-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, H5XSkMkQuq1QvRPb8tkk9fVs1dT5sTTv5hrxx56h3m2DlLV/cD0DTDj0Eyf+oVUw w8y12lsh08uXqy1w24gbzA== 0001047469-98-031709.txt : 19980817 0001047469-98-031709.hdr.sgml : 19980817 ACCESSION NUMBER: 0001047469-98-031709 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ODS NETWORKS INC CENTRAL INDEX KEY: 0000736012 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER COMMUNICATIONS EQUIPMENT [3576] IRS NUMBER: 751911917 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-20191 FILM NUMBER: 98690895 BUSINESS ADDRESS: STREET 1: 1101 E ARAPAHO ROAD CITY: RICHARDSON STATE: TX ZIP: 75081 BUSINESS PHONE: 2142346400 MAIL ADDRESS: STREET 1: 1101 E ARAPAHO ROAD CITY: RICHRICHARDSON STATE: TX ZIP: 75081 FORMER COMPANY: FORMER CONFORMED NAME: OPTICAL DATA SYSTEMS INC DATE OF NAME CHANGE: 19950517 10-Q 1 10-Q - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________to______________ Commission File Number 0-20191 --------- * * * * * * ODS NETWORKS, INC. ------------------------------------------------------ (Exact name of Registrant as specified in its charter) Delaware 75-1911917 - ------------------------------- ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1101 East Arapaho Road, Richardson, Texas 75081 ----------------------------------------------- (Address of principal executive offices) (Zip Code) (972) 234-6400 ---------------------------------------------------- (Registrant's telephone number, including area code) Not Applicable ------------------------------------------- (Former name, if changed since last report) * * * * * * Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes X No --- --- * * * * * * The number of shares outstanding of the Registrant's Common Stock, $.01 par value, on July 31, 1998 was 16,887,233. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ODS NETWORKS, INC. INDEX PART I - FINANCIAL INFORMATION PAGE ---- Item 1. Financial Statements Condensed Consolidated Balance Sheets as of June 30, 1998 and December 31, 1997 . . . . . . . . . . . . . . . . . . . 3 Condensed Consolidated Statements of Operations for the three months ended June 30, 1998 and June 30, 1997. . . . . . . . 4 Condensed Consolidated Statements of Operations for the six months ended June 30, 1998 and June 30, 1997. . . . . . . . 5 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1998 and June 30, 1997. . . . . . . . 6 Notes to Condensed Consolidated Financial Statements . . . . . . 7 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition. . . . . . . . . . . 10 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders . . 18 Item 5. Other Information . . . . . . . . . . . . . . . . . . . 18 Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . 18 Signature Page . . . . . . . . . . . . . . . . . . . . . . . . . 19
-2- PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS. ODS NETWORKS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except par value amounts)
June 30, Dec. 31, 1998 1997 ----------- ------- (Unaudited) ASSETS Current Assets: Cash and cash equivalents $12,343 $17,911 Short-term investments 8,960 14,667 Accounts receivable (net) 14,876 8,668 Income taxes receivable 527 3,159 Inventories 16,217 14,671 Deferred tax assets 2,524 1,721 Other assets 1,181 1,221 ------- ------- Total current assets 56,628 62,018 Property and equipment (net) 11,912 11,836 Long-term investments 2,756 3,168 Intangibles, net 3,982 - Equity investments 1,835 - Other assets 164 156 ------- ------- TOTAL ASSETS $77,277 $77,178 ------- ------- ------- ------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 7,875 $ 5,381 Accrued expenses 3,896 3,328 Deferred revenue 1,990 1,462 ------- ------- Total current liabilities 13,761 10,171 Deferred tax liabilities 2,091 628 Capital lease obligations 12 - Stockholders' Equity: Preferred stock, $.01 par value, Authorized shares - 5,000 No shares issued and outstanding Common stock, $.01 par value, Authorized shares - 80,000 Issued and outstanding shares - 16,887 in 1998 and 16,486 in 1997 169 165 Additional paid-in capital 22,698 19,488 Retained earnings 38,849 47,032 Foreign currency translation adjustments (303) (306) ------- ------- Total stockholders' equity 61,413 66,379 ------- ------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $77,277 $77,178 ------- ------- ------- -------
See accompanying notes. -3- ODS NETWORKS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) (Unaudited)
Three Months Ended ---------------------- June 30, June 30, 1998 1997 ------- ------- Net sales $25,215 $27,868 Cost of sales 14,389 16,076 ------- ------- Gross profit 10,826 11,792 Operating expenses: Sales and marketing 8,134 7,877 Research and development 2,932 2,823 In-process research and development 5,300 - General and administrative 1,491 1,258 ------- ------- Operating loss (7,031) (166) Interest income, net 356 374 ------- ------- Income (loss) before income taxes (6,675) 208 Income tax (benefit) provision (538) 79 ------- ------- Income (loss) before equity in affiliate (6,137) 129 Equity in net income (loss) of affiliate (72) - ------- ------- Net income (loss) $(6,209) $ 129 ------- ------- ------- ------- Basic and Diluted income (loss) per share $ (0.37) $ .01 ------- ------- ------- ------- Weighted average common shares outstanding 16,739 16,423 ------- ------- ------- ------- Weighted averages shares outstanding assuming dilution 16,739 16,753 ------- ------- ------- -------
See accompanying notes. -4- ODS NETWORKS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) (Unaudited) Six Months Ended ----------------------- June 30, June 30, 1998 1997 ------- ------- Net sales $ 43,428 $48,029 Cost of sales 24,587 27,241 -------- ------- Gross profit 18,841 20,788 Operating expenses: Sales and marketing 15,936 15,018 Research and development 5,599 5,653 In-process research and development 5,300 - General and administrative 2,654 2,520 -------- ------- Operating loss (10,648) (2,403) Interest income, net 795 711 -------- ------- Loss before income taxes (9,853) (1,692) Income tax (benefit) provision (1,742) (643) -------- ------- Loss before equity in affiliate (8,111) (1,049) Equity in net income (loss) of affiliate (72) - -------- ------- Net loss $ (8,183) $(1,049) -------- ------- -------- ------- Basic and Diluted loss per share $ (0.49) $ (0.06) -------- ------- -------- ------- Weighted average common shares outstanding 16,625 16,392 -------- ------- -------- ------- Weighted averages shares outstanding assuming dilution 16,625 16,392 -------- ------- -------- -------
See accompanying notes. -5- ODS NETWORKS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Six Months Ended ------------------------ June 30, June 30, 1998 1997 --------- --------- Operating Activities: Net loss ($ 8,183) ($ 1,049) Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities: In-process research and development 5,300 - Depreciation 1,692 1,530 Amortization 182 - Equity in net loss of affiliate 72 - Deferred income taxes (680) (1,265) Provision for doubtful accounts and returns - 35 Changes in operating assets and liabilities: Accounts receivable (5,349) 2,571 Inventories (1,200) 6,631 Other assets 9 (39) Accounts payable and accrued expenses 2,170 (403) Deferred revenue (12) (337) Income taxes 2,632 460 -------- ------- Net cash provided by (used in) operating activities (3,367) 8,134 ------- ------- Investing Activities: Payments for corporate acquisition (net of cash acquired) (5,604) - Equity Investment in Blue Ridge Networks (1,250) - Purchases of short-term investments (2,437) (10,849) Maturities of short-term investments 9,151 10,932 Purchases of long-term investments (600) (2,495) Maturities of long-term investments 5 13 Purchases of property and equipment (1,340) (1,943) ------- ------- Net cash used in investing activities (2,075) (4,342) ------- ------- Financing Activities: Repayment of Essential Communication Corp. line of credit (400) - Exercise of warrants and employee stock options 271 465 ------- ------- Net cash provided by (used in) financing activities (129) 465 ------- ------- Effect of foreign currency translation adjustment on cash and cash equivalents 3 (8) ------- ------- Net increase (decrease) in cash and cash equivalents (5,568) 4,249 Cash and cash equivalents at beginning of period 17,911 6,565 ------- ------- Cash and cash equivalents at end of period $12,343 $10,814 ------- ------- ------- ------- Supplemental disclosure of income taxes paid $ - $ 239 ------- ------- ------- ------- Supplemental schedule of non cash activities: Tax benefit of stock options exercised and sold $ - $ 27 ------- ------- ------- -------
