-----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, ACZm3uWPOCKJYyo9xUpuggTC84cDPxVB0TSnGWU8dEACknM5jE+j4vpG8q/eGmsP KAamzcT7jiKGE/V2eMz+Tw== 0001047469-97-003463.txt : 19971111 0001047469-97-003463.hdr.sgml : 19971111 ACCESSION NUMBER: 0001047469-97-003463 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971110 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: NETWORK COMPUTING DEVICES INC CENTRAL INDEX KEY: 0000886138 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER TERMINALS [3575] IRS NUMBER: 770177255 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-20124 FILM NUMBER: 97712043 BUSINESS ADDRESS: STREET 1: 350 N BERNARDO AVE CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 BUSINESS PHONE: 4156940650 MAIL ADDRESS: STREET 1: 350 NORTH BERNARDO AVE CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043 10-Q 1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _______________ FORM 10-Q (Mark One) [x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarterly period ended September 30, 1997 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: 0-20124 NETWORK COMPUTING DEVICES, INC. (Exact name of registrant as specified in its charter) California 77-0177255 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 350 North Bernardo Avenue, Mountain View, California 94043 (Address of principal executive offices and zip code) Registrant's telephone number: (650) 694-0650 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 was 16,379,595 at October 31, 1997. NETWORK COMPUTING DEVICES, INC. INDEX DESCRIPTION PAGE NUMBER - --------------------------------------------------------- ----------- Cover Page 1 Index 2 Part I: Financial Information Item 1: Financial Statements Condensed Consolidated Balance Sheets as of September 30, 1997 and December 31, 1996 3 Condensed Consolidated Statements of Operations for the Three- and Nine-Month Periods Ended September 30, 1997 and 1996 4 Condensed Consolidated Statements of Cash Flows for the Nine-Month Periods Ended September 30, 1997 and 1996 5 Notes to Condensed Consolidated Financial Statements 6 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Part II: Other Information Item 6: Exhibits and Reports on Form 8-K 16 Signature 17 2 NETWORK COMPUTING DEVICES, INC. PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
ASSETS September 30, December 31, 1997 1996 ------------- ------------ (UNAUDITED) Current assets: Cash and cash equivalents $ 24,787 $ 23,832 Short-term investments 12,624 11,839 Accounts receivable, net 18,012 21,549 Inventories 14,724 9,776 Refundable and deferred income tax assets 4,395 8,287 Other current assets 2,835 3,652 ----------- ---------- Total current assets 77,377 78,935 Property and equipment, net 4,604 4,895 Other assets 1,637 1,863 ----------- ---------- Total assets $ 83,618 $ 85,693 ----------- ---------- ----------- ---------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 9,412 $ 4,383 Accrued expenses 9,471 9,337 Current portion of capital lease obligations 198 748 Deferred revenue 4,262 3,486 ----------- ---------- Total current liabilities 23,343 17,954 Long-term portion of capital lease obligations 182 314 Shareholders' equity: Undesignated preferred stock - - Common stock 59,285 68,217 Retained earnings (accumulated deficit) 808 (792) ----------- ---------- Total shareholders' equity 60,093 67,425 ----------- ---------- Total liabilities and shareholders' equity $ 83,618 $ 85,693 ----------- ---------- ----------- ----------
See accompanying notes. 3 NETWORK COMPUTING DEVICES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED - IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 1997 1996 1997 1996 --------------- -------------- --------------- ------------- Net revenues: Hardware products and services $ 26,532 $ 22,642 $ 76,347 $ 69,742 Software licenses and services 8,114 5,309 23,725 17,976 --------------- -------------- --------------- ------------- Total net revenues 34,646 27,951 100,072 87,718 Cost of revenues: Hardware products and services 19,764 14,875 53,600 55,592 Software licenses and services 2,579 1,779 7,121 5,964 --------------- -------------- --------------- ------------- Total cost of revenues 22,343 16,654 60,721 61,556 --------------- -------------- --------------- ------------- Gross margin 12,303 11,297 39,351 26,162 Operating expenses: Research and development 3,703 3,207 10,674 11,346 Marketing and selling 7,379 6,181 22,749 25,140 General and administrative 1,722 2,219 5,064 8,255 Credit on litigation settlement (147) - (147) - --------------- -------------- --------------- ------------- Total operating expenses 12,657 11,607 38,340 44,741 --------------- -------------- --------------- ------------- Operating income (loss) (354) (310) 1,011 (18,579) Interest income, net 435 343 1,452 1,167 Other income - - 200 - Gain on sale of product lines - - - 6,932 --------------- -------------- --------------- ------------- Income (loss) before income taxes 81 33 2,663 (10,480) Provision for income taxes (income tax benefit) 30 13 1,063 (4,193) --------------- -------------- --------------- ------------- Net income (loss) $ 51 $ 20 $ 1,600 $ (6,287) --------------- -------------- --------------- ------------- --------------- -------------- --------------- ------------- Net income (loss) per share: Primary $ 0.00 $ 0.00 $ 0.09 $ (0.38) --------------- -------------- --------------- ------------- --------------- -------------- --------------- ------------- Fully diluted $ 0.00 $ 0.00 $ 0.09 $ (0.38) --------------- -------------- --------------- ------------- --------------- -------------- --------------- ------------- Shares used in per share computations: Primary 17,848 17,122 18,520 16,460 --------------- -------------- --------------- ------------- --------------- -------------- --------------- ------------- Fully diluted 17,957 17,700 18,520 16,460 --------------- -------------- --------------- ------------- --------------- -------------- --------------- -------------
See accompanying notes. 4 NETWORK COMPUTING DEVICES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED - IN THOUSANDS)
