-----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, Pr0cZ2cD47c8tSUDi9QIqKLjU2T7W6OA+IeDEWECjPGY07XUzEU2kjXLw5+vOM5J UGHa1sQnP+bCShB2CTWHeA== 0001047469-98-012877.txt : 19980401 0001047469-98-012877.hdr.sgml : 19980401 ACCESSION NUMBER: 0001047469-98-012877 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 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-K405 SEC ACT: SEC FILE NUMBER: 000-20124 FILM NUMBER: 98581873 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-K405 1 10-K405 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _________________________ FORM 10-K [ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended DECEMBER 31, 1997 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ____________ to ____________ COMMISSION FILE NUMBER 0-20124 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) (Zip Code) (650) 694-0650 (Registrant's telephone number, including area code) Securities registered pursuant to 12(b) of the Act: None Securities registered pursuant to 12(g) of the Act: COMMON STOCK, NO PAR VALUE (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this form 10-K or any amendment to this form 10-K. [ X ] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on February 28, 1998, as reported on the Nasdaq National Market, was approximately $194,268,021. Shares of Common Stock held by each officer, director and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of February 28, 1998, 16,354,169 shares of the registrant's Common Stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Annual Meeting of Shareholders of Network Computing Devices, Inc. (the "Proxy Statement") scheduled to be held on June 3, 1998, are incorporated by reference in Part III of this Report on Form 10-K. PART I THIS REPORT INCLUDES A NUMBER OF FORWARD-LOOKING STATEMENTS WHICH REFLECT THE COMPANY'S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED IN "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- FUTURE PERFORMANCE AND RISK FACTORS" AND ELSEWHERE IN THIS REPORT, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM HISTORICAL RESULTS OR THOSE CURRENTLY ANTICIPATED. IN THIS REPORT, THE WORDS "ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE" AND SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE HEREOF. ITEM 1. BUSINESS. GENERAL The Company provides thin client hardware and software that delivers simultaneous, high-performance, easy-to-manage access to any application from thin client, UNIX and PC desktops. The Company's product lines include the NCD EXPLORA and family of thin clients, NCD WINCENTER PRO-TM- multi-user WINDOWS NT-Registered Trademark- application server software, and NCD PC-XWARE-Registered Trademark- software that delivers PC access to UNIX and multi-user WINDOWS NT PCs. The Company's thin client computing products provide businesses and other enterprises with an open systems approach to thin client computing based on the Company's Network Computing Architecture ("NCA"). The Company's thin clients offer graphical multi-window interfaces for users in various operating system environments using industry-standard communication protocols. They provide a cost-effective, high-performance alternative to networked workstations and personal computers and offer significant performance advantages over "dumb" terminals used in traditional mainframe or minicomputer-based systems, particularly with respect to windowing and graphics capabilities. Since introducing its first product in 1989, the Company has shipped over 500,000 thin clients to customers worldwide. With Microsoft's Windows Terminal Server software and new, lower-priced higher-performance thin clients, the Company now offers thin client computing systems that provide users access to a broad range of applications and services, including Microsoft applications. Network Computing Devices, Inc. was incorporated in California in February 1988. Unless the context otherwise requires, the terms "the Company" and "NCD" refer to Network Computing Devices, Inc. and its consolidated subsidiaries. INDUSTRY BACKGROUND NETWORK COMPUTING SYSTEMS Computing environments made a pendulum-like swing from the highly centralized mainframe and minicomputer systems of the 1970s to the fully distributed personal computer- and workstation-based systems of the 1980s. While the earlier approach benefited from centralized system administration and security, users had to compete for under-powered, centralized processors on a timesharing basis, using low-performance, character-based "dumb" terminals. During the 1980s, microprocessor-based systems improved in price and performance, and graphical user interfaces ("GUIs") with easy-to-use windows, menus and icons became widely available. User groups within large organizations began implementing their own solutions, using personal computers and workstations on the desktop to give each individual user a dedicated computing resource. The need to interconnect these computing resources led to the development of local area networks ("LANs"), which resulted in processing, data and applications being spread across many desktops. This approach brought with it new problems: the high cost of installing, maintaining and upgrading a computer on every desktop; under-utilization of individual computing resources; and complex system management requiring large MIS staffs. As the 1990s approached, a new computing environment evolved: "thin client computing" combines the cost-effectiveness, manageability and security of the original centralized model with the performance, GUIs and network accessibility of the later distributed model. The key technology behind the original development of the thin client computing approach was the X Window System, or X, a graphical windowing system. X software runs over a TCP/IP (Transmission Control Protocol/Internet Protocol) network that allows full use of thin client computing resources. Unlike operating systems designed for stand-alone personal computers, X is an open system, not tied to any particular hardware or operating system, allowing the development of 1 applications that can run on multi-vendor products on a common network. This multi-vendor capability is possible because the X architecture separates windowing into two distinct parts: the graphical display function on the user's desk; and the computing function, which executes the applications, at shared "compute servers" (personal computers, workstations, or larger computers) anywhere on the network. This model, which the Company refers to as NCA, addresses both the individual's need for an advanced GUI and the organization's need for reduced system management overhead and better utilization of computing resources. Users of thin client computing systems can simultaneously access multiple applications running on separate compute servers on the network, and view and manipulate these applications in separate windows on their screens. Thin client computing systems also allow the organization to keep up with advances in computing technologies while protecting existing equipment investments. Rather than replacing every desktop system when the industry attains new price/performance points, the organization can