See accompanying notes. -6- ODS NETWORKS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note A - Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The December 31, 1997 balance sheet was derived from audited financial statements, but does not include all the disclosures required by generally accepted accounting principles. However, the Company believes that the disclosures are adequate to make the information presented not misleading. In the opinion of management, all the adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included. The results of operations for the six month period ended June 30, 1998 are not necessarily indicative of the results which may be achieved for the full fiscal year or for any future period. The condensed consolidated financial statements included herein should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1997. Computation of Net Income Per Share The Company adopted Statement of Financial Accounting Standards (SFAS) No. 128 on December 31, 1997 and has restated all EPS data presented. Under SFAS No. 128 the Company is required to report two separate earnings per share numbers, basic EPS and diluted EPS. Diluted EPS is essentially the same number the Company has previously reported as primary earnings per share and includes the dilutive impact of employee stock options and warrants. Equity Investment In March 1998, the Company invested $1.25 million in Blue Ridge Networks, Inc., a privately-held company which provides secure remote access products for local and wide area virtual private networks. This investment was accounted for using the equity method of accounting. The Company's share of earnings or losses of Blue Ridge Networks, Inc. is reported in the income statement of the Company. Business Combinations On May 7, 1998, the Company acquired Essential Communication Corporation ("Essential"), a privately-held company based in Albuquerque, New Mexico. Essential designs and manufactures high-speed computer network equipment. The Company exchanged a combination of $5.8 million of cash and approximately 305,000 shares of the Company's common stock for all outstanding shares of Essential capital stock, and the Company issued 104,000 stock options in exchange for all unexpired and unexercised options to acquire Essential capital stock. In connection with the acquisition, the Company recognized a one-time charge of $5.3 million, or $0.32 per share, for in-process technology in the second quarter of 1998. Essential's operations have been included in the Company's condensed consolidated financial statements since May 7, 1998, and the acquisition was accounted for using the purchase method of accounting. The total purchase price of $9.0 million was allocated to the net assets acquired based on their estimated fair market value, which included approximately $4.1 million of intangible assets to be amortized over five years on a straight-line basis; and approximately $5.3 million of in-process research and development. The in-process research and development was expensed at the date of the acquisition. Pro forma financial information has not been presented. The acquisition of Essential does not meet the reporting requirements for a significant subsidiary. -7- Exchange of Stock Options in First Quarter 1998 On January 21, 1998, the Compensation Committee of the Board of Directors approved a stock option exchange program (the Exchange Program), pursuant to which certain employees and officers holding incentive stock options (i) awarded under the Company's 1987 Incentive Stock Option Plan in 1997 and (ii) awarded prior to December 31, 1997, under the Company's 1995 Stock Option Plan (the 1995 Plan), were given the opportunity to exchange such options (Existing Options) for new options (New Options), based on the fair market value of the Company's Common Stock at the close of business on January 30, 1998. All directors of the Company, including the President and Chief Executive Officer and the Senior Vice President, were ineligible to participate in the Exchange Program. As a result of significant declines in the market value of the Company's Common Stock since issuance of the Existing Options, the Existing Options were exercisable at prices which substantially exceeded the market value of the Common Stock. In approving the Exchange Program and in keeping with the Company's philosophy of utilizing equity incentives to motivate and retain qualified employees, the Compensation Committee acknowledged that retention and attraction of qualified employees are critical to the Company's success and its ability to continue to meet its performance objectives. Additionally, recognizing that stock options constitute a significant component of the Company's compensation structure, the Compensation Committee deemed it important to regain the incentive intended to be provided by the New Options to purchase shares of the Company's Common Stock and therefore serve as a significant factor in the Company's ability to continue to attract and retain the services of superior quality personnel. Pursuant to the Exchange Program, holders of the Existing Options were offered the opportunity to exchange, on a share-for-share basis, such options for New Options having an exercise price of $7.50 per share, the fair market value of the Company's Common Stock on the exchange date of January 30, 1998. Each New Option was awarded under the 1995 Plan and vests and is exercisable with respect to 20% of the shares covered thereby on each anniversary date thereof. Eligible employees holding Existing Options for an aggregate of 646,800 shares of Common Stock with an average per share exercise price of approximately $15.87 elected to participate in the Exchange Program and were issued New Options covering the same aggregate number of underlying shares as they had held pursuant to their respective Existing Options. Other than the new exercise price and the commencement of a new vesting schedule, the option agreements relating to the New Options are substantially identical to the option agreements of the Existing Options they replaced. -8- Note B - Inventories (in Thousands) Inventories consist of: June 30, Dec. 31, 1998 1997 --------- --------- Raw materials $ 5,846 $ 4,077 Work in process 1,884 2,004 Finished products 6,007 6,593 Demonstration systems 2,480 1,997 ------- ------- $16,217 $14,671 ------- ------- ------- -------
Note C - Accrued Expenses (in Thousands) Included in accrued expenses are the following: June 30, Dec. 31, 1998 1997 -------- -------- Accrued sales commissions $ 897 $ 563 Accrued property taxes 365 689 Accrued vacation expense 881 724 Accrued warranty expense 475 475 Other (individually less than 5% of current liabilities) 1,278 877 ------- ------- $ 3,896 $ 3,328 ------- ------- ------- -------
Note D - Earnings per Share (in Thousands, except per share amounts) Three Months Ended June 30, Six Months Ended June 30, --------------------------- ------------------------- 1998 1997 1998 1997 ------- ------- ------- -------- Numerator: Net income (loss) $(6,209) $ 129 $(8,183) $ (1,049) ------- ------- ------- -------- Numerator for basic and diluted earnings per share $(6,209) $ 129 $(8,183) $ (1,049) Denominator: Denominator for basic earnings per share - weighted average common shares outstanding 16,739 16,423 16,625 16,392 Effect of dilutive securities: Stock options and warrants 0 330 0 0 Denominator for diluted earnings per share - adjusted weighted average common shares out- standing 16,739 16,753 16,625 16,392 ------- ------- ------- -------- ------- ------- ------- -------- Basic income (loss) per share $(0.37) $ .01 $(0.49) $(0.06) ------- ------- ------- -------- ------- ------- ------- -------- Diluted income (loss) per share $(0.37) $ .01 $(0.49) $(0.06) ------- ------- ------- -------- ------- ------- ------- --------