Nine Months Ended September 30, ------------------------------- 1997 1996 -------------- -------------- Cash flows from operations: Net income (loss) $ 1,600 $ (6,287) Reconciliation to cash provided (used) by operations: Depreciation and amortization 2,403 3,227 Gain on sale of product lines - (6,932) Deferred income taxes 862 (2,563) Other, net - 526 Changes in: Accounts receivable, net 3,537 9,634 Inventories (4,948) 445 Refundable income taxes 3,030 - Other current assets and other 817 (1,945) Accounts payable 5,029 (8,726) Accrued expenses 134 (1,948) Deferred revenue 776 1,179 -------------- -------------- Cash provided (used) by operations 13,240 (13,390) Cash flows from investing activities: Short-term investments, net (785) 10,229 Proceeds from sale of product lines - 8,625 Changes in other assets 226 249 Property and equipment purchases, net (2,112) (2,105) -------------- -------------- Cash provided (used) by investing activities (2,671) 16,998 Cash flows from financing activities: Principal payments on capital lease obligations (682) (1,037) Repurchases of common stock (10,719) (89) Proceeds from issuance of common stock, net 1,787 2,876 -------------- -------------- Cash provided (used) by financing activities (9,614) 1,750 Increase in cash and equivalents 955 5,358 Cash and equivalents: Beginning of period 23,832 13,364 -------------- -------------- End of period $ 24,787 $ 18,722 -------------- -------------- -------------- --------------
See accompanying notes. 5 NETWORK COMPUTING DEVICES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS BASIS OF PRESENTATION The unaudited condensed consolidated financial information of Network Computing Devices, Inc. (the "Company") furnished herein reflects all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary to fairly state the Company's consolidated financial position, results of operations and cash flows for the periods presented. This Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 1996 Annual Report on Form 10-K. The consolidated results of operations for the three- and nine-month periods ended September 30, 1997 are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending December 31, 1997. Certain financial statement amounts from 1996 have been reclassified to conform to the current year's presentation. PER SHARE INFORMATION Per share information is computed using the weighted-average number of common and dilutive common equivalent shares outstanding. For primary and fully diluted earnings per share, common equivalent shares consist of the incremental shares issuable upon the assumed exercise of dilutive stock options (using the treasury stock method). The effect of common equivalent shares is not included in earnings per share calculations during periods in which such effect would be antidilutive. The Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." SFAS No. 128 requires the presentation of basic earnings per share ("EPS") and, for companies with complex capital structures, diluted EPS. SFAS No. 128 is effective for annual and interim periods ending after December 15, 1997. The Company expects that for profitable periods, basic EPS will be higher than primary earnings per share as presented in the accompanying consolidated financial statements, and diluted EPS will not differ materially from fully diluted earnings per share as presented in the accompanying financial statements. Computations for loss periods should not change significantly. INVENTORIES Inventories, stated at the lower of standard cost, which approximates actual cost on a first-in, first-out basis, or market, consisted of (in thousands): September 30, December 31, 1997 1996 ---- ---- Purchased components and sub-assemblies $ 12,650 $ 8,396 Work in process 761 240 Finished goods 1,313 1,140 -------- ------- $ 14,724 $ 9,776 -------- ------- -------- ------- INTEREST AND TAX PAYMENTS Interest payments, primarily related to interest on capital lease liabilities, were $9,000 and $33,000 for the third quarters of 1997 and 1996, respectively, and $45,000 and $98,000 for the first nine months of 1997 and 1996, respectively. Income tax payments were $71,300 and $185,000 for the third quarter and first nine months of 1997, while income tax refunds of $27,800 and $3.0 million were received during the third quarter and first nine months of 1997. Income tax payments were $209,000 for the first nine months of 1996. 1997 STOCK REPURCHASE PROGRAM In April 1997, the Company's Board of Directors adopted a program to repurchase from time to time at management's discretion up to 1,000,000 shares of the Company's common stock on the open market during the 12-month period ending April 30, 1998 at prevailing market prices. Repurchases were made under the program using the Company's cash resources. 6 NETWORK COMPUTING DEVICES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Shares repurchased are available for the issuance under the Company's stock plans and for other corporate purposes. In the third quarter of 1997, a total of 708,500 shares were repurchased at prices ranging from $8.38 to $12.00 per share for a total purchase price of $7.3 million. Through September 30, 1997, the repurchase program was completed with an aggregate of 1,000,000 shares repurchased at prices ranging from $8.38 to $12.00 per share for a total purchase price of $10.7 million. In November 1997, the Company's Board of Directors adopted an additional program to repurchase from time to time at management's discretion up to 1,000,000 shares of the Company's common stock on the open market during the 12 month period ending October 31, 1998 at prevailing market prices. MAJOR CUSTOMERS AND RELATED ACCOUNTS RECEIVABLE International Business Machines Corporation ("IBM") accounted for approximately 33% and 25% of the Company's revenues for the third quarter and first nine months of 1997, respectively. At September 30, 1997, related accounts receivable due from IBM were approximately $5.2 million, or 29% of the total accounts receivable balance. 7 NETWORK COMPUTING DEVICES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW THIS DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS, INCLUDING BUT NOT LIMITED TO STATEMENTS WITH RESPECT TO THE COMPANY'S FUTURE FINANCIAL PERFORMANCE, OPERATING RESULTS, PLANS AND OBJECTIVES. