sales .................................    29,078    21,457    16,769    11,927     7,540
                                                  -------   -------   -------   -------   -------
        Gross profit ..........................    36,930    30,621    27,575    23,295    14,969
                                                  -------   -------   -------   -------   -------

Expenses:
     Research and development .................    11,005    10,120     8,922     7,300     4,316
     Selling, general and administrative ......    22,019    16,150    13,958    10,514     7,494
     Purchased research & development .........     3,651         0         0         0         0
                                                  -------   -------   -------   -------   -------
        Total expenses ........................    36,675    26,270    22,880    17,814    11,810
                                                  -------   -------   -------   -------   -------
        Operating income ......................       255     4,351     4,695     5,481     3,159
Other income ..................................     2,524     2,495     2,281     1,098       242
                                                  -------   -------   -------   -------   -------
        Income before provision
        for income taxes ......................     2,779     6,846     6,976     6,579     3,401
Provision for income taxes ....................       847     2,149     2,162     2,171     1,197
                                                  -------   -------   -------   -------   -------
        Net income ............................   $ 1,932   $ 4,697   $ 4,814   $ 4,408   $ 2,204
                                                  =======   =======   =======   =======   =======
Earnings per share (basic)
--------------------------
Net income per share(1) .......................   $  0.21   $  0.52   $  0.55   $  0.55   $  0.32
                                                  =======   =======   =======   =======   =======
Shares used in computing per share
amounts(1) ....................................     9,249     9,107     8,783     7,976     6,891
                                                  =======   =======   =======   =======   =======
Earnings per share (diluted)
----------------------------
Net income per share(1) .......................   $  0.20   $  0.50   $  0.51   $  0.48   $  0.31
                                                  =======   =======   =======   =======   =======
Shares used in computing per share
amounts(1) ....................................     9,600     9,478     9,467     9,113     7,169
                                                  =======   =======   =======   =======   =======

</TABLE>



<PAGE>



                                            Year Ended December 31,
                                            -----------------------
                                                                        
(in thousands)                  1997      1996      1995      1994      1993
                                ----      ----      ----      ----      ----
Balance Sheet Data:
Cash, cash equivalents and
    marketable securities ... $42,429   $44,048   $37,609   $31,688   $ 4,505
Working capital .............  28,901    28,523    27,483    23,352     8,789
Total assets ................  66,056    62,733    54,755    46,829    14,687
Total shareholders' equity ..  57,334    53,802    47,773    40,211     9,905


------------------
(1)  See Note 1 of Notes to Consolidated Financial Statements for an explanation
     of the  determination  of the number of shares used in computing net income
     per share.  Amounts  have been  restated  for the  adoption of Statement of
     Financial Accounting Standard No. 128 "Earnings Per Share."


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
         FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     Except  for the  historical  statements  contained  herein,  this Form 10-K
contains  forward  looking  statements  within the meaning of Section 27A of the
Securities  Act of 1933, as amended ("the  "Securities  Act") and Section 21E of
the  Securities  Exchange Act of 1934, as amended (the  "Exchange  Act").  These
forward looking  statements  involve a number of risks,  known and unknown,  and
uncertainties,  such as the loss of, or  difference  in actual from  anticipated
levels  of  purchases  from,  the  Company's  major  customers,  the  impact  of
competitive  products and pricing and other risks which are described throughout
this Form 10-K,  including under the sections titled  "Products and Technology,"
"Customers  and  End  Users,"  "Research  and   Development,"   "Manufacturing,"
"Competition,"   "Intellectual   Property  and  Other  Proprietary  Rights"  and
"Employees" in Item 1 hereof and within "Management's Discussion and Analysis of
Financial Condition and Results of Operations," including under the title "Other
Factors That May Affect Future Operating  Results," in Item 7 of this Form 10-K.
The actual  results that Digital Link  achieves may differ  materially  from any
forward looking statements due to such risks and uncertainties.
     When  used in this  Form  10-K  words  such as  "believes,"  "anticipates,"
"expects,"  "intends," and similar  expressions are intended to identify forward
looking  statements,  but  are not  the  exclusive  means  of  identifying  such
statements.  Readers  are urged to  carefully  review and  consider  the various
disclosures  made by the  Company in this  report and in the  Company's  reports
filed  with the  Securities  and  Exchange  Commission  that  attempt  to advise
interested  parties  of the risks and  factors  that may  affect  the  Company's
business.
     Due  to  all   the   foregoing   factors,   the   Company   believes   that
period-to-period  comparisons of its results of operations  are not  necessarily
meaningful and should not be relied upon as an indication of future performance.
Similarly,  past performances are not necessarily  indicative of future results.
It is likely that, in some future quarters, the Company's operating results will
be below the expectations of stock market analysts and investors. In such event,
the price of the  Company's  Common Stock would likely be  materially  adversely
affected.  Consequently,  the purchase or holding of the Company's  Common Stock
involves an extremely high degree of risk.

Overview

     The Company  designs,  manufactures,  markets and supports a broad range of
high speed digital access products,  ranging from 56 Kbps to 155 Mbps for global
WANs.  The Company's  products are used by service  providers as  infrastructure
equipment and by business enterprises for connectivity to WAN services,  such as
leased lines,  Frame Relay, SMDS and ATM. The Company's products allow LAN-based
internetworking devices, such as routers, to access WANs and also integrate data
with  digitized  voice and video traffic for more  efficient  line  utilization.
Digital Link's products are used both in the CPE environment and in the networks
of IXCs, ISPs and telephone  companies.  The Company  believes it is a leader in
the WAN access  products  market  because of its broad range of products and its
diverse  sales  channels.  The Company  markets and sells its  products in North
America,  Europe,  South  America and Asia  primarily  through its direct  sales
force, VARs and OEMs.



<PAGE>


Results of Operations

     The following  table sets forth statement of income data as a percentage of
net sales for the years ended December 31, 1997, 1996 and 1995:

                                                        Year Ended December 31,
                                                        -----------------------
                                                      1997      1996      1995
                                                      ----      ----      ----
Net sales ........................................    100.0%    100.0%    100.0%
Cost of sales ....................................     44.1      41.2      37.8
                                                     ------     ------    ------
        Gross profit .............................     55.9      58.8      62.2
                                                     ------     ------    ------

Expenses:
     Research and development ....................     16.7      19.4      20.1
     Selling, general and administrative .........     33.3      31.0      31.5
     Purchased research and development ..........      5.5         0         0
                                                      ------    ------    ------
        Total expenses ...........................     55.5      50.4      51.6
                                                      ------    ------    ------
        Operating income .........................      0.4       8.4      10.6
Other income .....................................      3.8       4.8       5.1
                                                      ------    ------    ------
        Income before provision for income taxes .      4.2      13.2      15.7
Provision for income taxes .......................      1.3       4.1       4.9
                                                      ------    ------    ------
        Net income ...............................      2.9%      9.1%     10.8%
                                                      ======    ======    ======

     Net Sales

     Net sales  increased  27.0% to $66.0  million in 1997 from $52.1 million in
1996.  The increase in 1997 was  primarily  attributable  to an increase in unit
sales of broadband (i.e., transmission rates in excess of T1/E1) products and to
a lesser  extent,  an increase in unit sales of narrowband  (i.e.,  transmission
rates up to T1/E1)  products.  This  increase  was  offset in part by  decreased
average selling prices on certain  narrowband and broadband products as a result
of price  reductions  made in the first half of 1997. Net sales increased 17% to
$52.1  million in 1996 from  $44.3  million in 1995.  The  increase  in 1996 was
primarily  attributable to an increase in unit sales of both narrowband products
in the Encore product family and domestic  broadband  products.  These increases
were  offset  in part by  decreased  unit  sales of the  Company's  SMDS  access
products  primarily  sold in Europe  and  decreased  average  selling  prices on
certain of the Company's  narrowband and broadband products as a result of price
reductions made throughout  1996. The Company believes that the decrease in unit
sales of the Company's SMDS access products in Europe in 1996 was due in part to
delays in the further  deployment  of SMDS  networks due to  technical  problems
within the networks and market  confusion in Europe among Frame Relay,  SMDS and
ATM technologies, which began in late 1995.
     During the fourth quarter of 1997, the Company experienced decreased demand
from certain  domestic carrier  customers which resulted in significantly  lower
than anticipated levels of net sales and a net loss for the quarter. The Company
anticipates  that this market condition will continue through at least the first
half of 1998,  which will result in lower levels of net sales as compared to net
sales in the first half of 1997.  However,  actual  results  could vary from the
foregoing  forward looking  statements as a result of the loss of, or difference
in actual  from  anticipated  levels of  purchases  from,  the  Company's  major
customers,  the impact of  competitive  products  and  pricing  and other  risks
described throughout this Form 10-K.
     In  1997,  narrowband  sales  in  absolute  dollars  increased  by 15%  and
decreased  as a  percentage  of net  sales  to 55% as  compared  to 61% in 1996.
Broadband  sales  increased  in  absolute  dollars  by 45%  and  increased  as a
percentage  of net sales to 45% in 1997 as  compared  to 39% in 1996.  Broadband
sales as a percentage of net sales  increased  from 1996 to 1997  primarily as a
result higher broadband sales to certain domestic carrier customers and ISPs. In
1997,  narrowband  sales  increased  primarily as a result of increased sales to
ISPs and Frame Relay networks.  In 1996,  narrowband  sales in absolute  dollars
increased by 28% and  increased as a percentage  of net sales to 61% as compared
to  56% in  1995.  Broadband  sales  increased  in  absolute  dollars  by 5% and
decreased  as a  percentage  of net sales to 39% in 1996 as  compared  to 44% in
1995. In 1996,  narrowband  sales  increased  primarily as a result of increased
sales  to ISPs  and  Frame  Relay  networks.  Narrowband  sales  increased  as a
percentage  of net  sales  from  1995 to 1996  primarily  as a  result  of lower
broadband sales of SMDS products in Europe.  Broadband sales in absolute dollars
increased  in 1996  primarily  as a result of higher  sales to certain  domestic
carriers  and ISPs,  which were  offset,  in part by lower SMDS sales in Europe.
Broadband  sales  as a  percentage  of net  sales  decreased  from  1995 to 1996
primarily as a result of lower SMDS sales in Europe,  which were slightly offset
by higher broadband sales to certain domestic carrier customers and ISPs.
     International sales (including sales in Canada)  represented  approximately
17%, 17% and 28% of net sales in 1997, 1996 and 1995, respectively. The decrease
in  international  sales as a  percentage  of net  sales  from  1995 to 1996 was
primarily  related to the decline in sales of the Company's  SMDS  products,  as
described above.  International  sales are subject to inherent risks,  including
difficulties  in  homologating  products  in other  countries,  difficulties  in
staffing  and  managing  foreign  operations,  greater  difficulty  in  accounts
receivable  collection,   unexpected  changes  in  regulatory  requirements  and
tariffs,  and  potentially  adverse  tax  consequences,  which may in the future
contribute to fluctuations in the Company's business and operating results.
     In 1997, 1996 and 1995, net sales to MCI represented approximately 20%, 13%
and 12%, respectively, of the Company's net sales. In addition, net sales to BBN
Planet  Corporation during 1996 was 13% of the Company's net sales and net sales
to Siemens during 1995 was 11%. A significant  portion of the Company's business
is  derived  from  substantial  orders  placed by large end users and  telephone
companies,  and the timing of such orders could cause material  fluctuations  in
the Company's business and operating results.  For example, in the quarter ended
December 31, 1997,  the Company  experienced a shortfall in revenues as compared
to its  expectations,  which was due primarily to lower than  expected  revenues
from certain domestic carriers.