-9- Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This quarterly report, other than historical information, may include forward-looking statements with respect to financial results, product introductions, market demand, industry trends, sufficiency of cash resources and certain other matters. These statements are made under the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and involve risks and uncertainties which could cause actual results to differ materially from those in the forward-looking statements, including those discussed in the section entitled "Factors That May Affect Future Results of Operations" and elsewhere in this filing, as well as those discussed in the Company's Annual Report on Form 10-K and other filings with the Securities and Exchange Commission. The following table sets forth, for the periods indicated, certain financial data as a percentage of net sales: THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 1998 1997 1998 1997 ------ ------ ------ ------ Net sales 100.0% 100.0% 100.0% 100.0% Cost of sales 57.1 57.7 56.6 56.7 ------ ------ ------ ------ Gross profit 42.9 42.3 43.4 43.3 Sales and marketing expenses 32.2 28.3 36.7 31.3 Research and development expenses 11.5 10.1 12.9 11.8 In-process research and development 21.1 - 12.2 - General and administrative expenses 5.9 4.5 6.1 5.2 ------ ------ ------ ------ Operating income (loss) (27.8) (0.6) (24.5) (5.0) Interest income, net 1.4 1.3 1.8 1.5 ------ ------ ------ ------ Income (loss) before income taxes (26.4) 0.7 (22.7) (3.5) Income tax (benefit) provision (2.1) 0.3 (4.0) (1.3) ------ ------ ------ ------ Income (loss) before equity in affiliate (24.3) 0.4 (18.7) (2.2) Equity in net income (loss) of affiliate (0.3) - (0.1) - ------ ------ ------ ------ Net income (loss) (24.6)% 0.4% (18.8)% (2.2)% ------ ------ ------ ------ ------ ------ ------ ------ Switching product sales 52.1% 42.3% 47.5% 35.7% Shared bandwidth hub sales 40.7 52.3 44.5 58.3 Other sales 7.2 5.4 6.0 6.0 ------ ------ ------ ------ Net sales 100.0% 100.0% 100.0% 100.0% ------ ------ ------ ------ ------ ------ ------ ------ Domestic sales 75.8% 68.3% 77.7% 72.5 Export sales to: Europe 14.1 7.7 13.3 8.7 Canada 2.7 2.3 3.5 3.6 Asia 7.2 18.6 5.1 12.5 Latin America .2 3.1 .4 2.7 ------ ------ ------ ------ Net sales 100.0% 100.0% 100.0% 100.0% ------ ------ ------ ------ ------ ------ ------ ------
-10- RESULTS OF OPERATIONS NET SALES. Net sales for the quarter and six months ended June 30, 1998 decreased to $25.2 million and $43.4 million, respectively, compared to $27.9 million and $48.0 million, respectively, for the same periods of 1997 as sales of the Company's new network switching products did not increase quickly enough to offset the decrease in sales of its prior generation shared bandwidth intelligent hubs. Export sales for the quarter and six months ended June 30, 1998 decreased to $6.1 million and $9.7 million, respectively, compared to $8.8 million and $13.2 million, respectively, for the same periods of 1997 primarily due to adverse economic developments in Malaysia and South Korea. Sales to FORE Systems, Inc. ("FORE Systems") were 15.4% and 10.8%, respectively, of net sales during the quarter and six months ended June 30, 1998. Direct net sales to various agencies of the U.S. Government were 15.0% and 14.5%, respectively, of net sales during the quarter and six months ended June 30, 1998, compared to 13.2% and 11.6%, respectively, of net sales for the same periods of 1997. Sales to Electronic Data Systems Corporation ("EDS") were 2.2% and 7.0%, respectively, of net sales during the quarter and six months ended June 30, 1998, compared to 14.6% and 14.5%, respectively, of net sales for the same periods of 1997. Sales to Sapura Holdings Sdn. Bhd. ("Sapura") were 5.0% and 3.1%, respectively, of net sales during the quarter and six months ended June 30, 1998, compared to 13.9% and 8.1%, respectively, of net sales for the same periods of 1997. GROSS PROFIT. Gross profit decreased to $10.8 million or 42.9% of net sales for the second quarter of 1998 compared to $11.8 million or 42.3% of net sales for the second quarter of 1997. Gross profit decreased to $18.8 million or 43.4% of net sales for six months ended June 30, 1998 compared to $20.8 million or 43.3% of net sales for the same period of 1997. Gross profit margins in future periods may be affected by several factors such as continued product transition, declining market demand for prior generation products, obsolescence or surplus of inventory, shifts in product mix, changes in channels of distribution, sales volume, fluctuation in manufacturing costs, pricing strategies of the Company and its competitors and fluctuations in sales of integrated third-party products. Gross profit margins are typically lower on sales of integrated third-party products. SALES AND MARKETING. Sales and marketing expenses increased to $8.1 million or 32.2% of net sales for the second quarter of 1998 from $7.9 million or 28.3% of net sales for the second quarter of 1997. Sales and marketing expenses increased to $15.9 million or 36.7% of net sales for six months ended June 30, 1998 compared to $15.0 million or 31.3% of net sales for the same period of 1997. The increase in sales and marketing expense was primarily due to the acquisition of Essential on May 7, 1998 and increased marketing efforts. Sales and marketing expenses may vary as a percentage of net sales in the future. RESEARCH AND DEVELOPMENT. Research and development expenses, excluding the one-time charge for in-process research and development, increased to $2.9 million or 11.5% of net sales for the second quarter of 1998 from $2.8 million or 10.1% of net sales for the second quarter of 1997. Research and development expenses, excluding the one-time charge for in-process research and development, decreased to $5.6 million or 12.9% of net sales for six months ended June 30, 1998 compared to $5.7 million or 11.8% of net sales for the same period of 1997. The Company expects to continue to invest in research and development activities in the future in order to broaden its family of network switching, management and security products. -11- IN-PROCESS RESEARCH AND DEVELOPMENT. During the second quarter of 1998, the Company incurred a one-time charge associated with the acquisition of Essential of $5.3 million to expense the purchased in-process research and development that had not reached technological feasibility. GENERAL AND ADMINISTRATIVE. General and administrative expenses increased to $1.5 million or 5.9% of net sales for the second quarter of 1998 from $1.3 million or 4.5% of net sales for the second quarter of 1997. General and administrative expenses increased to $2.7 million or 6.1% of net sales for six months ended June 30, 1998 compared to $2.5 million or 5.2% of net sales for the same period of 1997. The increase in general and administrative expenses for the second quarter of 1998 was primarily due to the amortization of intangibles related to the acquisition of Essential on May 7, 1998. General and administrative expenses may vary as a percentage of net sales in the future. INTEREST. Net interest income remained relatively constant at $0.4 million and $0.8 million, respectively, for the quarter and six months ended June 30, 1998 compared to $0.4 million and $0.7 million, respectively, for the same periods of 1997. Net interest income may vary in the future based on the Company's cash flow and rate of return on investments. INCOME TAXES. The Company's effective income tax rate was 8% and 17.7%, respectively, for the quarter and six months ended June 30, 1998 compared to the 38.0% for the same periods of 1997. The effective tax rate represented by the Company's provision for income taxes in the second quarter ended June 30, 1998 would have been approximately 37.1%, disregarding the expenses associated with the Company's write-off of purchased research and development costs which were not deductible for tax purposes. LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of liquidity at June 30, 1998 were $12.3 million of cash and cash equivalents, $9.0 million of short-term investments, $2.8 million of highly liquid investments with a stated maturity beyond one year and an available line of credit. As of June 30, 1998, working capital was $42.9 million compared to $51.8 million as of December 31, 1997. Cash flows used in operations for the first six months of 1998 were $3.4 million, primarily due to an increase in inventory and accounts receivable balances and a net loss for the period partially offset by an increase in accounts payable. Future fluctuations in accounts receivable and inventory balances will be dependent upon several factors, including but not limited to quarterly sales, ability to collect accounts receivable timely, the Company's strategy as to building inventory in advance of receiving orders from customers, and the accuracy of the Company's forecasts of product demand and component requirements. Cash used in investing activities in the first six months of 1998 was $2.1 million, primarily due to property and equipment purchases of $1.3 million, an equity investment in Blue Ridge Networks, Inc. of $1.25 million and cash used in the