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "FUTURE PERFORMANCE AND RISK FACTORS." THE FOLLOWING DISCUSSION SHOULD BE READ ONLY IN CONJUNCTION WITH THE UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED IN PART I -- ITEM 1 OF THIS QUARTERLY REPORT ON FORM 10-Q, AND THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996, CONTAINED IN THE COMPANY'S 1996 ANNUAL REPORT ON FORM 10-K. The Company provides network computer hardware and software that delivers high-performance, easy-to-manage, simultaneous access to any application on an enterprise network from any desktop. The Company's product lines include the EXPLORA and HMX families of Universal Network Computers, WINCENTER PRO-TM-multi-user WINDOWS NT-Registered Trademark- application server software, and PC-XWARE-Registered Trademark- network computer software for PCs. During 1996, the Company underwent significant changes to its operations, including changes in senior management, product focus, and business unit organization. During the first half of the year, the Company initiated and completed the disposition of two software product lines, MARINER and Z-MAIL-Registered Trademark-. Also during the first half of 1996, the Company recorded operating losses of $18.3 million, and combined cash and short-term investments had declined from $36.2 million at December 31, 1995 to $26.4 million at June 30, 1996. By the end of the second quarter, the Company announced that it had appointed a new President and Chief Executive Officer, Robert G. Gilbertson, and a new Executive Vice President of Operations & Finance and Chief Financial Officer, Rudolph G. Morin. Shortly thereafter, Doug Klein, a founder of the Company, was appointed to Senior Vice President & Chief Technology Officer and Lorraine Hariton, the Vice President of Business Development, was added to the senior management team. In September 1996, Cecil M. Dye was appointed Senior Vice President of Sales & Marketing. This new senior management team initiated a "turnaround" program that included recombining its Systems and Software business units, spending and hiring controls, significant reorganization of the Research & Development and Sales & Marketing functions and asset management initiatives. By the end of the second half, profitable, cash-flow positive operations had been achieved. The Company's ability to continue this trend is subject to various risks and uncertainties, however, and there is no assurance that this trend toward profitability will continue into the future. See below under "Future Performance and Risk Factors." In June 1996, the Company announced an agreement with International Business Machines Corporation ("IBM") for the joint development of a network application terminal for resale by IBM. In November 1997, the agreement (the "IBM Agreement") was amended to include a renewal through December 31, 2000. Under the IBM Agreement as amended, IBM agreed to fund a portion of the Company's development efforts through the first quarter of 1998. The IBM Agreement as amended further provides for IBM to purchase a substantial portion of its requirements for such products from the Company during 1997 through December 31, 2000. In March 1997, IBM commenced shipping production versions of such products. However, the volume of sales to IBM under the IBM Agreement may be difficult to predict. See below under "Future Performance and Risk Factors --Fluctuations in Operating Results." During 1995, the Company took various actions to reorganize the two basic components of its business into two separate business units: the Systems business, consisting of the Company's network computers and related software; and the Software business, consisting of its lines of PC connectivity software and, initially, its electronic messaging software and its MARINER Internet access software. In addition, the Company took steps to consolidate the management and sales organizations of the geographically separated segments of its Software business and reoriented its software sales strategy toward the increased use of distributors, value added resellers ("VARs") and other resellers. During the third quarter of 1995, the Company created and began implementing a plan to restructure the business to improve its operating performance. The plan included substantial modifications to the Company's manufacturing processes, phasing out lower margin products, a reduction in the amount of leased space, and a reduction in the number of employees. During 8 NETWORK COMPUTING DEVICES, INC. the third quarter of 1995, the Company recognized charges totaling $7.5 million for the implementation of this plan. Included in these restructuring charges were amounts related to the severance of personnel, phase-out of certain products, and costs associated with the termination of lease obligations. In the fourth quarter of 1996, the Company substantially concluded such restructuring activities and determined that $1.1 million in related accruals was in excess of amounts required. As a result, the Company recognized a $1.1 million credit for business restructuring during the fourth quarter of 1996. The credit relates primarily to lease obligations that were exited or subleased at dates or rates more favorable than those anticipated at the time of the initial restructuring plan. In 1994, the Company began the development of MARINER, an Internet access and navigation tool which it intended to market to large enterprises, as well as to original equipment manufacturers ("OEMs") and VARs. In January 1995, the Company entered into a software development and licensing agreement with AT&T to develop a custom version of MARINER for AT&T (the "AT&T Agreement"). The AT&T Agreement provided for total minimum royalties of $15 million through 1998, and contemplated the development of additional Internet access products for license to AT&T. In September 1995, the AT&T Agreement was amended to terminate these provisions for additional product development and to provide instead that the Company would be paid fees totaling $9 million through 1996 for development work completed at the time of the amendment and for a license to evaluate the MARINER product. In 1995, the Company recognized license fees totaling $6.8 million under the AT&T Agreement and received $500,000 in fees for non-recurring engineering costs that offset research and development expenses. In 1995, the Company also recognized revenues of $300,000 from other customers related to the MARINER product line. In 1996 and the first nine months of 1997, the Company recognized license fees totaling $426,000 and $1.2 million, respectively. No additional related revenues will be recognized in the future. In light of the Company's inability to develop a long-term relationship with AT&T, as well as other changes in the Internet market, including the development of intense price competition among vendors of Internet access products, the Company determined in late 1995 to sell the MARINER product line and focus its attention on its core business of providing desktop information access solutions for network computing environments. In February 1996, the Company sold the MARINER product line to FTP Software, Inc. ("FTP") for $9.8 million. The Company paid FTP a one-time license fee of $2.5 million for the right to incorporate MARINER technology into future versions of the Company's hardware and software products. The net gain recognized on this transaction was $7.0 million. In February 1994, the Company acquired all of the outstanding stock of