     Gross Profit

        Gross  profit  increased  by 21% in 1997 to  $36.9  million  from  $30.6
million  for  1996.  Gross  margin  decreased  to 55.9% of net  sales in 1997 as
compared to 58.8% in 1996. This decrease in gross margin is primarily due to the
above referenced price reductions,  which were somewhat offset by a shift in the
mix of products sold to include more broadband  products,  which  generally have
higher gross margins than narrowband products.
     Gross profit  increased  11% to $30.6 million in 1996 from $27.6 million in
1995, while gross margin  decreased to 58.8% from 62.2%.  This decrease in gross
margin in 1995 was primarily due to the above referenced price  reductions,  and
to a  lesser  extent,  a shift  in the mix of  products  sold  to  include  more
narrowband  products,  which  generally  have lower gross margins than broadband
products.
     A significant  portion of the Company's business is very price competitive,
which has in the past and will in the future  require  the  Company to lower its
prices,  resulting in  fluctuations  in the  Company's  business  and  operating
results.  The Company  anticipates  that this pricing  pressure will continue at
least through the end of 1998. In addition, the Company anticipates that its mix
of  products  sold will  change to  include a higher  percentage  of  narrowband
products, which generally have lower gross margins and would therefore adversely
affect the Company's overall gross margins.

     Research and Development

     The primary types of expenses included in research and development  ("R&D")
expenses  are  personnel,   consulting,  prototype  materials  and  professional
services.  R&D expenses increased 9% to $11.0 million in 1997 from $10.1 million
in 1996.  This increase is primarily  attributable to higher  personnel  related
expenses offset by a decrease in consulting fees related to the Company's DL7100
product.  R&D expenses  increased 13% to $10.1 million in 1996 from $8.9 million
in 1995.  This  increase is primarily  attributable  to higher  consulting  fees
related to the Company's  DL7100  product,  offset by a decrease in professional
services,  personnel related expenses and material costs for prototype products.
As a percentage  of net sales,  R&D  expenses  were 16.7% in 1997 as compared to
19.4% in 1996.  The  decrease as a  percentage  of net sales was  primarily  the
result of operating efficiencies from higher sales volume during the period. The
Company  anticipates  that its R&D  expenses  in 1998 will  increase in absolute
dollars and may increase as a percentage  of net sales as compared to 1997, as a
result in part of an increase in personnel  related  costs due to the  Company's
acquisition of Performance Telecom.  See "--Purchased  Research and Development"
below.  However,  actual results could vary from the foregoing  forward  looking
statement due to, among other factors set forth or referenced in "Other  Factors
That May Affect  Future  Operating  Results"  below,  the  Company's  ability to
accelerate or defer  operating  expenses,  achieve  revenue  levels and hire new
personnel during 1998.
     All of the  Company's  R&D  expenditures  to date  have  been  expensed  as
incurred.  In the future, the Company may be required to capitalize a portion of
its software  development  costs  pursuant to Statement of Financial  Accounting
Standards No. 86,  "Accounting for Costs of Computer Software to be Sold, Leased
or Otherwise Marketed."

     Selling, General and Administrative

     The   primary   types  of  expenses   included  in  selling,   general  and
administrative ("SG&A") expenses are personnel,  advertising, other promotional,
and travel  and  entertainment.  SG&A  expenses  increased  36% in 1997 to $22.0
million from $16.2 million in 1996.  This increase is primarily  attributable to
higher personnel related expenses and, to a lesser extent,  consulting expenses.
SG&A  expenses  increased  16% for 1996 to $16.2  million from $14.0 million for
1995.  This  increase  in  absolute  dollars  was  primarily  a result of higher
personnel   related   expenses,   primarily   within  the  sales  and  marketing
organization,  and higher  evaluation  product and  promotional  expenses.  As a
percentage of net sales,  SG&A expenses  increased to 33.4% for 1997 as compared
to 31.0% for 1996.  This  increase as a percentage  of net sales was primarily a
result of a higher rate of growth in personnel  related expenses compared to the
rate of growth in net sales over the same period.  As a percentage of net sales,
SG&A expenses  decreased slightly to 31.0% for 1996 as compared to 31.5% for the
prior year.  The decrease as a percentage  of net sales was primarily the result
of  operating  efficiencies  from  higher net sales  during  1996.  The  Company
believes  SG&A expenses as a percentage of net sales will be higher for at least
the first half of 1998 compared to 1997 as a result of anticipated  lower levels
of net sales for 1998 as compared to 1997.
     The Company has in the past hired more of its SG&A  personnel  and incurred
increased  expenses  related  to trade  shows and other  promotional  activities
during the first half of the year. Accordingly, SG&A expenses as a percentage of
net sales are generally higher during the first half of the year.  However,  any
decrease in such expenses as a percentage of net sales in the second half of the
year are subject to, among other  factors set forth or referenced in "Net Sales"
above and "Other Factors That May Affect Future  Operating  Results" below,  the
Company's ability to accelerate or defer operating  expenses and achieve revenue
levels during such periods.

     Purchased Research and Development

     In  connection  with its  acquisition  of  certain  assets  and  in-process
technology  for  $5  million  in  cash  from  Performance   Telecom,  for  which
technological feasibility had not been achieved, the Company incurred an expense
of $3.7 million  related to  purchased  research  and  development  in the third
quarter  of 1997.  Such  in-process  technology  was  valued,  along  with other
acquired assets,  in accordance with valuation  techniques  commonly used in the
technology  industry  and was  expensed  upon  acquisition  in  accordance  with
Financial  Accounting  Standard No. 2,  "Accounting for Research and Development
Costs." This technology  enables network service providers to offer applications
such as Internet  access,  interactive  video  services,  remote data access and
multimedia  applications  at   multi-megabit-per-second   speeds  over  standard
voice-grade  copper  lines.  The  Company  intends  to  integrate  the  acquired
technologies into its existing products, but there can be no assurance that such
integration will be completed in the expected time or at the expected cost.

     Other Income

     Other income includes  primarily  interest  income and purchase  discounts.
Other income  remained flat at $2.5 million in both 1997 and 1996.  Other income
increased 9% to $2.5 million in 1996 from $2.3  million in 1995.  This  increase
was primarily a result of higher  interest  income due to higher rates of return
on marketable securities.

     Provision for Income Taxes

     The  Company's  effective  tax rate  decreased to 30.5% in 1997 compared to
31.4% in 1996.  This  decrease is due  primarily to  increases in foreign  sales
corporation  tax  benefit  and  nontaxable  municipal  interest.  The  Company's
effective  rate  increased  to 31.4%  in 1996  compared  to 31.0% in 1995.  This
increase is due primarily to lower foreign sales which resulted in lower foreign
sales corporation tax benefit.

     Recent Accounting Pronouncements

     In June 1997, the Financial  Accounting  Standards  Board  ("FASB")  issued
Statement  of   Financial   Accounting   Standard   ("SFAS")   130,   "Reporting
Comprehensive  Income." SFAS 130 establishes standards for reporting and display
of  comprehensive  income and its  components  in a full set of  general-purpose
financial statements. It is effective for the Company's fiscal year 1998.
     In June 1997, the FASB issued SFAS 131,  "Disclosures  About Segments of an
Enterprise and Related  Information."  SFAS 131 changes  current  practice under
SFAS 14 by  establishing  a new  framework  on which to base  segment  reporting
(referred to as the "management"  approach) and also requires interim  reporting
of segment information. It is effective for the Company's fiscal year 1998.
     During October 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-2 ("SOP 97-2"),  "Software Revenue Recognition."
The Company  will be studying  the  implications  of these  Statements,  but the
impact of their  implementation  on the financial  statements of the Company has
not yet been determined.

Quarterly Results of Operations

     The  following  table  sets forth  certain  unaudited  quarterly  financial
information for each of the Company's last eight quarters.  The Company believes
this information  reflects all adjustments,  consisting only of normal recurring
adjustments,  that  the  Company's  management  considers  necessary  for a fair
representation  of  this  information  in  accordance  with  generally  accepted
accounting  principles.  Quarterly  results are not  necessarily  indicative  of
future results of operations.


<PAGE>
<TABLE>
<CAPTION>



                                                                         Quarter Ended
                                         -------------------------------------------------------------------------------------
                                         Mar. 31,   June 30,   Sept. 30,  Dec. 31,    Mar. 31,  June 30,   Sept. 30,   Dec. 31,
(in thousands, except per share data      1996       1996        1996       1996       1997       1997       1997        1997
                                         -------------------------------------------------------------------------------------

<S>                                     <C>        <C>        <C>        <C>        <C>        <C>        <C>         <C>     
Net sales ............................  $ 10,203   $ 12,026   $ 14,127   $ 15,722   $ 16,038   $ 17,033   $ 18,529    $ 14,408
Cost of sales ........................     4,366      4,838      5,666      6,587      6,816      6,856      7,948       7,458
                                        --------   --------   --------   --------   --------   --------   --------    --------
     Gross profit ....................     5,837      7,188      8,461      9,135      9,222     10,177     10,581       6,950
                                        --------   --------   --------   --------   --------   --------   --------    --------
Expenses:                                                                                          
   Research and development ..........     2,050      2,335      2,749      2,986      3,032      2,594      2,603       2,776
   Selling, general and ..............     3,584      4,145      4,206      4,215      4,916      5,768      5,858       5,477
         administrative                                                         
   Purchased research & development .          0          0          0          0          0          0      3,651           0
                                        --------   --------   --------   --------   --------    --------  --------    -------- 
      Total expenses .................     5,634      6,480      6,955      7,201      7,948      8,362     12,112       8,253
                                        --------   --------   --------   --------   --------   --------   --------    --------
     Operating income ................       203        708      1,506      1,934      1,274      1,815     (1,531)     (1,303)
Other income .........................       633        574        625        663        641        638        646         599
                                        --------   --------   --------   --------   --------   --------   --------    --------
     Income before provision for
        income taxes .................       836      1,282      2,131      2,597      1,915      2,453       (885)       (704)
Provision for income taxes ...........       280        430        650        789        583        748       (270)       (214)
                                        --------   --------   --------   --------   --------   --------   --------    --------
     Net income (loss) ...............  $    556   $    852   $  1,481   $  1,808   $  1,332   $  1,705   $   (615)   $   (490)
                                        ========   ========   ========   ========   ========   ========   ========    ========
Earnings per share (basic)
--------------------------
Net income (loss) per share ..........  $   0.06   $   0.09   $   0.16   $   0.20   $   0.14   $   0.19   $  (0.07)   $  (0.05)
                                        ========   ========   ========   ========   ========   ========   ========    ========
Shares used in computing per
share amounts  .......................     9,007      9,082      9,149      9,187      9,190      9,188      9,240       9,375
                                        ========   ========   ========   ========   ========   ========   ========    ========
Earnings per share (diluted)
----------------------------
Net income (loss) per share ..........  $   0.06   $   0.09   $   0.16   $   0.19   $   0.14   $   0.18   $  (0.07)   $  (0.05)
                                        ========   ========   ========   ========   ========   ========   ========    ========
Shares used in computing per
share amounts ........................     9,352      9,449      9,451      9,659      9,577      9,506      9,240       9,375
                                        ========   ========   ========   ========   ========   ========   ========    ========
</TABLE>