acquisition of Essential Communications Corporation of $5.6 million offset by net maturities of short-term and long-term investments of $6.1 million. Cash used in financing activities in the first six months of 1998 was $0.1 million, due to the repayment of Essential's line of credit in the amount of $0.4 million offset by the issuance of Common Stock relating to the exercise of certain employee stock options in the amount of $0.3 million. During the first six months of 1998 the Company funded its operations solely -12- through cash flows from operations. The Company has a bank line of credit agreement with $15.0 million of maximum available borrowings. Borrowings under this line are secured by the Company's accounts receivable and inventory and are subject to certain limitations and conditions, including the maintenance of certain financial ratios and minimum net tangible worth amounts. Borrowings on this line accrue interest at prime with interest due monthly and principal due April 12, 1999. As of June 30, 1998, the Company had no borrowings outstanding under its bank credit facility and had $15.0 million available for allowable borrowings at an applicable interest rate of 8.5% per annum. The Company intends to seek acquisitions of businesses, products and technologies that are complementary to those of the Company. The Company is continuing to identify and prioritize additional networking and security technologies which it may wish to develop, either internally or through the licensing or acquisition of products from third parties. While the Company engages from time to time in discussions with respect to potential acquisitions, there can be no assurances that any such acquisitions will be made or that the Company will be able to successfully integrate any acquired business. In order to finance such acquisitions, it may be necessary for the Company to raise additional funds through public or private financings. Any equity or debt financings, if available at all, may be on terms which are not favorable to the Company and, in the case of equity financings, may result in dilution to the Company's stockholders. FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS As noted above, this report includes foregoing discussions including forward-looking statements that involve risks and uncertainties. In addition to those factors discussed elsewhere in this quarterly report and those discussed in the Company's annual report on Form 10-K and other filings with the Securities and Exchange Commission, the Company identifies the following factors which could affect the Company's actual results and cause actual results to differ materially from those in the forward-looking statements. TECHNOLOGICAL CHANGES. The market for the Company's products is characterized by frequent product introductions, rapidly changing technology and continued evolution of new industry standards. The market for network intelligent hubs, switches, management and security products requires the Company's products to be compatible and interoperable with products and architectures offered by various vendors, including other networking products, workstation and personal computer architectures and computer and network operating systems. The Company's success will depend to a substantial degree upon its ability to develop and introduce in a timely manner new products and enhancements to its existing products that meet changing customer requirements and evolving industry standards. The development of technologically advanced products is a complex and uncertain process requiring high levels of innovation as well as the accurate anticipation of technological and market trends. There can be no assurance that the Company will be able to identify, develop, manufacture, market and support new or enhanced products successfully in a timely manner. Further, the Company or its competitors may introduce new products or product enhancements that shorten the life cycle of or obsolete the Company's existing product lines which could have a material adverse effect on the Company's business, operating results and financial condition. COMPETITION AND MARKET ACCEPTANCE. The market for network intelligent hubs, switches, management and security products is intensely competitive and subject to frequent product introductions with improved price/performance characteristics. Even if the Company does introduce advanced products which meet evolving customer requirements in a timely manner, there can be no assurance that the new Company -13- products will gain market acceptance. Many networking companies, including Cisco Systems, Inc. ("Cisco"), Cabletron Systems, Inc. ("Cabletron"), Bay Networks, Inc. ("Bay Networks"), FORE Systems, Xylan Corporation ("Xylan") and others, have substantially greater financial, technical, sales and marketing resources, better name recognition and a larger customer base than the Company. Many of the Company's large competitors offer customers a broader product line which provides a more comprehensive networking solution than the Company currently offers. The Company anticipates increased competition from large telecommunication equipment vendors which are expanding their capabilities in the data networking market. For example, Lucent Technologies and Nortel have acquired several networking companies to enhance their capabilities in data networking. Further the Company anticipates increased competition from private "start-up" companies that have developed or are developing advanced network switching and security products. Increased competition in the networking industry could result in significant price competition, reduced profit margins or loss of market share, any of which could have a material adverse effect on the Company's business, operating results and financial condition. The Company is pursuing a strategy to increase the percentage of its revenue generated through indirect sales channels including value added resellers, system integrators, original equipment manufacturers and network service providers. There can be no assurance that the Company's products will gain market acceptance in these indirect sales channels. Further, competition among networking and security companies to sell products through these indirect sales channels could result in significant price competition and reduced profit margins. The Company is also pursuing a strategy to broaden and further differentiate its product line by introducing complementary network switching, management and security products and incorporating new technologies into its existing product line. There can be no assurance that the Company will successfully introduce these products or that such products will gain market acceptance. The Company anticipates competition from networking companies, network security companies and others in each of its product lines. The Company anticipates that profit margins will vary among its product lines and that product mix fluctuations could have an adverse effect on the Company's overall profit margins. ACQUISITIONS. Cisco, Cabletron, Bay Networks, FORE Systems, Lucent Technologies, Nortel and other competitors have recently acquired several networking and security companies with complementary technologies, and the Company anticipates that such acquisitions will continue in the future. These acquisitions may permit such competitors to accelerate the development and commercialization of broader product lines and more comprehensive networking solutions than the Company currently offers. In the past, the Company has relied upon a combination of internal product development and partnerships with other networking vendors to provide competitive networking solutions to customers. Certain of the recent and future acquisitions by the Company's competitors may have the effect of limiting the Company's access to commercially significant technologies. Further, the business combinations and acquisitions in the networking and security industry are creating companies with larger market shares, customer bases, sales forces, product offerings and technology and marketing expertise. There can be no assurance that the Company will be able to compete successfully in such an environment. In March 1998, the Company invested $1.25 million in Blue Ridge Networks, Inc. a private corporation which provides secure remote access products for local and wide area virtual private networks. On May 7, 1998, the Company acquired Essential Communication Corporation, a privately-held company based in Albuquerque, New Mexico. Essential designs and