Z-Code Software Corp. ("Z-Code"), a developer of electronic mail and messaging application products (collectively, "Z-MAIL") for open system environments. The Company's Z-MAIL electronic messaging product was a part of the Company's Software business unit. In light of disappointing operating results, intensifying competition in this market, and other related factors, the Company determined during the second quarter of 1996 to sell or discontinue this product line. In June 1996, the Company sold its Z-MAIL product line to NetManage, Inc. for a total sales price of $1.3 million. The net loss recognized on this transaction was $27,000. RESULTS OF OPERATIONS As mentioned above under "Overview," the Company determined to recombine its two former business units (i.e., "Systems" and "Software") into a single operation in June 1996. Although the Company is now managed as one operating entity, the Company is reporting hardware and software revenues independently. Revenues, cost of revenues and gross margins relating to prior operating periods have been conformed to the current presentation, and the following discussions of net revenues and gross margins address the revised presentation. TOTAL NET REVENUES Total net revenues were $34.6 million and $28.0 million for the third quarters of 1997 and 1996, respectively, representing an increase of 24%, and $100.1 million and $87.7 million for the first nine months of 1997 and 1996, respectively, representing an increase of 14%. Total international revenues were 34% and 32% of total net revenues for the third quarters of 1997 and 1996, respectively, and 33% and 32% for the first nine months of 1997 and 1996, respectively. International revenues excluding revenues related to the IBM Agreement were 28% and 29% for the third quarter and first nine months of 1997, down from 32% for the same periods of 1996. There were no international IBM revenues recognized in the third quarter and first nine months of 1996. Revenues under the IBM Agreement accounted for approximately 33% and 25% of the Company's revenues for the third quarter and first nine months of 1997, respectively. No single customer accounted for greater than 10% of the Company's revenues in the same periods of 1996. 9 NETWORK COMPUTING DEVICES, INC. HARDWARE REVENUES Hardware revenues consist primarily of revenues from the sale of network computers, related hardware, and to a lesser extent, fees for related service activities. Hardware revenues were $26.5 million and $22.6 million for the third quarters of 1997 and 1996, respectively, and $76.3 million and $69.7 million for the first nine months of 1997 and 1996, respectively. The increases in revenues were due to increased unit volume shipments, including revenues from IBM related to the IBM Agreement, partially offset by lower average selling prices. SOFTWARE REVENUES Software revenues consist primarily of revenues from the licensing of software products and related support services. Current software products that are generating revenue include WINCENTER, the Company's multi-user WINDOWS NT application server software, PC-XWARE, the Company's network computer software for PCs, and NCDWARE-Registered Trademark-, the Company's proprietary network computer software. Revenues from software and related services were $8.1 million and $5.3 million for the third quarters of 1997 and 1996, respectively, and $23.7 million and $18.0 million for the first nine months of 1997 and 1996, respectively. The increase in the software revenues resulted primarily from higher sales of WINCENTER and the related support revenues. This increase was offset in part for the first nine months by declines in revenues related to PC-XWARE and the absence of revenues related to the former Z-MAIL product line, which was sold during the second quarter of 1996. Revenues related to the former Z-MAIL product line of $1.1 million had been recognized in the first nine months of 1996, while no such revenues were recognized during the first nine months of 1997. In addition, revenues related to the AT&T Agreement of $166,000 were recognized in the third quarter of 1997 while no such revenues were recognized in the third quarter of 1996. Revenues related to the AT&T Agreement of $1.2 million were recognized in the first nine months of 1997 compared to $426,000 in the first nine months of 1996. No additional revenues related to the AT&T Agreement will be recognized in the future. GROSS MARGIN ON HARDWARE REVENUES The Company's gross margin percentages on hardware revenues were 26% and 34% for the third quarters of 1997 and 1996, respectively, and 30% and 20% for the first nine months of 1997 and 1996, respectively. The decrease in margin for the third quarter was primarily related to sale of IBM network computers which have lower margins than other NCD product lines. The dramatic increase in margin in the first nine months of 1997 compared to the same period in 1996 is primarily due to a charge of approximately $3.0 million incurred in the second quarter of 1996 to reduce the value of certain inventories to market price. Also benefiting margin percentages in 1997 were declines in material costs, reflecting declines in the cost of certain semiconductor and other components. In addition, the Company benefited from certain reduced component prices related to volume purchase discounts in association with the IBM Agreement during the third quarter and first nine months of 1997 while no such purchasing benefits were realized in the same periods of 1996. The Company currently anticipates that the mix of hardware OEM revenues as a component of total hardware revenues will continue to rise. In addition, the Company plans to increase the mix of revenues generated through indirect channels. The anticipated changes in the mix of revenues by sales channel are likely to result in overall reduced gross margin percentages on hardware revenues in future periods. GROSS MARGIN ON SOFTWARE REVENUES The Company's gross margin percentages on software revenues were 68% and 66% for the third quarters of 1997 and 1996, respectively, and 70% and 67% for the first nine months of 1997 and 1996, respectively. The increase in the gross margin percentage for the third quarter of 1997 was primarily due to increased support revenues related to the WINCENTER product line. This was offset slightly by a higher mix of WINCENTER revenues in 1997, which carry a lower margin due to higher third-party royalty costs. The gross margin percentage for the first nine months of 1997 increased from the same period of 1996 due to increased sales of high margin WINCENTER software support and from increased AT&T revenues