     The Company  acquired  certain assets of  Performance  Telecom in September
1997,  incurring a one-time  charge of $3.7 million for  purchased  research and
development.  As a result,  the Company incurred a net loss in the third quarter
of 1997.
     A significant portion of the Company's business is derived from substantial
orders placed by large  end-users and  telephone  companies.  The timing of such
orders can, in general,  cause material  fluctuations in the Company's operating
results and was of particular  significance  in the fourth quarter of 1997 where
weaker than expected demand from certain  domestic  carrier  customers  together
with expense levels geared in  expectation of higher revenue levels  combined to
produce a net loss.
     The  Company  has in the past  hired more of its SG&A  personnel  primarily
within the sales and marketing  organizations,  and incurred  increased expenses
related to trade shows and other promotional  activities,  during the first half
of the  year.  In the  first  half of 1997,  the  Company  increased  its  sales
organization personnel in anticipation of increased revenue opportunities.
     A significant  portion of the Company's business is very price competitive,
which has in the past and will in the future  require  the  Company to lower its
prices,  resulting in  fluctuations  in the  Company's  business  and  operating
results.  For  example,  periodically  throughout  1996 and in the first half of
1997, the Company  reduced the prices on some of its access  products to address
competitive  pricing  pressures,  which  adversely  affected the Company's gross
margins  during  1996 and 1997.  The  Company  anticipates  that this  increased
pricing  pressure will  continue at least through 1998. In addition,  the mix of
products  sold  may  continue  to  change  to  include  a higher  percentage  of
narrowband  products that generally have lower gross margins and would therefore
adversely  affect the Company's  overall gross  margins.  Other factors that may
cause  fluctuations in the Company's  operating  results include the loss of, or
difference in actual from  anticipated  levels of purchases  from, the Company's
major customers, seasonal capital spending patterns of large domestic customers,
changes in sales volumes through the Company's distribution channels, the timing
of  new  product   announcements  and  introductions  by  the  Company  and  its
competitors,  market  acceptance  of new or enhanced  versions of the  Company's
products,  availability and cost of components from the Company's  suppliers and
economic conditions  generally or in various geographic areas. In addition,  the
Company's  expense  levels are based,  in part,  on its  expectations  of future
revenue.  The Company  typically  operates  with limited  order  backlog,  and a
substantial  majority of its revenues in each quarter  result from orders booked
in that quarter.  If revenue levels are below  expectations,  the Company may be
unable to adjust  spending  in a timely  manner,  which would  adversely  affect
operating results.

Liquidity and Capital Resources

     With the exception of $1.0 million that the Company  received from the sale
of Preferred Stock in 1987, through 1993 the Company financed its operations and
capital  equipment  requirements  primarily from cash flows from operations.  In
early 1994, the Company sold approximately 1,937,500 shares of common stock at a
price per share of $14.00 in its initial public offering.  The Company has added
the net proceeds of that  offering to working  capital,  where such proceeds are
available to support general corporate purposes.
     The Company's  working  capital  increased to $28.9 million at December 31,
1997 from $28.5  million at December 31, 1996 and $27.5  million at December 31,
1995. The Company's  cash, cash  equivalents and long and short-term  marketable
securities decreased to $42.4 million at December 31, 1997 from $44.0 million at
December 31, 1996 and $37.6  million at December 31, 1995.  Net cash provided by
operating  activities  was $5.8 million,  $6.4 million and $4.6 million in 1997,
1996 and 1995,  respectively.  The Company paid $5 million for certain assets of
Performance  Telecom in the third  quarter of 1997,  accounting  for much of the
decline in cash, cash equivalents and long and short-term  marketable securities
at the end of 1997.  The decline in net cash  provided by  operating  activities
from 1996 to 1997 was largely due to a shortfall  in the fourth  quarter of 1997
in net sales as  discussed  under  "--Results  of  Operations  -- Net Sales" and
"Quarterly  Results of  Operations,"  and the related  decline in net income for
1997.  In  addition,   investments   were  made  in  inventory  during  1997  in
anticipation  of higher levels of net sales that did not  materialize.  In 1996,
net cash provided by operating  activities was primarily a result of net income,
a decrease in  accounts  receivable  and an  increase  in  accounts  payable and
accrued payroll and other accrued  expenses,  offset to some extent by increased
inventories.  To date, the Company has not  experienced  any material  inventory
obsolescence  as a  result  of new  product  development,  but  there  can be no
assurance  that  future  product  development  efforts  will not render  Company
products obsolete.  Leasehold  improvements and capital equipment additions were
$2.3 million in 1997,  $1.3 million in 1996,  and $1.4 million in 1995. Net cash
used in financing activities amounted to $10,000 in 1997 as compared to net cash
provided  by  financing  activities  of $812,000  and  $852,000 in 1996 and 1995
respectively,  primarily  from  the  proceeds  of  employee  stock  options  and
purchases.  The use of cash in financing activities in 1997 was due primarily to
the  Company's  repurchase  of $2.4 million of its Common  Stock,  offset by the
proceeds from the exercise of stock options and employee stock purchases.
     In  October  1996,   the  Company's   Board  of  Directors   announced  the
authorization for the Company to repurchase up to 500,000 shares of common stock
for  cash  from  time  to time at  market  prices  and as  market  and  business
conditions warrant, in open market,  negotiated or block transactions,  at which
time the stock  will be  retired.  No time limit was set for  completion  of the
program. The Company purchased 142,000 shares of common stock under this program
in 1997 at a cost of $2,422,000.
     The Company believes that existing cash and cash flows from operations will
be sufficient to meet its anticipated cash  requirements for working capital and
capital expenditures for at least the next 12 months.



<PAGE>


OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

     In addition to the factors set forth above in this "Management's Discussion
and Analysis of Financial  Conditions  and Results of  Operations,"  there are a
number of other factors that may affect the Company's future operating results.

Operating Results May Fluctuate; Absence of Significant Backlog

     The  Company  believes  that the loss of,  or  difference  in  actual  from
anticipated levels of purchases from, the Company's major customers could in the
future affect operating  results.  Other factors that may cause  fluctuations in
the  Company's  operating  results  include,  but are not limited  to,  seasonal
capital spending  patterns of large domestic  customers,  changes in the product
mix sold toward narrowband  products that yield lower gross margins,  completion
of the build out of carrier and ISP  infrastructures,  the timing of new product
announcements and  introductions by the Company and its competitors,  changes in
sales volumes through the Company's distribution channels,  market acceptance of
new or enhanced  versions of the Company's  products,  availability  and cost of
components from the Company's suppliers and economic conditions  generally or in
various geographic areas. In addition, the Company's expense levels are based in
part on its  expectations of future revenue.  The Company  operates with limited
order backlog, and a substantial majority of its revenues in each quarter result
from orders booked in that quarter.  If revenue  levels are below  expectations,
the Company  may be unable to adjust  spending  in a timely  manner  which would
adversely  affect  operating  results.  The  Company's  industry has in the last
several  years been  characterized  by  declining  prices on existing  products,
therefore continual  improvement of manufacturing  efficiencies and enhancements
to existing products are required to maintain gross margins.

Market for the Company's Products is Highly Competitive

     The market for the Company's  products is highly  competitive.  The Company
expects competition to increase in the future from existing competitors and from
other  companies  that may enter the Company's  existing or future  markets.  In
addition,  the Company  faces  competition  from  suppliers  of  internetworking
equipment, such as routers, and telephone equipment, such as switches, which are
including a direct WAN  interface  in certain of their  products.  An  increased
reliance by customers on such  suppliers  for WAN access would reduce demand for
the  Company's  products,  which  would  have a material  adverse  affect on the
Company's  business  and  operating  results.  As  discussed  above,   increased
competition has also placed increasing pressures on the pricing of the Company's
products, which has resulted in lower operating results. The Company anticipates
that this pricing pressure will continue at least through 1998.

Company Depends on Key Personnel

     The Company believes that its future success will depend in large part upon
the continued  contributions of members of the Company's  senior  management and
other key  personnel,  and upon its ability to attract and retain highly skilled
managerial,   engineering,   sales,  marketing  and  operations  personnel,  the
competition  for  whom is  intense.  Certain  of the  Company's  key  management
personnel have only recently joined the Company and certain  personnel have only
limited experience in the Company's industry.  In February 1998, Alan I. Fraser,
the Company's  President and Chief Executive  Officer,  resigned to pursue other
interests.  Vinita Gupta, Chairman of the Board, assumed the responsibilities of
President  and Chief  Executive  Officer upon Mr.  Fraser's  departure,  and the
Company  recently  began  searching  for an  individual  to succeed Ms. Gupta as
President and Chief Executive Officer. In addition, the Company is searching for
a Vice  President,  Sales.  The  current  availability  of  qualified  sales and
engineering personnel is quite limited, and competition among companies for such
personnel is intense.  The Company is currently  attempting  to hire a number of
sales and  engineering  personnel  and has  experienced  delays in filling  such
positions.  There can be no  assurance  that the Company will be  successful  in
attracting and retaining skilled personnel to hold these important positions.

Company Must Respond to Technological Change

     The  Company's  future  prospects  will  depend in part on its  ability  to
enhance  the  functionality  of its  existing  WAN  access  products  and DL7100
products  (formerly known as the W/ATM GateWay  Products) in a timely manner and
to identify,  develop and achieve market acceptance of new products that address
new technologies  and meet customer needs in the WAN access market.  Any failure
by the Company to anticipate or to respond adequately to competitive  solutions,
technological developments in its industry, changes in customer requirements, or
changes in regulatory  requirements  or industry  standards,  or any significant
delays in the  development,  introduction or shipment of products,  could have a
material adverse affect on the Company's business and operating  results.  There
can be no assurance that the Company's product  development  efforts will result
in  commercially  successful  products or that product delays will not result in
missed  market  opportunities.   In  addition,   customers  could  refrain  from
purchasing  the  Company's  existing  products  in  anticipation  of new product
introductions by the Company or its competitors.  New products could also render
certain of the  Company's  existing  products  obsolete.  Either of these events
could materially adversely affect the Company's business and operating results.

Risks of Company's Involvement With Products for Emerging Markets

     The Company is currently  developing and may in the future develop products
with which the Company has only limited  experience  and/or that are targeted at
emerging market segments,  including the Company's  DL7100 product.  The Company
has experienced delays in the development of the DL7100 product, in part related
to technical problems that required some software to be redesigned.  This became
available  for revenue  shipments  in the second  half of 1997.  The Company has
experienced  very  limited  customer  interest  to date of this  product  in the
marketplace. The Company does not anticipate that the DL7100 revenue will become
a significant  portion of the Company's  revenue until at least 1999.  Given its
complexity,  there can be no  assurance  that this  product  will not  encounter
further  technical  or other  difficulties  that could  significantly  delay its
deployment or acceptance or could result in the  termination of the  development
program  for this  product.  There can be no  assurance  that the market for ATM
infrastructure products will continue to develop, the DL7100 will meet the needs
of the  emerging  ATM market or any other  market or,  that  products  currently
available or under  development by competitors  would not directly  compete with
the DL7100 product.  The occurrence of any of these events would have a material
adverse affect on the Company's business and operating results.