manufactures high-speed computer network equipment. The Company may, in the future, acquire or invest in additional companies, business units, product lines, or technology to accelerate the development -14- of products and sales channels complementary to the Company's existing products and sales channels. Acquisitions involve numerous risks, including difficulties in assimilation of operations, technologies, and products of the acquired companies; risks of entering markets in which the Company has no or limited direct prior experience and where competitors in such markets have stronger market positions; the potential loss of key employees of the acquired company; and the diversion of management's attention from normal daily operation of the Company's business. There can be no assurance that any potential acquisition or investment will be consummated or that anticipated benefits of such acquisition or investment will be realized. PRODUCT TRANSITIONS. Once current networking products have been in the market place for a period of time and begin to be replaced by higher performance products (whether of the Company's or a competitor's design), the Company expects the net sales of such networking products to decrease. In order to achieve revenue growth in the future, the Company will be required to design, develop and successfully commercialize higher performance products in a timely manner. For example, the market for shared bandwidth intelligent hubs, sales of which represented the majority of the Company's net sales over the past several years, decreased in the first half of 1998 compared to the same period of 1997 and may continue to decrease as switching products with enhanced price/performance characteristics gain market acceptance. There can be no assurance that the Company will be able to introduce new products and gain market acceptance quickly enough to avoid adverse revenue transition patterns during current or future product transitions. MANUFACTURING AND AVAILABILITY OF COMPONENTS. The Company's manufacturing operations consist primarily of final assembly, testing and quality control of subassemblies and finished units. Materials used by the Company in its manufacturing processes include semiconductors such as microprocessors, memory chips and application specific integrated circuits ("ASICs"), printed circuit boards, power supplies and enclosures. All of the materials used in the Company's products are purchased under contracts and purchase orders with third parties. While the Company believes that many of the materials used in the production of its products are generally readily available from a variety of sources, certain components are available from one or a limited number of suppliers. For example, certain ASICs designed into the Company's InfiniteSwitch products are supplied by FORE Systems (see "Factors That May Affect Future Results of Operations -Competition and Market Acceptance"). The lead times for delivery of components vary significantly and exceed twelve weeks for certain components. If the Company should fail to forecast its requirements accurately for components, it may experience excess inventory or shortages of certain components which could have an adverse effect on the Company's business and operating results. Further, any interruption in the supply of any of these components, or the inability of the Company to procure these components from alternative sources at acceptable prices within a reasonable time, could have additional adverse effect on the Company's business and operating results. THIRD-PARTY PRODUCTS. The Company believes that it is beneficial to work with third parties with complementary technologies to broaden the appeal of the Company's switches, intelligent hub and network security products. These alliances allow ODS to provide integrated solutions to its customers, combining ODS developed technology with third-party products such as certain routers from Cisco, ATM switches from FORE Systems and Gigabit Ethernet switch technology from Lucent Technologies. As the Company also competes with these technology partners in certain segments of the market, there can be no assurance that the Company will have access to all of the third-party products which may be desirable to offer fully integrated solutions to ODS customers. -15- DEPENDENCE ON KEY CUSTOMERS. A relatively small number of customers have accounted for a significant portion of the Company's revenue. U.S. Government agencies and strategic network integrators are expected to continue to account for a substantial portion of the Company's net revenue. The Company continuously faces competition from Cisco, Cabletron, Bay Networks, FORE Systems, Xylan and others for U.S. Government networking projects and corporate networking installations. Any reduction or delay in sales of the Company's products to these customers could have a material adverse effect on the Company's operating results. INTERNATIONAL OPERATIONS. Export sales accounted for approximately 24.3% of the Company's revenue in the second quarter of 1998. The Company expects that export sales will represent a significant portion of its business in the future. The Company's international operations may be affected by changes in demand resulting from fluctuations in currency exchange rates and local purchasing practices, including seasonal fluctuations in demand, as well as by risks such as increases in duty rates, difficulties in distribution and other constraints upon international trade. For example, the fluctuations in currency exchange rates and adverse economic developments in Malaysia, South Korea and certain other countries adversely affected demand for the Company's products in those countries in the fourth quarter of 1997 and the first half of 1998. These conditions may continue to adversely affect demand for the Company's products in those countries throughout 1998. Additionally, while the Company's current products are designed to meet relevant regulatory requirements of the foreign markets in which they are sold, any inability to obtain any required foreign regulatory approvals on a timely basis could have a material adverse effect on the Company's operating results. INTELLECTUAL PROPERTY. The Company's success and its ability to compete is dependent, in part, upon its proprietary technology. The Company does not hold any issued patents and currently relies on a combination of contractual rights, trade secrets and copyright laws to establish and protect its proprietary rights in its products. There can be no assurance that the steps taken by the Company to protect its intellectual property will be adequate to prevent misappropriation of its technology or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. The Company is also subject to the risk of adverse claims and litigation alleging infringement of intellectual property rights of others. The Company could incur substantial costs in defending itself and its customers against any such claim regardless of the merits of such claims. In the event of a successful claim of infringement, the Company may be required to obtain one or more licenses from third parties. There can be no assurance that the Company could obtain the necessary licenses on reasonable terms. IMPACT OF YEAR 2000. Some of the Company's older computer programs were written using two digits rather than four to define the applicable year. As a result, those computer programs have time-sensitive software that recognize a date using "00" as the year 1900 rather than the year 2000. Accordingly the date January 1, 2000 could cause a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. The Company has completed an assessment and will have to modify or replace portions of its software so that its computer systems will function properly with respect to dates in the year 2000 and thereafter. The total Year 2000 project cost is estimated to be immaterial. -16- The Company has initiated communications with all of its significant suppliers and large customers to determine the extent to which the Company's interface systems are vulnerable to those third parties' failure to remediate their own Year 2000 issues. There can be no guarantee that the systems of other companies on which the Company's systems rely will be timely converted and would not have an adverse effect on the Company's systems. The Company has determined it has immaterial exposure to contingencies related to the Year 2000 issue for the products it has sold. The Company's Year 2000 project is estimated to be completed not later than