recognized in 1997 of $1.2 compared to $426,000 in 1996, partially offset by reduced margin from increased WINCENTER sales and the absence of sales of higher margin Z-MAIL products and the reduction of PC-XWARE sales. Certain technology used in the Company's products is licensed from third parties on a royalty-bearing basis. The costs associated with such royalties increased substantially during 1996, and will continue to be a significant component of total software cost of sales. RESEARCH AND DEVELOPMENT EXPENSES Research and development ("R&D") expenses were $3.7 million and $3.2 million for the third quarters of 1997 and 1996, respectively, and $10.7 million and $11.3 million for the first nine months of 1997 and 1996, respectively. Increases in the 10 NETWORK COMPUTING DEVICES, INC. third quarter of 1997 are primarily due to increased investment in research and development in the area of network computing products. This increase is partially offset for the first nine months of 1997 by the absence of R&D expenses related to the MARINER and Z-MAIL product lines while spending on such product line development was a significant component of R&D expenses during the same period of 1996. As a percentage of net revenues, R&D expenses were 11% for the third quarters of 1997 and 1996, and 11% and 13% for the first nine months of 1997 and 1996, respectively. The Company plans to maintain its current level of investment in research and development in the area of network computing products through 1997. MARKETING AND SELLING EXPENSES Marketing and selling expenses were $7.4 million and $6.2 million for the third quarters of 1997 and 1996, respectively, and $22.7 million and $25.1 million for the first nine months of 1997 and 1996, respectively. The increase in the third quarter 1997 expenses primarily relates to increased headcount necessary for increased sales. The decreases in the first nine months of 1997 reflects lower labor and other employee-related expenses due to decreased headcount from the sale of the Z-MAIL and MARINER product lines. The Company also experienced increased efficiencies in these areas resulting from the reconsolidation of the Company's remaining business units, which commenced in June of 1996. As a percentage of net revenues, marketing and selling expenses were 21% and 22% for the third quarters of 1997 and 1996, respectively, and 23% and 29% for the first nine months of 1997 and 1996, respectively. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative ("G&A") expenses were $1.7 million and $2.2 million for the third quarters of 1997 and 1996, respectively, and $5.1 million and $8.3 million for the first nine months of 1997 and 1996, respectively. The decreases were primarily related to cost containment measures implemented by new senior management, including reductions in legal costs and outside consulting fees and the reconsolidation of separate business units into a single operating entity. G&A expenses for the third quarter and first nine months of 1996 included increased expense related to both the severance costs associated with the elimination of certain positions within the Company and to increased personnel costs that resulted from the division of the Systems and Software businesses into separate business units. As a percentage of net revenues, G&A expenses were 5% and 8% for the third quarters of 1997 and 1996, respectively, and 5% and 9% for the first nine months of 1997 and 1996, respectively. CREDIT ON LITIGATION SETTLEMENT A credit of $147,000 was recognized in the third quarter of 1997, reflecting the remainder of the $1.1 million dollar accrual that was made in the fourth quarter of 1996 to account for legal costs to settle all pending litigation associated with the shareholder lawsuit. No further charges related to such settlement will be incurred in the future. INTEREST INCOME Interest income, net of interest expense, was $435,000 and $343,000 for the third quarters of 1997 and 1996, respectively, and $1.5 million and $1.2 for the first nine months of 1997 and 1996, respectively. The increase was primarily due to higher average balances in interest-bearing accounts. OTHER INCOME Other income for the first nine months of 1997 includes the receipt of insurance proceeds for certain legal expenses incurred in association with securities litigation costs. GAIN ON SALE OF PRODUCT LINES The gain on the sale of product lines for the first nine months of 1996 represents the net gain recognized on the sale of the Company's MARINER product line in February 1996, offset slightly by the net loss on the sale of Z-MAIL in June 1996. INCOME TAXES AND INCOME TAX BENEFIT The Company recognized an income tax provision of $30,000, $13,000 and $1.1 million for the third quarters of 1997 and 1996 and the first nine months of 1997, respectively, and an income tax benefit of $4.2 million for the first nine months of 1996. 11 NETWORK COMPUTING DEVICES, INC. FINANCIAL CONDITION Total assets as of September 30, 1997 decreased by $2.1 million, or 2%, from December 31, 1996. The change in total assets reflected decreases in refundable and deferred income tax assets of $3.9 million and in accounts receivable of $3.5 million, partially offset by a $4.9 million increase in inventory and a $1.7 million increase in cash and short-term investments. The decrease in refundable and deferred income tax assets was primarily related to income tax refunds received, while the decrease in accounts receivable was primarily related to increased collections. The increase in inventory was primarily related to lower than budgeted sales volumes, while the increase in cash and short-term investments was related to increased collections, income tax refunds received and increased accounts payable, partially offset by repurchases of the Company's common stock. Total liabilities as of September 30, 1997 increased by $5.3 million, or 29%, from December 31, 1996. This increase was primarily due to an increase of $5.0 million in accounts payable which was primarily related to increased inventory receipts. CAPITAL REQUIREMENTS Capital spending requirements for the remainder of 1997 are estimated at approximately $1.0 million, and at September 30, 1997, the Company had commitments for capital expenditures of approximately $500,000, primarily related to manufacturing tooling and information technology. LIQUIDITY In April 1997, the Company's Board of Directors adopted a program to repurchase from time to time at management's discretion up to 1,000,000 shares of the Company's common stock on the open market during the 12-month period ending April 30, 1998 at prevailing market prices. Repurchases