Risks Associated with Acquisitions

     The Company  completed an acquisition  of Performance  Telecom in the third
quarter of 1997 and may  complete  additional  acquisitions  in the future.  The
process  of  integrating  an  acquired  company's  business  into the  Company's
operations may result in unforeseen operating  difficulties and expenditures and
may absorb  significant  management  attention that would otherwise be available
for the ongoing development of the Company's business. Moreover, there can be no
assurance that the anticipated  benefits of an acquisition will be realized.  In
addition,   acquisitions  involve  numerous  risks,  including  difficulties  in
managing diverse geographic sales and research and development operations, risks
of  entering  markets  in which  the  Company  has no or  limited  direct  prior
experience, difficulties in the assimilation of the technologies and products of
the acquired  companies and the potential  loss of key employees of the acquired
company.  The  inability  of the  Company's  management  to respond to  changing
business  conditions  effectively,  including  the changes  associated  with its
recent  acquisition,  could  have a  material  adverse  affect on the  Company's
business, financial condition and results of operations.

Year 2000 Compliance

     The Company has  assessed  and  continues  to assess the impact of the Year
2000 issue on its  operations,  including the development of cost estimates for,
and the extent of programming changes required to address,  this issue. Although
final cost  estimates have yet to be  determined,  it is anticipated  that these
Year 2000 costs will not be  material to the  Company  expenses  during 1998 and
1999.  The Company doe not currently  have any  information  concerning the Year
2000 compliance status of its suppliers and customers.  In the event that any of
the  Company's  significant  suppliers or customers  does not  successfully  and
timely achieve Year 2000 compliance,  the Company's business or operations could
be adversely affected.

Legal Proceedings

     In April 1996, a class action  complaint  was filed against the Company and
certain of its officers and directors in the Santa Clara  Superior  Court of the
State of California, alleging violations of the California Corporations Code and
California  Civil Code. In October 1996, a similar  parallel lawsuit against the
Company and the same  individuals  was filed in the United States District Court
for the  Northern  District of  California  alleging  violations  of the federal
securities  laws. The class period in both of these lawsuits runs from September
12,  1994  through  December  29,  1995,  and both  complaints  allege  that the
defendants  concealed and/or  misrepresented  material adverse information about
the  Company and that the  individual  defendants  sold shares of the  Company's
stock based upon material nonpublic information. The complaints seek unspecified
monetary  damages.  To date,  the  Superior  Court  has  dismissed  portions  of
plaintiff's  state court  complaint  without leave to amend.  The Superior Court
also  dismissed  five of the  individual  defendants  without leave to amend and
another individual defendant with leave to amend. The Superior Court also denied
motions to dismiss filed by the Company and two other individual defendants with
respect to the remaining portions of the complaint.  Plaintiff has filed a third
amended  complaint  that  names the  Company  and three  individual  defendants.
Discovery to date has been limited in the state court  action,  and the Superior
Court has not set a trial date.  The  Company  also moved to dismiss the federal
complaint.  On September 11, 1997,  the Court  granted the  Company's  motion to
dismiss.  The Court granted plaintiff leave to file, and plaintiff has filed, an
amended complaint. The Company has moved to dismiss the amended complaint. There
has been no discovery in the federal action, and no trial date has been set.
     The Company  believes  that both  actions are without  merit and intends to
defend  both  actions  vigorously.  However,  litigation  is subject to inherent
uncertainties  and, thus,  there can be no assurance that these lawsuits will be
resolved  favorably to the Company or that they will not have a material adverse
affect on the  Company's  financial  condition  and  results of  operations.  No
provision for any liability that may result upon  adjudication  has been made in
the accompanying financial statements.

Risk of Third Party Claims of Infringement

     The  telecommunications  industry is  characterized  by the  existence of a
large number of patents and frequent  litigation  based on allegations of patent
infringement.  For example, a third party has on several occasions expressed its
belief that certain of the  Company's  products,  including  its  CSU/DSUs,  may
infringe  upon patents held by it and has suggested on such  occasions  that the
Company acquire a license to such patents.  The Company believes that a license,
to the extent required,  will be available;  however,  no assurance can be given
that the terms of any offered license would be favorable to the Company.  Should
a license be unavailable,  the Company could be required to discontinue the sale
of or to redesign certain of its products. In addition, Larscom, a competitor of
the  Company,  has  continued to express its belief that the  Company's  inverse
multiplexer  products may infringe a patent jointly owned by Larscom and a third
party and has suggested  that the Company  acquire a license to the patent.  The
Company  does not believe that there is merit to  Larscom's  claim.  Management,
after  review  and  consultation  with  counsel,   believes  that  the  ultimate
resolution of both these  allegations is uncertain and there can be no assurance
that these assertions will be resolved without costly  litigation or in a manner
that is not adverse to the Company.  While the Company  accrued  certain amounts
for these  matters  in prior  years,  it is  currently  unable to  estimate  the
possible loss or range of loss regarding these matters.  Therefore, the ultimate
resolution  of these  matters  could result in payments in excess of the amounts
accrued in the accompanying financial statements and require royalty payments in
the future which could adversely impact gross margins. There can be no assurance
that other third parties will not assert infringement claims against the Company
in the future, that any such claims will not result in costly litigation or that
the Company will prevail in any such  litigation or be able to license any valid
and infringed patents from third parties on commercially reasonable terms.

Possible Adverse Changes in Future Market Price

     The risks  outlined  herein are difficult for the Company to forecast,  and
these or other factors can materially affect the Company's operating results and
stock price for one quarter or a series of  quarters.  Further,  in recent years
the stock market has experienced extreme price and volume fluctuations that have
particularly  affected the market prices of  securities of many high  technology
companies,  for reasons frequently unrelated to the operating performance of the
specific companies. These fluctuations,  as well as general economic,  political
and market conditions,  may materially  adversely affect the market price of the
Company's common stock.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Not Applicable.


<PAGE>


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The  quarterly   supplementary   data  is  included  as  part  of  Item  7,
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations." The financial statements required by this item are set forth below.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS                                  Page

Report of Independent Accountants ........................................   25

Consolidated Financial Statements:

     Consolidated Balance Sheets as of December 31, 1997 and 1996 ........   26

     Consolidated Statements of Income for each of the three years in the
     period ended December 31, 1997 ......................................   27

     Consolidated Statements of Shareholders' Equity for each of the three
     years in the period ended December 31, 1997 .........................   28

     Consolidated Statements of Cash Flows for each of the three years in
     the period ended December 31, 1997 ..................................   29

     Notes to Consolidated Financial Statements ..........................   30



<PAGE>


                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Shareholders
Digital Link Corporation and Subsidiaries:

     We have audited the  accompanying  consolidated  balance  sheets of Digital
Link  Corporation  and  Subsidiaries  as of December 31, 1997 and 1996,  and the
related consolidated  statements of income,  shareholders' equity and cash flows
for each of the  three  years in the  period  ended  December  31,  1997.  These
financial  statements are the  responsibility of the Company's  management.  Our
responsibility  is to express an opinion on these financial  statements based on
our audits.
     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
     In our opinion,  the financial statements referred to above present fairly,
in all material  respects,  the consolidated  financial position of Digital Link
Corporation  and  Subsidiaries  as of  December  31,  1997  and  1996,  and  the
consolidated  results of their  operations  and their cash flows for each of the
three years in the period ended  December 31, 1997 in conformity  with generally
accepted accounting principles.



                                                COOPERS & LYBRAND L.L.P.


San Jose, California
January 20, 1998



<PAGE>
<TABLE>
<CAPTION>

                    DIGITAL LINK CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                        (in thousands, except share data)


                                     ASSETS

                                                                              December 31,
                                                                              ------------
                                                                             1997      1996
                                                                             ----      ----
Current assets:
<S>                                                                        <C>       <C>    
         Cash and cash equivalents .....................................   $ 2,504   $ 2,043
         Short-term marketable securities ..............................    18,026    19,585
         Accounts receivable, less allowance for doubtful accounts of
         $517 in 1997 and $465 in 1996 .................................     5,193     6,490
         Inventories, net ..............................................     8,163     5,920
         Prepaid and other current assets ..............................     1,433     1,131
         Deferred income taxes .........................................     2,304     2,285
                                                                           -------   -------
                  Total current assets .................................    37,623    37,454

Property and equipment, net ............................................     3,325     2,147
Long-term marketable securities ........................................    21,899    22,420
Deferred income taxes ..................................................     2,062       418
Other assets ...........................................................     1,147       294
                                                                           -------   -------
                           Total assets ................................   $66,056   $62,733
                                                                           =======   =======


                      LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
         Accounts payable ..............................................   $ 2,407   $ 2,300
         Accrued payroll and related expense ...........................     2,344     1,648
         Other accrued expenses ........................................     3,785     3,442
         Income taxes payable ..........................................       186     1,541
                                                                           -------   -------
                  Total current liabilities ............................     8,722     8,931

Commitments and contingencies (Note 3)
Shareholders' equity:
         Preferred stock, no par value:
              Authorized:  5,000,000 shares;
              Issued and outstanding:  none in 1997 and 1996
         Common stock, no par value:
              Authorized:  25,000,000 shares;
              Issued and outstanding:  9,427,306 shares in 1997 and
              9,218,150 shares in 1996 .................................    34,609    30,913
         Unrealized gain on marketable securities ......................       107       257
         Retained earnings .............................................    22,618    22,632
                                                                           -------   -------
                  Total shareholders' equity ...........................    57,334    53,802
                                                                           -------   -------

                           Total liabilities and shareholders' equity ..   $66,056   $62,733
                                                                           =======   =======

</TABLE>



     The accompanying notes are an integral part of these consolidated financial
 statements.


<PAGE>


                    DIGITAL LINK CORPORATION AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME
                      (in thousands, except per share data)
--------------------------------------------------------------------------------


                                                      Year Ended December 31,
                                                      -----------------------
                                                     1997      1996      1995
                                                     ----      ----      ----
Net sales ......................................   $66,008   $52,078   $44,344
Cost of sales ..................................    29,078    21,457    16,769
                                                   -------   -------   -------
       Gross profit ............................    36,930    30,621    27,575
                                                   -------   -------   -------

Expenses:
    Research and development ...................    11,005    10,120     8,922
    Selling, general and administrative ........    22,019    16,150    13,958
    Purchased research and development .........     3,651        --        --
                                                   -------   -------   -------
       Total expenses ..........................    36,675    26,270    22,880
                                                   -------   -------   -------
       Operating income ........................       255     4,351     4,695
Other income ...................................     2,524     2,495     2,281
                                                   -------   -------   -------
       Income before provision for income taxes      2,779     6,846     6,976
Provision for income taxes .....................       847     2,149     2,162
                                                   -------   -------   -------
       Net income ..............................   $ 1,932   $ 4,697   $ 4,814
                                                   =======   =======   =======
Earnings per share (basic)
--------------------------
Net income per share ...........................   $  0.21   $  0.52   $  0.55
                                                   =======   =======   =======
Shares used in computing per share amounts .....     9,249     9,107     8,783
                                                   =======   =======   =======
Earnings per share (diluted)
----------------------------
Net income per share ...........................   $  0.20   $  0.50   $  0.51
                                                   =======   =======   =======
Shares used in computing per share amounts .....     9,600     9,478     9,467
                                                   =======   =======   =======












     The accompanying notes are an integral part of these consolidated financial
statements.