December 31, 1998, which is prior to any anticipated impact on its operating systems. The Company believes that with modifications to existing software and conversions to new software, the Year 2000 issue will not pose significant operational problems for its computer systems. However, if such modifications and conversions are not made, or are not completed timely, the Year 2000 issue could have a material impact on the operations of the Company. The costs of the project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continuous availability of certain resources and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties. The Company is concerned that many enterprises will be devoting a substantial portion of their information systems spending to resolving this upcoming year 2000 problem. This may result in spending being diverted from networking solutions over the next two years. The year 2000 issue could lower demand for the Company's products. This factor, while not quantified, could have a material adverse impact on the Company's financial results. GENERAL. Sales of networking products fluctuate, from time to time, based on numerous factors, including customers' capital spending levels and general economic conditions. While certain industry analysts believe that there is a significant market for network intelligent hubs, switches, management and security products, there can be no assurance as to the rate or extent of the growth of such market or the potential adoption of alternative technologies. Future declines in networking product sales as a result of general economic conditions, adoption of alternative technologies or any other reason could have a material adverse effect on the Company's business, operating results and financial condition. Due to the factors noted above and elsewhere in Management's Discussion and Analysis of Financial Condition and Results of Operations, the Company's future earnings and stock price may be subject to significant volatility, particularly on a quarterly basis. Past financial performance should not be considered a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods. Any shortfall in revenue and earnings from the levels anticipated by securities analysts could have an immediate and significant effect on the trading price of the Company's common stock in any given period. Also, the Company participates in a highly dynamic industry which often results in volatility of the Company's common stock price. -17- PART II - OTHER INFORMATION Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Annual Meeting of Stockholders was held on April 21, 1998 at the Holiday Inn Richardson Select in Richardson, Texas. The following is a brief description of each matter voted upon by stockholders, including number of votes cast for, against, or withheld with regard to each matter of nominee. (1) Election of five (5) directors to serve until the next Annual Meeting of Stockholders and until their respective successors are duly elected and qualified. FOR WITHHELD --- -------- G. Ward Paxton 14,979,571 140,512 Robert Anderson 14,979,121 140,962 J. Fred Bucy 14,982,825 137,258 T. Joe Head 14,985,320 134,763 Donald M. Johnston 14,986,070 134,013
(2) Ratification and approval of selection by the Board of Directors of Ernst & Young LLP as independent auditors of the Registrant for the fiscal year ending December 31, 1998. FOR AGAINST WITHHELD --- ------- -------- 15,062,577 19,969 37,537
Item 5. OTHER INFORMATION. Stockholder Proposals Stockholders may submit proposals on matters appropriate for stockholder action at subsequent annual meetings of the stockholders consistent with Rule 14a-8 promulgated under the Exchange Act. For such proposals to be considered for inclusion in the Proxy Statement and Proxy relating to the 1999 Annual Meeting of Stockholders, such proposals must be received by the Company not later than November 20, 1998. Such proposals should be directed to ODS Networks, Inc., 1101 East Arapaho Road, Richardson, Texas 75081, Attention: Secretary (telephone: (972) 234-1467; telecopy: (972) 234-1467. Pursuant to new amendments to Rule 14a-4(c) of the Securities Exchange Act of 1934, as amended, if a stockholder who intends to present a proposal at the 1999 annual meeting of stockholders does not notify the Company of such proposal on or prior to February 3, 1999, then management proxies would be allowed to use their discretionary voting authority to vote on the proposal when the proposal is raised at the annual meeting, even though there is no discussion of the proposal in the 1999 proxy statement. Item 6. EXHIBITS AND REPORTS ON FORM 8-K. (A.) EXHIBITS. The following exhibits are included herein: (10.13) First Amendment Agreement to Third Amended and Restated Revolving Credit Loan Agreement, dated April 30, 1998, between NationsBank of Texas, N.A. (formerly, NCNB Texas National Bank) and the Company. (10.14) Amendment to the ODS 401(K) Savings Plan, Effective May 29, 1998 (27) Financial Data Schedule (B.) FORM 8-K. On May 21, 1998, the Company filed a report on Form 8-K (Item 2) to announce the acquisition of Essential Communications Corporation. -18- S I G N A T U R E S Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ODS NETWORKS, INC. (Company) Date: August 14, 1998 BY: /s/ TIMOTHY W. KINNEAR -------------------------------------- Timothy W. Kinnear Chief Financial Officer (Principal Financial Officer) BY: /s/ KANDIS TATE THOMPSON -------------------------------------- Kandis Tate Thompson Controller - Finance and Accounting (Principal Accounting Officer) -19- EXHIBIT INDEX EXHIBIT ------- 10.13 First Amendment Agreement to Third Amended and Restated Revolving Credit Loan Agreement, dated April 30, 1998, between NationsBank of Texas, N.A. (formerly NCNB Texas National Bank) and the Company. 10.14 Amendment to the ODS 401(K) Savings Plan, Effective May 29, 1998. 27 Financial Data Schedule
-20- EX-10.13 2 EXHIBIT 10.13 EXHIBIT 10.13 FIRST AMENDMENT AGREEMENT TO THIRD AMENDED AND RESTATED REVOLVING CREDIT LOAN AGREEMENT Date: As of April 30, 1998 NationsBank of Texas, N.A. Attention: Mr. Frank Izzo 901 Main Street, 7th Floor Dallas, Texas 75201 Ladies and Gentlemen: The undersigned, ODS Networks, Inc. (formerly known as Optical Data Systems, Inc.), a Texas corporation ("Borrower"), entered into a Third Amended and Restated Revolving Credit Loan Agreement (the "Loan Agreement") dated December 31, 1997, with NationsBank of Texas, N.A., a national banking association ("Bank"). Pursuant to the Loan Agreement, Bank agreed, under certain terms and conditions, to extend a loan (the "Loan") to Borrower evidenced by a Ninth Renewal Promissory Note (the "Note") dated December 31, 1997, executed by Borrower and payable to the order of Bank in the original principal amount of $15,000,000.00. Borrower has informed Bank that it desires, through its wholly-owned subsidiary ECC Acquisition Corp., to merge (such merger herein referred to as the "Essential Merger") with Essential Communication Corporation, a Delaware corporation, with Essential Communication Corporation being the surviving entity. Borrower has also informed Bank that Borrower desires to purchase (such purchase referred to herein as the "Blue Ridge Investment") convertible preferred stock in Blue Ridge Networks, Inc. ("Blue Ridge") for a maximum consideration of $1,250,000, which shares are convertible into common voting stock of Blue Ridge in an amount, if converted, equal to a minimum of 25% of the then outstanding voting interests of Blue Ridge. Borrower has requested that Bank consent to Borrower's departure from the covenants set forth in SECTIONS 7.5, 7.6, 7.9 and 7.11 of the Loan Agreement (collectively, the "Applicable Covenants") to allow the Essential Merger and the Blue Ridge Investment. Upon the terms and subject to the conditions set forth in this First Amendment Agreement (the "Agreement", terms used in this Agreement shall have the same meaning as in the Loan Agreement, if defined therein, unless otherwise defined in this Agreement), Bank consents to Borrower's departure from the Applicable Covenants for the sole purpose of allowing the Essential Merger and the Blue Ridge Investment. Borrower has also requested that Bank make certain modifications to the terms of the Loan Agreement. Bank has advised Borrower that Bank is willing to do so upon the terms and subject to the conditions of this Agreement. In consideration for the above premises and mutual promises and covenants herein contained, Borrower and Bank do hereby agree as follows: 1. CONSENT. (a) The Bank hereby consents to Borrower's departure from the Applicable Covenants of the Loan Agreement to the extent such covenants would be violated by either the Essential Merger or the Blue Ridge Investment. (b) The consent specifically described in clause 1(a) above shall not constitute and shall not be deemed a waiver of any Event of Default or a consent to the departure from any provisions to the Loan Agreement other than the Applicable Covenants, or a waiver of any rights or remedies arising as a result of any Event of Default. The failure to comply with the covenants described in clause 1(a) above for any activity other than the Essential Merger or the Blue Ridge Investment shall constitute an Event of Default. 