were made under the program using the Company's cash resources. Shares repurchased are available for the issuance under the Company's stock plans and for other corporate purposes. In the third quarter of 1997, a total of 708,500 shares were repurchased at prices ranging from $8.38 to $12.00 per share for a total purchase price of $7.3 million. Through September 30, 1997, the repurchase program was completed with an aggregate of 1,000,000 shares repurchased at prices ranging from $8.38 to $12.00 per share for a total purchase price of $10.7 million. In November 1997, the Company's Board of Directors adopted an additional program to repurchase from time to time at management's discretion up to 1,000,000 shares of the Company's common stock on the open market during the 12 month period ending October 31, 1998 at prevailing market prices. As of September 30, 1997, the Company had combined cash and equivalents and short-term investments totaling $37.4 million, with no significant debt. The Company believes that its existing sources of liquidity, including cash generated from operations, will be sufficient to meet operating cash requirements and capital lease repayment obligations at least through the next twelve months. FUTURE PERFORMANCE AND RISK FACTORS THE COMPANY'S FUTURE BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION ARE SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES, INCLUDING THOSE DESCRIBED BELOW. EVOLVING NETWORK COMPUTING MARKET The Company derives a majority of its revenues from the sale of network computer products and related software. During the past several years, the Company and other manufacturers of network computing systems and products have experienced intense competition from alternative desktop computing products, particularly personal computers, which has slowed the growth and development of the network computing market. Until recently, the absence of X protocol support from Microsoft Corporation ("Microsoft"), combined with the proliferation of off-the-shelf Windows-based application software, constituted an obstacle to the expansion of the network computing model into Windows-based environments. The introduction of the Company's WINCENTER multi-user WINDOWS NT application server software and new, lower-priced network computers have allowed the Company to offer network computing systems that provide users with access to Windows applications, although sales of these new products have been limited to date. The Company's future success will depend in substantial part upon increased acceptance of the network computing model and the successful marketing of the Company's new network 12 NETWORK COMPUTING DEVICES, INC. computing products. There can be no assurance that the Company's new network computing products will compete successfully with alternative desktop solutions or that the network computing model will be widely adopted in the rapidly evolving desktop computer market. The failure of new markets to develop for the Company's network computing products would have a material, adverse effect on the Company's business, operating results and financial condition. See "Item 1. Business - Industry Background" and "Business - Markets and Applications" in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. COMPETITION The desktop computer and information access markets are characterized by rapidly changing technology and evolving industry standards. The Company experiences significant competition from other network computer manufacturers, suppliers of personal computers and workstations and software developers. Competition within the network computing market has intensified over the past several years, resulting in price reductions and reduced profit margins. The Company expects this intense competition to continue, and there can be no assurance that the Company will be able to continue to compete successfully against current and future competitors as the desktop computer market evolves and competition increases. The Company's software products also face substantial competition from software vendors that offer similar products, including several large software companies. See "Item 1. Business - - Competition" in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. FLUCTUATIONS IN OPERATING RESULTS The Company's operating results have varied significantly, particularly on a quarterly basis, as a result of a number of factors, including general economic conditions affecting industry demand for computer products, the timing and market acceptance of new product introductions by the Company and its competitors, the timing of significant orders from and shipments to large customers, periodic changes in product pricing and discounting due to competitive factors, and the availability and pricing of key components, such as DRAMs, video monitors, integrated circuits and electronic sub-assemblies, some of which require substantial order lead times. The Company's operating results may fluctuate in the future as a result of these and other factors, including the Company's success in developing and introducing new products, its product and customer mix, licensing costs, the level of competition that it experiences and its ability to develop and maintain strategic business alliances. The Company has committed significant resources, including research and development, manufacturing and sales and marketing resources, to the implementation of the IBM Agreement (see "Overview"). The production cycle of related product requires the Company to rely on IBM to provide accurate product requirement forecasts, which have in the past and will in the future, be subject to changes by IBM. Should the Company commence production of related product based on provided forecasts that are subsequently reduced, the Company bears the risk of increased levels of unsold inventories. Should the expected business volumes associated with the IBM Agreement not occur, or occur in volumes below management's expectations, there would be a material, adverse effect on the Company's operating results. The Company currently anticipates that the mix of hardware revenues as a component of total revenues may rise as a result of the IBM Agreement and the Company's current efforts to develop other OEM relationships for its network computers. In addition, the Company plans to increase its revenues generated through indirect sales. This change in the mix of revenues by product type and by sales channel is likely to result in overall reduced gross margin percentages on hardware revenues and on total revenues. In addition, the Company operates with a relatively small backlog. Revenues