<PAGE>


                    DIGITAL LINK CORPORATION AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                 (in thousands)
<TABLE>
<CAPTION>


                                                                                                 Unrealized
                                                                                                    Gain
                                                                                                  (Loss) on
                                                    Preferred Stock           Common Stock        Marketable   Retained
                                                   Shares      Amount       Shares     Amounts    Securities   Earnings    Total
                                                   -----------------------------------------------------------------------------

<S>                                              <C>         <C>            <C>      <C>              <C>    <C>         <C>     
Balances, December 31, 1994 ....................       --         --         8,628    $ 27,162         (72)   $ 13,121    $ 40,211
                                                 --------   --------      --------    --------    --------    --------    --------
    Issuance of common stock in connection with:
      Stock option plan ........................       --         --           356         600        --          --           600
      Stock purchase plan ......................       --         --            16         252        --          --           252
    Tax benefit related to disqualifying
      dispositions from exercise of stock
      options ..................................       --         --            --       1,269         --         --         1,269
    Unrealized loss on marketable
      securities ...............................       --         --            --          --        627         --           627
    Net income .................................       --         --            --          --         --       4,814        4,814
                                                 --------   --------      --------    --------   --------    --------     --------
Balances, December 31, 1995 ....................       --         --         9,000      29,283        555      17,935       47,773
    Issuance of common stock in connection with:
      Stock option plan ........................       --         --           199         546         --          --          546
      Stock purchase plan ......................       --         --            19         266         --          --          266
    Tax benefit related to disqualifying
      dispositions from exercise of stock
      options ..................................       --         --            --         818         --          --          818
    Unrealized loss on marketable
      securities ...............................       --         --            --          --       (298)         --         (298)
    Net income .................................       --         --            --          --         --       4,697        4,697
                                                   --------   --------    --------    --------    --------    --------    --------
   Balances, December 31, 1996 .................       --         --         9,218      30,913        257      22,632       53,802
    Issuance of common stock in connection with:
      Stock option plan ........................       --         --           311       1,885         --          --        1,885
      Stock purchase plan ......................       --         --            40         527         --          --          527
      Repurchase of common stock ...............       --         --          (142)       (476)        --      (1,946)      (2,422)
    Tax benefit related to disqualifying
      dispositions from exercise of stock
      options ..................................       --         --            --       1,760        --           --        1,760 
   Unrealized loss on marketable
      securities ...............................       --         --            --          --      (150)          --        (150)
    Net income .................................       --         --            --          --        --        1,932       1,932
                                                  --------   --------     --------    --------   --------    --------    --------
Balances, December 31, 1997 ....................       --         --         9,427    $ 34,609    $  107     $ 22,618    $ 57,334
                                                  ========   ========     ========    ========    =======    ========    ========





</TABLE>



     The accompanying notes are an integral part of these consolidated financial
statements


<PAGE>


                    DIGITAL LINK CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
<TABLE>
<CAPTION>

                                                                            Year Ended December 31,
                                                                         1997        1996        1995
                                                                         ----        ----        ----
Cash flows from operating activities:
<S>                                                                    <C>         <C>         <C>     
   Net income ......................................................   $  1,932    $  4,697    $  4,814
   Adjustments to reconcile net income to net cash flows
      provided by operating activities:
      Depreciation and amortization ................................      1,224         752       1,720
      Amortization of goodwill .....................................         28          --          --
      Provision (reduction in allowance) for doubtful accounts .....         66        (383)        434
      Provision (reduction in allowance) for excess and obsolete
        inventories ................................................        555         457        (160)
      R&D write-off on acquisition .................................      3,651          --          --
      Deferred income taxes ........................................     (1,663)       (482)       (213)
      Changes in assets and liabilities:
         Accounts receivable .......................................      1,686       1,583        (405)
         Inventories ...............................................     (2,315)     (1,774)     (1,819)
         Prepaid and other current assets ..........................       (284)       (402)       (148)
         Accounts payable ..........................................        107       1,136        (656)
         Accrued payroll and other accrued expenses ................        421         700        (407)
         Income taxes payable ......................................        405         114       1,427
                                                                        -------    --------    --------
             Net cash flows provided by operating activities .......      5,813       6,398       4,587
                                                                        -------    --------    --------

Cash flows from investing activities:
   Purchases of marketable securities ..............................    (22,740)    (34,915)    (32,008)
   Maturities of marketable securities .............................     24,670      24,391      13,168
   Sales of marketable securities ..................................         --       4,008      12,816
   Acquisition of Performance Telecom Corporation assets ...........     (5,000)         --          --
   Acquisition of property and equipment ...........................     (2,272)     (1,290)     (1,414)
                                                                       --------    --------    --------
             Net cash flows used in investing activities ...........     (5,342)     (7,806)     (7,438)
                                                                       --------    --------    --------

Cash flows from financing activities:
   Proceeds from exercise of stock options and employee stock ......      2,412         812         852
        purchases
   Repurchase of common stock ......................................     (2,422)         --          --
                                                                       --------    --------    --------
             Net cash flows provided by (used in) financing activities      (10)        812         852
                                                                        --------    --------    --------

                  Net increase (decrease) in cash and cash
                  equivalents .......................................        461        (596)     (1,999)

Cash and cash equivalents at beginning of year .....................       2,043       2,639       4,638
                                                                        --------    --------    --------

Cash and cash equivalents at end of year ...........................    $  2,504    $  2,043    $  2,639
                                                                        ========    ========    ========

Supplemental disclosure of cash flow information:
   Cash paid during the year for income taxes ......................    $  2,377    $  1,727    $    662
                                                                       --------    --------    --------
   Cash received during the year for income taxes ..................    $     85    $     27    $  1,137
                                                                        ========    ========    ========

Supplemental schedule of noncash investing and financing activities:
   Unrealized gain (loss) on securities carried at market ..........    $   (150)   $   (298)   $    627
                                                                        ========    ========    ========
   Tax benefit related to disqualifying dispositions from exercise
       of stock option ............................................     $  1,760    $    818    $  1,269
                                                                        ========    ========    ========

</TABLE>


     The accompanying notes are an integral part of these consolidated financial
statements.


<PAGE>



                    DIGITAL LINK CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   Business and Summary of Significant Accounting Policies:

     Basis of Consolidation:

     The consolidated  financial statements include the accounts of Digital Link
Corporation and its wholly owned  subsidiaries (the "Company").  All significant
intercompany balances and transactions have been eliminated.

     Cash, Cash Equivalents and Marketable Securities:

     The Company  considers all highly  liquid  investments  with  maturities of
three  months or less at the time of purchase  and money market funds to be cash
equivalents.  The Company has  deposited  its cash and money market funds at one
major bank and two investment  firms.  Cash  equivalents are stated at cost plus
accrued interest, which approximates market.
     All marketable securities are deemed by management to be available for sale
and are reported at fair value with net unrealized gains or losses reported as a
separate  component in  shareholders'  equity.  Realized gains and losses on the
sale of marketable securities are computed on the specific identification basis.
Available for sale marketable securities with maturities less than one year from
the  balance  sheet date are  classified  as current  and those with  maturities
greater than one year from the balance sheet date are classified as long-term.

     Revenue Recognition:

     Product  revenues are recognized  upon shipment of the product if remaining
obligations are  insignificant  and  collections of the resulting  receivable is
probable.  The Company records  estimated product returns and accrues for future
warranty costs,  anticipated  retroactive  price  adjustments and  insignificant
vendor  obligations  at the time of  product  shipment.  Warranty  costs to date
generally have not been significant. Maintenance and support revenues, which are
not significant, are recognized over the terms of the related agreements.

     Inventories:

     Inventories  are  stated at the lower of cost  (determined  on a  first-in,
first-out basis) or market.

     Property and Equipment:

     Property and equipment is stated at cost.  Effective  January 1, 1996,  the
Company adopted the  straight-line  method of depreciation  for all property and
equipment  placed in service after that date.  Property and equipment  placed in
service  prior  to  January  1,  1996  continues  to be  depreciated  using  the
double-declining  balance method. The estimated useful lives under either method
range from three to five  years.  When  property  and  equipment  are retired or
otherwise disposed of, the cost and related accumulated depreciation are removed
from the accounts and the resulting gain or loss is included in income.



<PAGE>


     Fair Value:

     The fair value of cash  equivalents and marketable  securities is disclosed
in  relevant  notes  to  the  financial  statements.  For  all  other  financial
instruments, the carrying amount approximates fair value.

     Concentration of Credit Risk:

     Financial   instruments   which   potentially   subject   the   Company  to
concentration  of credit risk consist  principally  of investments in marketable
securities and accounts receivable.
     The  Company  currently  places its  investments  with  three  high  credit
qualified  financial  institutions.  With  respect to accounts  receivable,  the
Company's  customer base is dispersed  across many different  geographic  areas.
While its customers are dispersed across many industries,  a substantial portion
of its sales are from ISPs and domestic  carriers.  The Company performs ongoing
credit  evaluations of its customers,  generally does not require collateral and
maintains an allowance for potential credit losses.  At December 31, 1997, there
were  three  customers  with  balances  individually  in  excess  of 5% of total
accounts  receivable versus six customers at December 31, 1996.  Jointly,  these
customers  accounted for 23% of total  accounts  receivable at December 31, 1997
versus 46% at December 31, 1996.

     Use of Estimates:

     The  preparation  of financial  statements  in  conformity  with  generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect the  reported  amounts of assets and  liabilities  and
disclosure of  contingent  assets and  liabilities  at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from these estimates.

     Computation of Net Income per Share:

     Basic and  diluted  income per share is  computed  in  accordance  with the
Statement of Financial  Accounting  Standards No. 128 ("SFAS No. 128").  All per
share  amounts have been  restated in  accordance  with SFAS.  128. The weighted
average shares used in the computations for 1997, 1996 and 1995, were 9,249,000,
9,107,000  and  8,783,000.  The  Company  adopted  SFAS 128 for the  year  ended
December 31, 1997.

                                                   1997     1996     1995
                                                   ----     ----     ----
Basic
-----
Weighted-average common shares outstanding
     for the period ...........................    9,249    9,107    8,783
Shares used in computing per share amounts ....    9,249    9,107    8,783
                                                  ------   ------   ------   
Net income ....................................   $1,932   $4,697   $4,814
                                                  ======   ======   ======

Net income per share ..........................   $ 0.21   $ 0.52   $ 0.55
                                                  ======   ======   ======



<PAGE>



                                                      1997     1996      1995
                                                      ----     ----      ----
Diluted
-------
Weighted-average common shares outstanding
     for the period ..............................    9,249    9,107    8,783
Common equivalent shares from conversion of
     stock options under treasury stock method ...      351      371      684
                                                     ------  -------  -------
Shares used in computing per share amounts .......    9,600    9,478    9,467
                                                     ------  -------  -------
Net income .......................................   $1,932   $4,697   $4,814
                                                     ======   ======   ======

Net income per share .............................   $ 0.20   $ 0.50   $ 0.51
                                                     ======   ======   ======

     Advertising Costs:

     Costs  related to  advertising  and  promotion  of  products  is charged to
advertising expense as incurred. Advertising expense was $1,750,000,  $1,408,000
and $931,000 for 1997, 1996 and 1995, respectively.

     Research and Development Costs:

     Costs related to research,  design and  development of products are charged
to research and development expenses as incurred. Software development costs are
capitalized  beginning  when a  product's  technological  feasibility  has  been
established  and  ending  when a product is  available  for  general  release to
customers  provided that  research and  development  activities  for the related
hardware  portion of the product have been completed.  Generally,  the Company's
products   include   hardware  and  software   components   that  are  developed
concurrently.  As a  result,  the  Company  has  not  capitalized  any  software
development costs since such costs have not been significant.