2. AMENDMENTS TO THE LOAN AGREEMENT. Effective as of the date hereof, the Loan Agreement is hereby amended as follows: (a) The first sentence in SECTION 2.4 is amended and restated to read in its entirety as follows: "Borrower agrees to pay Bank a commitment fee of one-fourth of one percent (0.25%) per annum on the daily unused portion of the Revolving Credit Commitment." (b) SECTION 7.12 is amended and restated to read in its entirety as follows: 7.12 CONSOLIDATED TANGIBLE NET WORTH. Borrower will not permit, as of the last day of any calendar quarter, the Consolidated Tangible Net Worth for such day to be less than the amount opposite the applicable date in the following chart: -------------------------------------------------------- Minimum Consolidated Date Tangible Net Worth -------------------------------------------------------- December 31, 1997 $66,000,000 March 31, 1998 $63,000,000 June 30, 1998 $55,100,000 September 30, 1998 $55,050,000 -------------------------------------------------------- December 31, 1998 and the last day of each fiscal quarter thereafter $55,500,000 --------------------------------------------------------
(c) The first sentence in SECTION 7.13 is amended and restated to read in its entirety as follows: "Borrower will at all times maintain a Current Ratio of not less than 1.35 to 1.00." (d) Exhibit "C" to the Loan Agreement is amended by adding the following location to the list of U.S. Offices: 4374 Alexander Blvd., N.E., Suite T Albuquerque, NM 87107 3. CONDITIONS PRECEDENT. Bank's willingness to enter into this Agreement is subject to the conditions precedent that, as of the date hereof: (a) Bank shall receive the following (the "Amendment Documents"), duly executed by each party thereto, other than Bank, each in form and substance satisfactory to Bank: (i) this Agreement; (ii) a Subsidiary Joinder Agreement executed by Essential Communication Corporation; (iii) a certificate from the appropriate governmental authority evidencing Essential Communication Corporation's existence and good standing in the state of its incorporation; (iv) final, executed copies of each of the agreements, bills of sale and other documents effecting the Essential Merger and the Blue Ridge Investment; and (v) all other documents that Bank may request with respect to any matter relevant to this Agreement or the transactions contemplated hereby. (b) The representations and warranties of Borrower contained herein shall be true and correct in all material respects on and as of the date hereof, and Borrower shall have complied with all of the terms and conditions herein. The execution by Borrower of this Agreement is hereby deemed to constitute a representation and warranty by Borrower to the foregoing effect. 4. REPRESENTATIONS AND WARRANTIES. In order to induce Bank to enter into this Agreement, Borrower hereby represents and warrants to Bank that: (a) The Loan Papers are the legal, valid and binding obligations of Borrower, enforceable in accordance with their respective terms, except as limited by bankruptcy, insolvency or other laws of general application relating to the enforcement of creditors' rights; (b) Neither the execution and delivery of this Agreement nor the consummation of any of the transactions herein contemplated, nor compliance with the terms and provisions hereof will contravene or conflict with any provision of law, statute or regulation to which Borrower is subject or any judgment, license, order or permit applicable to Borrower or any indenture, mortgage, deed of trust or other instrument to which Borrower may be subject; no consent, approval, authorization or order of any court, governmental authority or third party is required in connection with the execution, delivery, or performance by Borrower of this Agreement or to consummate the transactions contemplated herein; (c) To the best of Borrower's knowledge, all financial statements delivered by Borrower to Bank prior to the date hereof are true and correct, fairly present the financial condition of Borrower and have been prepared in accordance with generally accepted accounting principles, consistently applied; as of the date hereof, there are no obligations, liabilities or indebtedness (including contingent and indirect liabilities) which are material to Borrower and not reflected in such financial statements; (d) To the best of Borrower's knowledge, no litigation, investigation, or governmental proceeding is pending, or, to the knowledge of any of Borrower's officers, threatened against or affecting Borrower, which may result in any material adverse change in Borrower's business, properties or operations, except as has been previously disclosed by Borrower to Bank; (e) To the best of Borrower's knowledge, Borrower owns all of the assets reflected on its most recent balance sheet free and clear of all liens, security interests or other encumbrances, other than those (if any) in favor of Bank; (f) To the best of Borrower's knowledge, Borrower is not in violation of any law, ordinance, governmental rule or regulation to which it is subject, and is not in default under any material agreement, contract or understanding to which it is a party, except as has been previously disclosed by Borrower to Bank; and (g) All of the representations and warranties contained in SECTION 5 of the Loan Agreement are true and correct on and as of the date hereof with the same force and effect as if made on and as of the date hereof, provided that the representations and warranties contained in SECTIONS 5.8 and 5.9 of the Loan Agreement are made with respect to the financial statements most recently submitted to Bank pursuant to SECTION 6.5 of the Loan Agreement. (h) Borrower has (i) begun analyzing the operations of Borrower and its subsidiaries and affiliates that could be adversely affected by failure to become Year 2000 compliant (that is, that computer applications, imbedded microchips and other systems will be able to perform date-sensitive functions prior to and after December 31, 1999) and; (ii) developed a plan for becoming Year 2000 compliant in a timely manner, the implementation of which is on schedule in all material respects. Borrower reasonably believes that it will become Year 2000 compliant for its operations and those of its subsidiaries and affiliates on a timely basis except to the extent that a failure to do so could not reasonably be expected to have a material adverse effect upon the financial condition of Borrower. (i) Borrower reasonably believes any suppliers and vendors that are material to the operations of Borrower or its subsidiaries and affiliates will be Year 2000 compliant for their own computer applications except to the extent that a failure to do so could not reasonably be expected to have a material adverse effect upon the financial condition of Borrower. (j) Borrower will promptly notify Bank in the event Borrower determines that any computer application which is material to the operations of Borrower, its subsidiaries or any of its material vendors or suppliers will not be fully Year 2000 compliant on a timely basis, except to the extent that such failure could not reasonably be expected to have a material adverse effect upon the financial condition of Borrower. 