and operating results therefore generally depend on the volume and timing of orders received, which are difficult to forecast and which may occur disproportionately during any given quarter or year. The Company's expense levels are based in part on its forecast of future revenues. If revenues are below expectations, the Company's operating results may be adversely affected. The Company has experienced a disproportionate amount of shipments occurring in the last month of its fiscal quarters. This trend increases the risk of material quarter-to-quarter fluctuations in the Company's revenues and operating results. In the past, the Company has experienced reduced orders during the first and third quarters due to buying patterns common in the computer industry. In addition, sales in Europe have been adversely affected in the third calendar quarter, when many European customers reduce their business activities. NEW PRODUCT DEVELOPMENT AND TIMELY INTRODUCTION OF NEW AND ENHANCED PRODUCTS The markets for the Company's products are characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and short product life cycles. The Company's future results will depend to a considerable 13 NETWORK COMPUTING DEVICES, INC. extent on its ability to continuously develop, introduce and deliver in quantity new hardware and software products that offer its customers enhanced performance at competitive prices. The development and introduction of new products is a complex and uncertain process requiring substantial financial resources and high levels of innovation, accurate anticipation of technological and market trends and the successful and timely completion of product development. Once a hardware product is developed, the Company must rapidly bring it into volume production, a process that requires accurate forecasting of customer requirements in order to achieve acceptable manufacturing costs. The introduction of new or enhanced products also requires the Company to manage the transition from older, displaced products in order to minimize disruption to customer ordering patterns, avoid excessive levels of older product inventories and ensure that adequate supplies of new products can be delivered to meet customer demand. As the Company is continuously engaged in this product development and transition process, its operating results may be subject to considerable fluctuation, particularly when measured on a quarterly basis. The inability to finance important research and development projects, delays in the introduction of new and enhanced products, the failure of such products to gain market acceptance, or problems associated with new product transitions could adversely affect the Company's operating results. See "Item 1. Business - -Industry Background" and "Business - Product Development" in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. RELIANCE ON INDEPENDENT DISTRIBUTORS AND RESELLERS The Company increasingly relies substantially on independent distributors and resellers, particularly in European markets, for the marketing and distribution of its products, particularly its software products. During 1995, the Company consolidated its Software sales operations by creating a single organization devoted to the sale of the Company's PC connectivity and messaging software and re-oriented its software sales strategy toward the increased use of distributors, VARs and other resellers. In early 1996, the Company experienced significant returns of its software products from its distributors. There can be no assurance that the Company will not experience some level of returns in the future. In addition, there can be no assurance that the Company's distributors and resellers will continue their current relationships with the Company or that they will not give higher priority to the sale of other products, which could include products of the Company's competitors. A reduction in sales effort or discontinuance of sales of the Company's products by its distributors and resellers could lead to reduced sales and could adversely affect the Company's operating results. In addition, there can be no assurance as to the continued viability or the financial stability of the Company's distributors and resellers, the Company's ability to retain its existing distributors and resellers or the Company's ability to add distributors and resellers in the future. See "Item 1. Business - Marketing and Sales" in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. RELIANCE ON INDEPENDENT CONTRACTORS The Company relies on independent contractors for virtually all of the sub-assembly of the Company's network computer products. The Company's reliance on these independent contractors limits its control over delivery schedules, quality assurance and product costs. In addition, a number of the Company's independent suppliers are located abroad. The Company's reliance on these foreign suppliers subjects the Company to risks such as the imposition of unfavorable governmental controls or other trade restrictions, changes in tariffs and political instability. The Company currently obtains all of the sub-assemblies used for its network computer products (consisting of all major components except monitors and cables) from a single supplier located in Thailand. Any significant interruption in the supply of sub-assemblies from this contractor would have a material adverse effect on the Company's business and operating results. Although the Company is currently planning to develop alternative locations in different countries from which to obtain sub-assemblies, there is no assurance that the Company will be successful in this pursuit. Disruptions in the provision of components by the Company's other suppliers, or other events that would require the Company to seek alternate sources of supply, could also lead to supply constraints or delays in delivery of the Company's products and adversely affect its operating results. The operations of certain of the Company's foreign suppliers were briefly disrupted during 1992 due to political instability in Thailand. See "Item 1. Manufacturing and Supplies" in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. INTERNATIONAL SALES A majority of the Company's international sales are denominated in U.S. dollars, and an increase in the value of the U.S. dollar relative to foreign currencies could make the Company's products less competitive in those markets. Over the past two years, from time to time, a significant portion of international revenues have been derived from sales to a customer in the United Kingdom that have been denominated in pound sterling and sales denominated in foreign