     Foreign Currency Translation:

     The Company's  foreign  subsidiaries  use the United States dollar as their
functional currency.  Resulting foreign transaction gains and losses, which have
been insignificant, are included in the results of operations.

     Accounting for Income Taxes:

     The  Company's  provision  for income taxes  comprises  its  estimated  tax
liability  currently  payable  and the  change  in its  deferred  income  taxes.
Deferred tax assets and liabilities are determined based on differences  between
financial  reporting  and tax bases of assets and  liabilities  and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.


     Stock-Based Compensation:

     The Company  accounts for employee  stock options under APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and provides pro forma disclosure in
Note 4 to the financial statements as if the measurement  provisions of SFAS No.
123 ("SFAS 123") "Accounting for Stock-Based Compensation," had been adopted.



<PAGE>


     Recent Pronouncements:

     In June 1997, the FASB issued SFAS 130, "Reporting  Comprehensive  Income."
SFAS 130 establishes standards for reporting and display of comprehensive income
and its components in a full set of general-purpose financial statements.
It is effective for the Company's fiscal year 1998.
     In June 1997, the FASB issued SFAS 131,  "Disclosures  About Segments of an
Enterprise and Related  Information."  SFAS 131 changes  current  practice under
SFAS 14 by  establishing  a new  framework  on which to base  segment  reporting
(referred to as the "management"  approach) and also requires interim  reporting
of segment information. It is effective for the Company's fiscal year 1998.
     During October 1997, the American Institute of Certified Public Accountants
issued SOP 97-2,  "Software  Revenue  Recognition." The Company will be studying
the implications of these Statements,  but the impact of their implementation on
the financial statements of the Company has not yet been determined.

     Balance Sheet Reclassifications:

     Certain  balance  sheet  items have been  reclassified  in 1996 in order to
conform to the 1997 presentation.


     2.  Balance Sheet Detail:


     Marketable Securities:

<TABLE>
<CAPTION>
                                                                December 31,
                                                         1997                1996
                                                         ----                ----
                                                              (in thousands)

                                                              Market             Market
                                                    Cost      Value     Cost     Value
Debt securities:
<S>                                                <C>       <C>       <C>       <C>    
     U.S. government corporations and ..........   $24,689   $24,679   $21,829   $22,050
         agencies
     U.S. treasury bills .......................        --        --     2,007     2,007
     State and municipal securities ............    15,129    15,246    15,361    15,387
     Other .....................................        --        --     2,551     2,561
                                                   -------   -------   -------   -------
                                                   $39,818   $39,925   $41,748   $42,005
                                                   =======   =======   =======   =======
</TABLE>

     Gross unrealized gains and unrealized losses for marketable securities were
$136,000  and  $29,000,  respectively,  at December  31, 1997 and  $288,000  and
$31,000, respectively, at December 31, 1996.
     At December 31, 1997, scheduled maturities of marketable  securities within
one year are $18,026,000  (cost  $17,947,000) and for one year to five years are
$21,899,000 (cost $21,871,000).



<PAGE>


     Inventories, net:

                                        December 31,
                                       1997     1996
                                       ----     ----
                                       (in thousands)

Raw materials .....................   $2,952   $2,255
Work in progress ..................    2,275    2,301
Finished goods ....................    2,936    1,364
                                      ------   ------
                                      $8,163   $5,920
                                      ======   ======

     The  Company's  products  are  concentrated  in a  single  segment  in  the
telecommunications  industry that is highly  competitive  and rapidly  changing.
Significant technological changes in the industry segment could affect operating
results adversely.  The Company's  inventories include high technology parts and
components  that may be specialized in nature or subject to rapid  technological
obsolescence.   While  the  Company  has   programs  to  minimize  the  required
inventories on hand and considers  technological  obsolescence in estimating the
required  allowance to reduce recorded amounts to market values,  such estimates
could  change in the future.  In  addition,  certain  semiconductor  devices and
components and subassemblies  are presently  available only from single sources,
and certain other  components  are  presently  available or acquired only from a
limited number of sources.

     Property and Equipment, net:

                                                             December 31,
                                                         1997        1996
                                                         ----        ----
                                                          (in thousands)

Manufacturing and development equipment .............  $  9,328    $  6,442
Furniture and fixtures ..............................       520       1,043
Leasehold improvements ..............................       215         201
                                                       --------    --------
                                                         10,063       7,686
                                                       --------    --------
Less accumulated depreciation and amortization ......    (6,738)     (5,539)
                                                       --------    --------
                                                       $  3,325      $2,147
                                                       ========    ========

     Other Accrued Expenses:

                                                      December 31,
                                                    1997       1996
                                                    ----       ----
                                                     (in thousands)

Product warranty ................................   $1,029   $  795
Deferred product revenue ........................      123       99
Other ...........................................    2,633    2,548
                                                    ------   ------
                                                    $3,785   $3,442
                                                    ======   ======



<PAGE>


3.   Commitments and Contingencies:

     Commitments:

     The Company  leases its  headquarters  facility  under an operating  lease.
Under  the  terms  of the  lease  agreement,  the  Company  is  responsible  for
insurance, maintenance and property taxes.

     Future  minimum lease  payments  under the lease are as follows at December
31, 1997 (in thousands):

                      1998                                         $1,021
                      1999                                          1,072
                      2000                                          1,126
                      2001                                          1,182
                      2002                                          1,241
                      2003                                          1,019
                                                                    -----
                      Total minimum lease payments                 $6,661
                                                                   ======

     Rent expense was $883,000,  $619,000 and $510,000 for 1997,  1996 and 1995,
respectively.

     Contingencies:

     Certain  third  parties  have  expressed  their  belief that certain of the
Company's products may infringe patents held by them and have suggested that the
Company acquire licenses to such patents. The Company believes that licenses, to
the extent required, will be available;  however, no assurance can be given that
the terms of any offered licenses would be favorable to the Company. Management,
after  review  and  consultation  with  counsel,   believes  that  the  ultimate
resolution of these  allegations is uncertain and there can be no assurance that
these assertions will be resolved without costly  litigation or in a manner that
is not adverse to the Company.  While the Company  accrued  certain  amounts for
these  matters in prior years,  it is currently  unable to estimate the possible
loss or range of loss regarding these matters.  The ultimate resolution of these
matters  could  result  in  payments  in excess of the  amounts  accrued  in the
accompanying  financial  statements and require  royalty  payments in the future
which could adversly impact gross margins.

     In April 1996, a class action  complaint  was filed against the Company and
certain of its officers and directors in the Santa Clara  Superior  Court of the
State of California, alleging violations of the California Corporations Code and
California  Civil Code. In October 1996, a similar  parallel lawsuit against the
Company and the same  individuals  was filed in the United States District Court
for the  Northern  District of  California  alleging  violations  of the federal
securities  laws. The class period in both of these lawsuits runs from September
12,  1994  through  December  29,  1995,  and both  complaints  allege  that the
defendants  concealed and/or  misrepresented  material adverse information about
the  Company and that the  individual  defendants  sold shares of the  Company's
stock based upon material nonpublic information. The complaints seek unspecified
monetary  damages.  To date,  the  Superior  Court  has  dismissed  portions  of
plaintiff's  state court  complaint  without leave to amend.  The Superior Court
also  dismissed  five of the  individual  defendants  without leave to amend and
another individual defendant with leave to amend. The Superior Court also denied
motions to dismiss filed by the Company and two other individual defendants with
respect to the remaining portions of the complaint.  Plaintiff has filed a third
amended  complaint  that  names the  Company  and three  individual  defendants.
Discovery to date has been limited in the state court  action,  and the Superior
Court has not set a trial date.  The  Company  also moved to dismiss the federal
complaint.  On September 11, 1997,  the Court  granted the  Company's  motion to
dismiss.  The Court granted plaintiff leave to file, and plaintiff has filed, an
amended complaint. The Company has moved to dismiss the amended complaint. There
has been no discovery in the federal action, and no trial date has been set. The
Company  believes that both actions are without merit and intends to defend both
actions  vigorously.  However,  litigation is subject to inherent  uncertainties
and,  thus,  there can be no  assurance  that these  lawsuits  will be  resolved
favorably to the Company or that they will not have a material adverse affect on
the Company's  financial  condition and results of operations.  No provision for
any  liability  that  may  result  upon   adjudication  has  been  made  on  the
accompanying financial statements.

4.   Shareholders' Equity:

     Stock Options Plan:

     The Company has a 1992 Equity  Incentive Plan ("Plan"),  which succeeds the
Company's prior plan. All outstanding  stock options issued under the prior plan
will continue to be governed by the terms and  conditions  of that plan,  but no
additional stock options will be granted under that prior plan.  During 1995, an
additional  500,000  shares  were  authorized  for  grant or sale to  employees,
officers,  directors and consultants of the Company under the Plan. During 1997,
an additional  800,000  shares were  authorized  for grant or sale to employees,
officers,  directors and  consultants  of the Company  under the Plan.  The Plan
expires ten years after its adoption.
     Options  granted  under the Plan may be either  incentive  stock options or
nonqualified  stock options,  as designated by the Board of Directors.  The Plan
provides  that the  exercise  price of options  granted must be no less than the
fair market value of the Company's  common stock at the date of grant. The Board
of Directors  also has the  authority to set exercise  dates (no longer than ten
years  from the date of  grant),  payment  terms and other  provisions  for each
grant. Generally, options granted under the Plan through October 31, 1995 become
exercisable  annually as to 20% and options granted on or after October 31, 1995
become exercisable as to 25% of the shares one year after the first vesting date
and  thereafter  with  respect  to an  additional  2.084%  at the  end  of  each
succeeding month.
     The Plan also  provides for the award of common stock based on  performance
and the sale of restricted stock to eligible persons at the fair market value of
the common  stock of the  Company at the date of sale or at  discounts  of up to
15%, as determined by the Board of Directors.  All restricted stock awards under
this Plan are  subject to a  repurchase  option  that  expires  over a five year
period at the original  issuance  price.  As of December 31, 1997, no restricted
stock awards have been issued under the Plan.

Directors Stock Options Plan:

     In October 1994, the Company  adopted the 1994 Directors  Stock Option Plan
(the "Directors  Plan"). The Company has reserved 200,000 shares of Common Stock
for issuance to directors of the Company who are not employees of the Company.
The Directors Plan expires ten years after its adoption.
     Options  granted under the Directors Plan are  nonqualified  stock options.
The Directors Plan provides that the exercise price of options  granted shall be
the  fair  market  value of the  Company's  common  stock at the date of  grant.
Options  granted under the Directors Plan become  exercisable  ratably over four
years.  The maximum term of these options  granted is ten years from the date of
grant.