5. MISCELLANEOUS. (a) WAIVER. No failure to exercise, and no delay in exercising, on the part of Bank, any right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right. The rights of Bank hereunder and under the other Loan Papers shall be in addition to all other rights provided by law. No notice or demand given in any case shall constitute a waiver of the right to take other action in the same, similar or other instances without such notice or demand. (b) GOVERNING LAW. THIS AGREEMENT IS BEING EXECUTED AND DELIVERED, AND IS INTENDED TO BE PERFORMED, IN THE STATE OF TEXAS, AND THE SUBSTANTIVE LAWS OF TEXAS SHALL GOVERN THE VALIDITY, CONSTRUCTION, ENFORCEMENT AND INTERPRETATION OF THIS AGREEMENT AND ALL OTHER LOAN PAPERS, EXCEPT TO THE EXTENT: (i) OTHERWISE SPECIFIED THEREIN; (ii) THE FEDERAL LAWS GOVERNING NATIONAL BANKS EXPRESSLY SUPERSEDE AND HAVE CONTRARY APPLICATION; OR (iii) FEDERAL LAWS GOVERNING MAXIMUM INTEREST RATES SHALL PROVIDE FOR RATES OF INTEREST HIGHER THAN THOSE PERMITTED UNDER THE LAWS OF THE STATE OF TEXAS. (c) INVALID PROVISIONS. If any provision of this Agreement is held to be illegal, invalid or unenforceable under present or future laws effective during the term of this Agreement, such provision shall be fully severable and this Agreement shall be construed and enforced as if such illegal, invalid or unenforceable provision had never comprised a part of this Agreement, and the remaining provisions of this Agreement shall remain in full force and effect and shall not be affected by the illegal, invalid or unenforceable provision or by its severance from this Agreement. (d) ENTIRETY AND AMENDMENTS. The Loan Papers embody the entire agreement between the parties and supersede all prior agreements and understandings, if any, relating to the subject matter hereof and thereof, and this Agreement and the other Loan Papers may be amended only by an instrument in writing executed by the party, or an authorized officer of the party, against whom such amendment is sought to be enforced. (e) PARTIES BOUND. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors, assigns and legal representatives; provided, however, that Borrower may not, without the prior written consent of Bank, assign any rights, powers, duties or obligations hereunder. (f) PAYMENT OF EXPENSES. Borrower agrees to pay all costs and expenses of Bank (including, without limitation, the reasonable attorneys' fees of Bank's legal counsel) incurred by Bank in connection with the preparation of this Agreement and the preservation and enforcement of Bank's rights under this Agreement and the other Loan Papers. (g) HEADINGS. Section headings are for convenience of reference only and shall in no way affect the interpretation of this Agreement. (h) COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall for all purposes be deemed an original and all of which are identical. 6. NO ORAL AGREEMENTS. THIS AGREEMENT, TOGETHER WITH THE OTHER LOAN PAPERS AS WRITTEN, REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. If Bank agrees to the foregoing, Bank should execute this Agreement in the space indicated below. BORROWER: ODS NETWORKS, INC. (formerly known as Optical Data Systems, Inc.) By: /s/ Timothy Kinnear --------------------------------- Name: Timothy Kinnear Title: Vice President and CFO ACCEPTED: NATIONSBANK OF TEXAS, N.A. By: /s/ Frank Izzo --------------------------------- Name: Frank Izzo Title: Senior Vice President SUBSIDIARY JOINDER AGREEMENT This SUBSIDIARY JOINDER AGREEMENT (the "Agreement") dated as of April 30, 1998, is executed by the undersigned (the "Debtor") for the benefit of NATIONSBANK OF TEXAS, N.A., (the "Bank") in connection with that certain Third Amended and Restated Revolving Credit Loan Agreement dated as of December 31, 1997, between the Bank and Optical Data Systems, Inc., now known as ODS Networks, Inc. (the "Borrower) (as modified from time to time, the "Credit Agreement", and capitalized terms not otherwise defined herein being used herein as defined in the Credit Agreement). The Debtor is a newly formed or newly acquired Granting Subsidiary and is required to execute this Agreement pursuant to the Credit Agreement. NOW THEREFORE, in consideration of the premises and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Debtor hereby agrees as follows: 1. The Debtor assumes all the obligations of a "Debtor" under the Subsidiaries Security Agreement and agrees that it is a "Debtor" and bound as a "Debtor" under the terms of the Subsidiaries Security Agreement as if it had been an original signatory thereto. In furtherance of the foregoing, the Debtor hereby assigns, pledges and grants to Bank a security interest in all of its right, title and interest in and to Debtor's Collateral (as defined in the Subsidiaries Security Agreement) to secure the Obligations (as defined in the Subsidiaries Security Agreement) under the terms of the Subsidiaries Security Agreement. 2. Schedules 3.1 and 3.2 of the Subsidiaries Security Agreement are hereby amended to add the information relating to Debtor set out on Schedules 3.1 and 3.2 hereof. The Debtor hereby confirms that the representations and warranties set forth in Article 3 of the Subsidiaries Security Agreement applicable to it and its Collateral and the representations and warranties set forth in the Credit Agreement are true and correct after giving effect to such amendment to the Schedules. 3. In furtherance of its obligations under Section 4.2 of the Subsidiaries Security Agreement, Debtor agrees to execute and deliver such UCC (as defined in the Subsidiaries Security Agreement) financing statements naming the Debtor as debtor, the Bank as secured party and describing its Collateral and such other documentation as the Bank may require to evidence, protect and perfect the Liens created by the Subsidiaries Security Agreement as modified hereby. 4. This Agreement shall be deemed to be part of, and a modification to, the Subsidiaries Security Agreement and shall be governed by all the terms and provisions of the Subsidiaries Security Agreement, which terms are incorporated herein by reference, and which is ratified and confirmed and shall continue in full force and effect as a valid and binding agreement of Debtor enforceable against Debtor. The Debtor hereby waives notice of Bank's acceptance of this Agreement. IN WITNESS WHEREOF, the Debtor has executed this Agreement as of the day and year first written above. DEBTOR: ESSENTIAL COMMUNICATION CORPORATION By: /s/ Timothy W. Kinnear ---------------------------------- Name: Timothy W. Kinnear Title: CFO and Secretary SCHEDULE 3.1 TO SUBSIDIARY JOINDER AGREEMENT LOCATIONS I. PRINCIPAL PLACE OF BUSINESS 4374 Alexander Blvd. N.E., Suite T Albuquerque, NM 87107 II. OTHER LOCATIONS None SCHEDULE 3.2 TO SUBSIDIARY JOINDER AGREEMENT TRADE AND OTHER NAMES; TAX ID NUMBER Trade Name: Essential Communications Corporation Tax ID#: 85-0401328 EX-10.14 3 EXHIBIT 10.14 EXHIBIT 10.14 AMENDMENT TO ODS 401(k) SAVINGS PLAN WHEREAS, ODS Networks, Inc. (the "Employer") heretofore adopted the ODS 401(k) Savings Plan (the "Plan"); and WHEREAS, the Employer reserved the right to amend the Plan; and WHEREAS, the Employer desires to amend the Plan; NOW, THEREFORE, the Plan is hereby amended, effective as of May 29, 1998, as follows: 1. Section 2.1 of the Plan shall be amended by adding the following paragraph to the conclusion of such Section: Any Employee who was employed by Essential Communications Corporation ("Essential Communications") as of the date of its acquisition by the Employer, shall be credited with any prior service with Essential Communications in determining such Employee's Year(s) of Service. 2. Section 3.1 of the Plan shall be amended by adding the following paragraph to the conclusion of such Section: Notwithstanding the foregoing provisions of this Section 3.1, any Employee who was employed by Essential Communications Corporation ("Essential Communications") as of the date of its acquisition by the Employer, shall be credited with any prior service with Essential Communications in determining such Employee's Month(s) of Service. In this regard, any such Employee who was credited with at least three (3) Months of Service pursuant to the preceding sentence, shall become a Participant under the Plan as of May 29, 1998, or as soon as administratively practical thereafter, subject to the terms hereof. 3. Except as hereinabove amended, the provisions of the Plan shall continue in full force and effect. IN WITNESS WHEREOF, the Employer, by its duly authorized officer, has caused this Amendment to be executed on the 21st day of April, 1998. ODS NETWORKS, INC. By /s/ Timothy W. Kinnear -------------------------------------- EX-27 4 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF INCOME FOUND ON PAGES 3-5 OF THE COMPANY'S 10-Q FOR THE YEAR TO DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 6-MOS DEC-31-1998 JAN-01-1998 JUN-30-1998 12,343 8,960 15,765 889 16,217 56,628 27,625 15,713 77,277 13,761 0 0 0 169 61,244 77,277 43,428 43,428 24,587 24,587 29,489 0 0 (9,853) (1,742) (8,111) 0 0 0 (8,183) (0.49) (0.49)
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