currencies may increase in the future. These sales are subject to exchange rate fluctuations which could affect the Company's operating results negatively 14 NETWORK COMPUTING DEVICES, INC. or positively, depending on the value of the U.S. dollar against the other currency. Where the Company believes foreign currency-denominated sales could pose significant exposure to exchange rate fluctuations, the Company acquires forward exchange contracts in an effort to reduce such exposure. International sales and operations may also be subject to risks such as the imposition of governmental controls, export license requirements, restrictions on the export of technology, political instability, trade restrictions, changes in tariffs and difficulties in staffing and managing international operations and managing accounts receivable. In addition, the laws of certain countries do not protect the Company's products and intellectual property rights to the same extent as the laws of the United States. There can be no assurance that these factors will not have an adverse effect on the Company's future international sales and, consequently, on the Company's operating results. DEPENDENCE ON KEY PERSONNEL The Company's success depends to a significant degree upon the continuing contributions of its senior management and other key employees, particularly Robert G. Gilbertson, its President and Chief Executive Officer, and Rudolph G. Morin, its Executive Vice President of Operations & Finance and Chief Financial Officer. The loss of these individuals or other key management personnel could have a material adverse effect on the Company's business, operating results or financial condition. The Company believes that its future success will depend in large part on its ability to attract and retain highly-skilled engineering, managerial, sales and marketing personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting, integrating and retaining such personnel. Failure to attract and retain key personnel could have a material adverse effect on the Company's business, operating results or financial condition. VOLATILITY OF STOCK PRICE The market price of the Company's common stock has fluctuated significantly over the past several years and is subject to material fluctuations in the future in response to announcements concerning the Company or its competitors or customers, quarterly variations in operating results, announcements of technological innovations, the introduction of new products or changes in product pricing policies by the Company or its competitors, general conditions in the computer industry, developments in the financial markets and other factors. In particular, shortfalls in the Company's quarterly operating results from historical levels or from levels forecast by securities analysts could have an adverse effect on the trading price of the common stock. The Company may not be able to quantify such a quarterly shortfall until the end of the quarter, which could result in an immediate and adverse effect on the common stock price. In addition, the stock market has, from time to time, experienced extreme price and volume fluctuations that have particularly affected the market prices for technology companies and which have been unrelated to the operating performance of the affected companies. Broad market fluctuations of this type may adversely affect the future market price of the Company's common stock. 15 NETWORK COMPUTING DEVICES, INC. PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed herewith: Exhibit 11.1 Statement Regarding Computation of Shares Used in Income (Loss) Per Share Computations. Exhibit 27 Financial Data Schedule. (b) The Company filed a report on Form 8-K on August 12, 1997 which reported, under Item 5, the distribution to its shareholders of rights to repurchase 1/100 share of Series A Participating Preferred Stock, no par value, under terms and conditions set forth in a Rights Agreement dated August 12, 1997 between the Company and ChaseMellon Shareholder Services, L.L.C. 16 NETWORK COMPUTING DEVICES, INC. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Network Computing Devices, Inc. (Registrant) Date: November 6, 1997 By: /s/ Rudolph G. Morin --------------------------------------- Rudolph G. Morin Executive Vice President, Operations & Finance and Chief Financial Officer (Duly Authorized and Principal Financial and Accounting Officer) 17 EX-11.1 2 EXHIBIT 11.1 Exhibit 11.1 NETWORK COMPUTING DEVICES, INC. Statement Regarding Computation of Shares Used in Income (Loss) Per Share Computations (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 1997 1996 1997 1996 -------------- -------------- ------------- -------------- Primary: Weighted average common shares outstanding during the period 16,355 16,615 16,852 16,460 Common share equivalents: Dilutive effect of stock options 1,493 507 1,668 - -------------- -------------- ------------- -------------- Total 17,848 17,122 18,520 16,460 -------------- -------------- ------------- -------------- -------------- -------------- ------------- -------------- Net income (loss) $ 51 $ 20 $ 1,600 $ (6,287) -------------- -------------- ------------- -------------- -------------- -------------- ------------- -------------- Primary income (loss) per share $ 0.00 $ 0.00 $ 0.09 $ (0.38) -------------- -------------- ------------- -------------- -------------- -------------- ------------- -------------- Fully Diluted: Weighted average common shares outstanding during the period 16,355 16,615 16,852 16,460 Common share equivalents: Dilutive effect of stock options 1,602 1,085 1,668 - -------------- -------------- ------------- -------------- Total 17,957 17,700 18,520 16,460 -------------- -------------- ------------- -------------- -------------- -------------- ------------- -------------- Net income (loss), adjusted for fully diluted calculations $ 51 $ 20 $ 1,600 $ (6,287) -------------- -------------- ------------- -------------- -------------- -------------- ------------- -------------- Fully diluted income (loss) per share $ 0.00 $ 0.00 $ 0.09 $ (0.38) -------------- -------------- ------------- -------------- -------------- -------------- ------------- --------------
EX-27 3 EXHIBIT 27
5 1,000 9-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 24,787 12,624 20,571 2,559 14,724 77,377 26,260 (21,656) 83,618 23,343 0 0 0 59,285 808 83,618 100,072 100,072 60,721 60,721 38,340 99 45 2,663 1,063 1,600 0 0 0 1,600 0.09 0.09 Includes revenues from licensing of software and support services. Includes costs from licensing of software and support services.
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