<PAGE>


     Activity under the Plan and the Directors  Plan during 1997,  1996 and 1995
is as follows:
<TABLE>
<CAPTION>

                                                    (in thousands, except per share amounts)
                                                              Outstanding Options
                                    ------------- ------------- ----------------- ------------- -------------
                                                                                                  Weighted
                                       Shares        Number          Price                         Average
                                     available        of              per          Aggregate      Exercise
                                     for grant       Shares          Share           Price         Price
                                     ---------------------------------------------------------------------
<S>                <C> <C>              <C>           <C>         <C>   <C>          <C>         <C>     
Balances, December 31, 1994 .           974           1,435       $0.33-$21.75       7,329       $   5.11
   Additional shares reserved           500              --           --                --             --
   Options granted ..........          (561)            561      $15.25-$28.25      10,882       $  19.40
   Options exercised ........            --            (356)      $0.33-$15.12        (600)      $   1.69
   Options cancelled ........           178            (178)      $0.67-$28.25      (1,798)      $  10.10
                                    -------        --------                        -------
 Balances, December 31, 1995 .        1,091           1,462       $0.60-$28.25      15,813       $  10.82
   Options granted ..........          (984)            984      $10.125-$23.25     15,302       $  15.55
   Options exercised ........            --            (199)      $0.60-$21.75        (546)      $   2.74
   Options cancelled ........           425            (425)      $0.83-$28.25      (6,079)      $  14.30
                                    -------        --------                        -------
Balances, December 31, 1996 .           532           1,822       $0.83-$28.25      24,490       $  13.45
   Additional shares reserved           800              --            --               --             --
   Options granted ..........          (540)            540      $13.25-$25.75       9,637       $  17.86
   Options exercised ........            --            (311)     $12.50-$27.375     (1,885)      $   6.06
   Options cancelled ........           434            (434)      $1.00-$28.25      (6,029)      $  13.91
                                    -------        --------                        -------
Balances, December 31, 1997 .         1,226           1,617       $1.00-$28.25      26.213       $  16.23
                                    =======        ========                        =======
</TABLE>

The  weighted-average  fair value of those options  granted in 1997 and 1996 was
$11.63 and $8.47,  respectively.  Options to purchase  481,000  shares,  350,000
shares,  and 267,000 shares were  exercisable with a  weighted-average  exercise
price of  $14.65,  $8.88,  and  $4.68,  at  December  31,  1997,  1996 and 1995,
respectively.

The  following  table  summarizes  information  with  respect  to stock  options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>

                                                            (number of options in thousands)
                                                  Options Outstanding                     Options Exercisable
                                   -------------------------------------------------------------------------------
                                                        Weighted
                                                         Average     
                                         Number        Remaining                          Number         Weighted
                                     Outstanding at                    Weighted       Exercisable at     Average
                                      December 31,    Contractual       Average        December 31,      Exercise
<S>                                       
Range of Exercise Price                   1997        Life (years)  Exercise Price         1997           Price
-------------------------------------------------------------------------------------------------------------------
<C>      <C>                              <C>              <C>            <C>             <C>              <C>   
$ 1.00 - $ 1.67                           36               4.12           $ 1.38          32               $ 1.35
$ 3.33 - $ 4.67                           22               5.78           $ 3.90          11               $ 3.49
$ 8.50 - $ 9.25                           67               6.54           $ 9.19          33               $ 9.19
$10.13 - $13.75                          128               8.52           $11.85          34               $10.68
$14.00 - $16.00                          758               8.49           $15.34         264               $15.35
$16.50 - $18.94                          259               9.18           $17.97          39               $17.07
$20.13 - $24.00                          324               8.65           $21.79          59               $22.68
$25.00 - $28.25                           23               7.96           $27.06           9               $27.13
                                    =================                                =================
$ 1.00 - $28.25                        1,617               8.41           $16.23         481               $14.65
                                    =================                                =================
</TABLE>

Employee Stock Purchase Plan:

     In December 1993, the Company  established the 1993 Employee Stock Purchase
Plan (the "Purchase  Plan") under which 300,000 shares of Common Stock have been
reserved  for  issuance.  Under the  Purchase  Plan,  an eligible  employee  may
purchase shares of Common Stock from the Company  through payroll  deductions of
up to 10% of his or her base compensation,  at a price per share equal to 85% of
the lesser of the fair  market  value of the  Company's  Common  Stock as of the
first day or last day of each six-month offering period under the Purchase Plan.
The Company sold 40,000 shares, 19,000 shares, and 16,000 shares to employees in
1997, 1996, and 1995,  respectively.  The  weighted-average  fair value of those
purchase rights granted in 1997 and 1996 was $6.02 and $5.66, respectively.

     Pro Forma Stock-Based Compensation:

     The Company  accounts for the fair value of its grants under the Plan,  the
Directors Plan and the Purchase Plan, in accordance with APB 25. Accordingly, no
compensation  expense has been  recognized  for these  plans.  Had  compensation
expense  been  determined  based on the fair value at the grant dates for awards
under these plans  consistent  with the method of SFAS 123,  the  Company's  net
income would have been reduced to the pro forma amounts indicated below:

(Amounts in thousands, except per share data)     1997        1996         1995
                                                  ----        ----         ----
Net income (loss)
     As reported ...........                  $   1,932    $   4,697   $   4,814
     Pro forma .............                  $    (338)   $   3,771   $   4,462
Earnings per share (Basic)
     As reported ...........                  $    0.21    $    0.52   $    0.55
     Pro forma .............                  $   (0.04)   $    0.41   $    0.51
Earnings per share (Diluted)
     As reported ...........                  $    0.20    $    0.50   $    0.51
     Pro forma .............                  $   (0.04)   $    0.40   $    0.47

     The fair value of each  option is  estimated  on the date of grant  using a
type of Black-Scholes  option-pricing model with the following  weighted-average
assumptions  used for grants under the Plan and the Directors Plan in 1997, 1996
and 1995:

                                  1997               1996             1995
                                  ----               ----             ----

Dividend yield                     0.00%              0.00%            0.00%
Expected life of option       4.50 years         4.50 years       4.50 years
Risk-free interest rate            5.74%              6.05%            6.05%
Expected volatility                  80%                60%              60%

     The  Company  has also  estimated  the fair value for the  purchase  rights
issued under the Purchase Plan using the Black-Scholes option-pricing model with
the following assumptions for grants in 1997, 1996 and 1995:

                                  1997               1996             1995
                                  ----               ----             ----

Dividend yield                     0.00%              0.00%            0.00%
Expected life of option       0.50 years         0.50 years       0.50 years
Risk-free interest rate            5.80%              5.34%            5.07%
Expected volatility                  80%                60%              60%

     The above pro forma  disclosures are not likely to be representative of the
effects on reported net income for future years.

5. Segments, Significant Customers, Suppliers and Foreign Revenues:

     The Company operates in a single industry segment  encompassing the design,
development,  manufacture,  marketing and support of high-speed  digital  access
products for wide area  networks  worldwide.  The Company  markets and sells its
products primarily in North America,  Europe,  South America and Asia, through a
direct sales force, VARs OEMs. In addition to twenty sales offices in the United
States, the Company opened its first international offices in the United Kingdom
and Germany during 1993.
     In 1997,  sales to one customer  accounted  for 20% of net sales.  In 1996,
sales to two customers  each accounted for 13% of net sales.  In 1995,  sales to
two  customers  accounted  for 12% and 11% of net sales.  The loss of any one or
more of the Company's  major  customers could  materially  adversely  affect the
Company's business and operating results.
     The Company's  product designs are  proprietary  but generally  incorporate
industry standard hardware components.  However,  certain  semiconductor devices
and  components  and  subassemblies  are  presently  available  only from single
sources,  and certain other components are presently  available or acquired only
from a limited  number of sources.  To date, the Company has been able to obtain
adequate supplies of these components, as well as subassemblies from third party
contractors,  in a timely manner from existing sources or, when necessary,  from
alternative  sources.  The inability to obtain sufficient sole or limited source
components or subassemblies as required in the future, or to develop alternative
sources or redesign its products if and as required in the future,  could result
in delays or reductions in product  shipments  that could  materially  adversely
affect  the  Company's   business  and  operating  results  or  damage  customer
relationships.
     Outside  of Europe,  no  geographic  segment  had sales in excess of 10% of
total sales. International sales in 1997, 1996, and 1995 were as follows:
   
                               1997             1996            1995
                               ----             ----            ----
                                           (in thousands)
Europe                      $  5,888          $  4,142        $  7,524
Other                       $  5,465          $  4,524        $  4,730
                            --------          --------        --------
Total international sales   $ 11,353          $  8,666         $12,254
                            ========          ========         =======

6.   Employee Benefit Plan:

     The Company has a 401(k)  profit  sharing plan for its full time  employees
who  have  attained  the  age of  21.  Eligible  employees  may  make  voluntary
contributions  to the Plan up to 18% of their annual  compensation.  The Company
makes a matching contribution equal to 50% of each employee's contributions.  In
applying this matching contribution, however, only contributions up to 6% of the
employee's compensation will be considered. For 1997, 1996 and 1995, the Company
contributed $356,000, $191,000, and $184,000 respectively.



<PAGE>


7.   Income Taxes:
     The provision for income taxes comprises:

                             1997                  1996                  1995
                             ----                  ----                  ----
                                              (in thousands)

Current:
     Federal               $2,246                $2,376                $1,987
     State                    390                   135                   388
                           ------                ------                ------
                            2,636                 2,511                 2,375

Deferred:
     Federal               (1,613)                 (295)                 (172)
     State                   (176)                  (67)                  (41)
                           -------               -------               -------
                           (1,789)                 (362)                 (213)
                           -------               -------              --------
                           $  847                $2,149                $2,162
                           ======                ======                ======

     The difference  between the actual tax provision and the amount obtained by
applying the U.S.  Federal  statutory rate to income before provision for income
taxes is as follows:
<TABLE>

<CAPTION>

                                              1997           1996             1995
                                              ----           ----             ----

<S>                                          <C>             <C>              <C>  
Tax provision at federal statutory rate       34.0%          34.0%            34.0%
State taxes, net of federal tax benefit        6.6            5.4              6.1
Nontaxable municipal interest                 (6.3)          (2.1)            (1.1)
Foreign sales corporation                     (2.5)          (0.6)            (1.9)
Research and development tax credit           (3.2)          (6.3)            (7.7)
Other                                          1.9            1.0              1.6
                                             -----           ----             -----
                                             30.5%           31.4%            31.0%
                                             ====            ====             ====
</TABLE>

     The components of the deferred tax asset are as follows:

                                                               December 31,
                                                          1997              1996
                                                          ----              ----
                                                              (in thousands)

Deferred tax assets:
     Allowance for doubtful accounts receivable         $   203          $   184
     Allowance for excess and obsolete inventories          885              577
     Depreciation                                           379              418
     Amortization of purchased research and
       development                                        1,216               --
     Accrual for warranty, royalties and other            1,483            1,524
     Other                                                  200               --
                                                         ------           ------
         Total deferred tax assets                       $4,366           $2,703
                                                         ======           ======

     The Company has not  provided a valuation  allowance  on the  deferred  tax
assets as those  amounts can be realized  through  carryback to prior years when
the  Company  paid  income  taxes or are  expected  to be  realized  from future
operations based upon the Company's history of profitable operations.

8.    Acquisition:

     In  connection  with its  acquisition  of  certain  assets  and  in-process
technology  for $5 million in cash from  Performance  Telecom  Corporation,  for
which technological  feasibility had not been achieved,  the Company incurred an
expense of $3.7 million  related to purchased  research and  development  in the
third  quarter  of  1997.  The  financial  statements  include  the  results  of
operations  since September 30, 1997.  This  technology  enables network service
providers  to offer  applications  such as Internet  access,  interactive  video
services,    remote    data    access    and    multimedia    applications    at
multi-megabit-per-second  speeds over standard  voice-grade  copper lines.  Such
in-process   technology  was  valued,  along  with  other  acquired  assets,  in
accordance with valuation  techniques  commonly used in the technology  industry
and was expensed  upon  acquisition  in  accordance  with  Financial  Accounting
Standard No. 2,  "Accounting  for Research and  Development  Costs." The Company
intends to integrate the acquired  technologies into its existing products,  but
there  can be no  assurance  that  such  integration  will be  completed  in the
expected time or at the expected cost. The acquired company's  financial results
did not significantly  impact Digital Link's 1997 results and, combined results,
pro forma basis would not have significantly  impacted revenues or net income of
the Company.

9.   Subsequent Event:

     During the period from January 1, 1998 through March 25, 1998,  the Company
repurchased  on the open market a total of 131,000  shares of common  stock at a
price ranging from $10.50 to $11.50 a share.  This stock has  subsequently  been
retired.

     On  January  21,  1998,  the  Company's  Board of  Directors  approved  the
repricing of certain employee stock options.  At the close of market on February
9, 1998 all employees,  including  executive  officers,  choosing to participate
were  granted  new  options  with an  exercise  price of $11.00 per  share.  All
employee  options,  except  executive  officers,  retain their original  vesting
schedules,  but are subject to a one-year blackout period. All executive officer
options were issued with a new vesting schedule.

     On February  25,  1998,  the Company  extended the term on the lease of its
headquarters  facility  for an  additional  period of six years,  commencing  on
October  16,  1997 and  expiring  on October  15,  2003.  See Note 3 of Notes to
Consolidated Financial Statements.



<PAGE>



ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
         FINANCIAL DISCLOSURE

     Not Applicable

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     Information  required by this Item is  incorporated  by reference  from the
sections  titled  "Nominees"  under  "Proposal  No. 1 - Election of  Directors,"
"Executive   Officers"  and  "Section  16(a)  Beneficial   Ownership   Reporting
Compliance"  from the Definitive Proxy Statement to be filed with the Securities
and Exchange Commission relative to the Company's annual meeting of shareholders
to be held on May 20, 1998 (the "Definitive Proxy Statement").

ITEM 11.  EXECUTIVE COMPENSATION

     Information  required by this Item is  incorporated  by reference  from the
sections  titled  "Director  Compensation"  under  "Proposal No. 1 - Election of
Directors" and "Executive Compensation" from the Definitive Proxy Statement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
          MANAGEMENT

     Information  required  by  this  Item is  incorporated  by  reference  from
"Security  Ownership  of  Certain  Beneficial  Owners and  Management"  from the
Definitive Proxy Statement.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Information  required  by  this  Item is  incorporated  by  reference  from
"Certain Transactions" from the Definitive Proxy Statement.


<PAGE>


                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
          FORM 8-K

     The following financial  statements and schedules are filed as part of this
report:

                                                                          Page
(a)1.           Financial Statements

                See index in Part II, Item 8...........................     24

(a)2. and (d)   Financial Statement Schedules

                Report of Independent Accountants......................     46
                Schedule II - Valuation and Qualifying Accounts........     47

     All schedules not listed above are omitted  because they are not applicable
or the required  information  is included in the  financial  statements or notes
thereto.

(a)3. and (c)       Exhibits


3.01      Registrant's Amended and Restated Articles of Incorporation filed on 
          February 7, 1994. (1)
3.02      Registrant's Certificate of Correction of Amended and Restated 
          Articles of Incorporation filed on April 7, 1994. (1)
3.03      Registrant's Bylaws, as amended. (2)
4.01      Form of Specimen Certificate for Registrant's Common Stock. (3)
4.02      Registration Rights Agreement among Registrant, Vinita Gupta, Summit 
          Ventures L.P., SV Eurofund C.V. and Summit Investors, L.P. dated 
          December 23, 1987 and certain exhibits thereto. (3)
+10.01    Registrant's 1986 Stock Option Plan, as amended. (3)
+10.02    Form of Agreement for Registrant's 1986 Stock Option Plan. (1)
+10.03    Registrant's 1986 Stock Purchase Plan. (3)
+10.04    Form of Agreement for Registrant's 1986 Stock Purchase Plan, as
          amended. (1)
+10.05    Registrant's 1992 Equity Incentive Plan, as amended. (8)
+10.06    Form of Agreement for Registrant's 1992 Equity Incentive Plan,
          as amended. (1)
+10.07    Registrant's 1993 Employee Stock Purchase Plan. (3)
+10.08    Registrant's 1994 Directors Stock Option Plan. (1)
+10.09    Form of Agreement for Registrant's 1994 Directors Stock Option 
          Plan. (1)
10.10     Form of Indemnity Agreement entered into with each of Registrant's 
          directors. (3)
10.11     Lease Agreement between Registrant and John Hancock Mutual Life 
          Insurance Company dated June 17, 1992. (3)
10.12     Form of Patent License Agreement between Registrant and QPSX 
          Communications Ltd. dated December 1993. (3)
10.13*    Software License Agreement between Registrant and Epilogue Technology
          Corporation dated January 20, 1992. (3)
10.14     Stockholder Agreement among Registrant, Vinita Gupta, Narendra Gupta, 
          Summit Ventures, L.P., SV Eurofund C.V. and Summit Investors, L.P.
          dated December 23, 1987. (3)
10.16     Original Equipment Manufacturer Agreement between Registrant and
          Siemens Aktiengesellschaft dated April 7, 1995.(4)
+10.18    Employment Agreement between Registrant and Alan Fraser dated
          September 5, 1996.(6)
+10.19    Security Agreement between Registrant and Alan Fraser dated 
          September 30, 1996.(6)
+10.20    Secured Promissory Note from Alan Fraser dated September 30, 1996. (6)
+10.21    Separation Agreement between Registrant and James Checco dated 
          November 19, 1996. (7)
21.01     List of Subsidiaries. (3)
23.01     Consent of Independent Accountants
27.01     Financial Data Schedule
-----
   *      Confidential treatment has been obtained with respect to portions 
          of this exhibit.
  (1)     Filed as an exhibit to Registrant's Form 10-K for the year ended 
          December 31, 1994 and incorporated herein by reference.
  (2)     Filed as an exhibit to Registrant's Registration Statement on 
          Form S-8 (No. 33-95176) filed on July 31, 1995 and incorporated 
          herein by reference.
  (3)     Filed as an exhibit to Registrant's Form S-1 Registration Statement
          (File No. 33-72642), which was declared effective January 31, 1994,
          and incorporated herein by reference.
  (4)     Filed as an exhibit to Registrant's Form 10-Q for the quarter ended
          June 30, 1995 and incorporated herein by reference.
  (5)     Filed as an exhibit to Registrant's Form 10-K for the year ended 
          December 31, 1995 and incorporated herein by reference.
  (6)     Filed as an exhibit to Registrant's Form 10-Q for the quarter ended 
          September 30, 1996 and incorporated herein by reference.
  (7)     Filed as an exhibit to Registrant's Form 10-K for the year ended 
          December 31, 1996 and incorporated herein by reference.
  (8)     Filed as an exhibit to Registrant's Registration Statement on 
          Form S-8 (No. 333-27855) filed on May 27, 1997 and incorporated 
          herein by reference.
   +      Management contract or compensatory plan required to be filed as 
          an exhibit to this Form 10-K.

(b)       Reports on Form 8-K

          No reports on Form 8-K were filed during the last quarter of
          the period covered by this report.


<PAGE>


                                   SIGNATURES
     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                            DIGITAL LINK CORPORATION

March 20, 1998                          By:       /s/ Stanley E. Kazmierczak
                                               -------------------------------
                                                Stanley E. Kazmierczak
                                                Chief Financial Officer

     Each person whose signature  appears below  constitutes and appoints Vinita
Gupta and Stanley E.  Kazmierczak,  jointly and  severally,  his or her true and
lawful attorneys-in-fact, each with the power of substitution, for him or her in
any and all  capacities,  to sign amendments to this Report on Form 10-K, and to
file the same,  with all  exhibits  thereto and other  documents  in  connection
therewith,  with the Securities and Exchange  Commission,  hereby  ratifying and
confirming  all  that  said  attorneys-in-fact,  or  his or  her  substitute  or
substitutes, may do or cause to be done by virtue hereof.
     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
Report has been signed below by the following person on behalf of the Registrant
and in the capacities and on the dates indicated.

    Signature                                 Title                  Date

                                Chairperson of the Board, Chief    
/s/ Vinita Gupta               Executive Officer and President
-----------------------------   (Principal Executive Officer)     March 20, 1998
Vinita Gupta                    

                                 Chief Financial Officer
                               and Vice President, Finance
                                   and Administration
                                (Principal Financial and
/s/ Stanley E. Kazmierczak         Accounting Officer)            March 20, 1998
-----------------------------
Stanley E. Kazmierczak

/s/ Richard C. Alberding                Director                  March 20, 1998
-----------------------------
Richard C. Alberding

/s/ Gregory M. Avis                     Director                  March 20, 1998
-----------------------------
Gregory M. Avis

/s/ Lance B. Boxer                      Director                  March 20, 1998
-----------------------------
Lance Boxer

/s/ Alan I. Fraser                      Director                  March 20, 1998
-----------------------------
Alan I. Fraser

/s/ Narendra K. Gupta                   Director                  March 20, 1998
-----------------------------
Narendra K. Gupta


<PAGE>


                        REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders
Digital Link Corporation and Subsidiaries:

     Our  report  on the  consolidated  financial  statements  of  Digital  Link
Corporation  and  Subsidiaries  is  included  on page 25 of this Form  10-K.  In
connection  with our audits of such financial  statements,  we have also audited
the related financial  statement schedule listed in the index on page 43 of this
Form 10-K.
     In our opinion,  the financial  statement  schedule referred to above, when
considered  in  relation  to the basic  financial  statements  taken as a whole,
presents  fairly,  in all  material  respects,  the  information  required to be
included therein.




                                                  COOPERS & LYBRAND L.L.P.


San Jose, California
January 20, 1998



<PAGE>


<TABLE>
<CAPTION>

                                   SCHEDULE II


                            DIGITAL LINK CORPORATION

                        VALUATION AND QUALIFYING ACCOUNTS
                   For the Years Ended December 31, 1995, 1996
                                    and 1997
                             (Amounts in thousands)



                                                       Balance at
                                                        Beginning      Charged to                              Balance at
                                                           of          Costs and            Deductions           End of
                                                                                      ------------------------
                     Description                       the Period       Expenses       Description    Amount   the Period
                                                       ------------ ----------------- -------------- --------- ------------
Balances for the year ended December 31, 1995:
<S>                                                      <C>             <C>               <C>         <C>       <C>   
     Allowance for doubtful accounts  receivable .....   $  461          $  434                                  $  895
     Allowance for excess and obsolete inventories ...    1,004              --            (a)         $  160       844

Balances for the year ended December 31, 1996:
     Allowance for doubtful accounts receivable ......      895              --            (b)            383
                                                                                           (a)             47       465
     Allowance for excess and obsolete inventories ...      844             457            (a)            167     1,134

Balances for the year ended December 31, 1997
     Allowance for doubtful accounts receivable ......      465              66            (a)             14       517
     Allowance for excess and obsolete inventories ...    1,134             555            (a)            (23)    1,712

</TABLE>

(a)  Write-offs & adjustments

(b)  Credit to selling, general and administrative expenses