simply add new computing resources to the network; the desktop devices stay in place. Although X-based network computing systems have been deployed in a wide range of network environments, particularly in UNIX and other large computer-based applications, these systems require the availability of X protocol support from the vendors of host operating systems software and application software developers. Until the mid-1990's, the absence of support by Microsoft Corporation ("Microsoft"), combined with the proliferation of off-the-shelf Windows-based application software, constituted an obstacle to the expansion of the thin client computing model into Windows-based environments. Over the last several years, a number of important developments occurred which expanded the potential markets for network computing systems. First, the availability of the powerful Pentium microprocessor enabled the development of large Windows-based systems. Second, Microsoft NT Server software, combined with Microsoft-authorized multi-user software, became available to support multi-user Windows applications. Third, the rapid growth of the Internet and Internet-based computing has popularized the concept of remote computing and created new interest in the network computing model. INFORMATION ACCESS SOFTWARE The market for enterprise information access software is large and comprised of a number of segments, many of which are expanding rapidly. Segments of this market include: PC-based TCP/IP software stacks and applications, including X access software; electronic mail software; and Internet access software. With the continuing proliferation of increasingly powerful and low-cost PCs in large organizations, the Company identified a demand for software products to enable DOS-based and Windows-based PCs to emulate X terminals for use in predominantly UNIX environments. In order to address this market, the Company, in 1992, acquired Graphic Software Systems, a pioneer in the development of PC X software. In 1993, the Company introduced PC-XWARE, its initial PC-UNIX integration software product. PC-XWARE is based on the Company's NCDWARE X terminal software and provides network connectivity using an NCD-developed TCP/IP software stack. NCD now offers versions of PC-XWARE for WINDOWS 3.1, WINDOWS 95-Registered Trademark- and WINDOWS NT users. In an effort to enhance its position in the information access market, the Company, in February 1994, acquired Z-Code Software Corp. ("Z-Code"), a developer of electronic mail and messaging application products for multivendor open system environments. Following the Z-Code acquisition, the Company developed and introduced e-mail products, including Z-MAIL-Registered Trademark- for Windows and Macintosh operating systems. However, due to insufficient operating results, intensifying competition in this market and other factors, the Company sold its Z-MAIL product line during June 1996. Taking advantage of its expertise in TCP/IP-based networking software, the Company in 1995 developed MARINER, an Internet access and navigation tool. 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. The MARINER product line was sold in the first quarter of 1996. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." 2 MARKETS AND APPLICATIONS NETWORK COMPUTING SYSTEMS NCD's network computing systems are used in a broad range of industries for a wide variety of applications. Historically, the Company's X-based systems have been sold primarily into three types of computing environments as: (1) an upgrade to ASCII and 3270 "dumb" terminals in mainframe and minicomputer transaction processing environments; (2) a lower cost desktop alternative to workstations in distributed environments; and (3) an enhancement or alternative to personal computer networks. TERMINAL REPLACEMENT. A principal market for X-based thin clients is replacement of the installed base of approximately 25 million ASCII and 3270 terminals. Many commercial users in transaction processing applications are upgrading their centralized systems in order to obtain the productivity advantages of GUIs and windowing and the flexibility of "open" systems based on industry-standard operating systems such as UNIX. The Company's NCA provides these users with a three-tiered X-based network computing environment in which: (1) existing applications and corporate-wide databases remain on the central mainframe or minicomputer; (2) departmental-level applications are run on RISC-based UNIX compute servers; and (3) thin clients on each user's desk provide simultaneous access to applications and data on the mainframe, minicomputers and compute servers. WORKSTATION ENVIRONMENTS. Many of the early buyers of X terminals were also early users of workstation technology and viewed X-based thin clients primarily as a low-cost alternative for expanding their workstation networks. In these environments, X terminals can access the excess processing power of existing workstations, supplying users with a GUI at a considerably lower cost than a workstation with equivalent display characteristics. Thus, organizations can provide windowing and graphics for uses that previously could not justify the cost of a full workstation. Many users of X terminals in UNIX and VMS workstation or minicomputer environments have developed an optimized configuration of workstations and X terminals. In these environments, rather than providing some users with workstations and others with X terminals, every user is given an X terminal, and compute servers based on high-performance workstations (without monitors) are shared among all users. The organization thereby realizes cost advantages by centralizing processing, memory and disk requirements into fewer, high-performance servers. PERSONAL COMPUTER ENVIRONMENTS. Until recently, users of X terminals in predominantly UNIX-based environments who needed access to DOS or Windows applications could access these applications using an X terminal running on a Windows emulation system on a compute server. Although these emulation systems met the needs of the occasional user of these applications, a more robust, high performance means of executing Windows applications in large UNIX-based network environments has become an increasing market requirement over the past several years. The recent introductions of the Company's NCD WINCENTER Windows application server software, running on Pentium-based server hardware, and the Company's new, lower-priced NCD EXPLORA thin clients, were intended to address this requirement. In addition, NCD WINCENTER software and NCD EXPLORA thin clients are now being marketed to users of Windows who recognize the benefit of the network computing model. INTRANET ENVIRONMENTS. With the popularization of the Internet and the availability of low cost Internet software and authoring tools, many companies are utilizing Internet protocols for internal electronic communications systems. These systems are being used to facilitate employee collaboration and distribute company information in an easy to manage, low cost manner. NCD thin clients are being used as a means of providing low cost, easy maintenance access to corporate intranets. Many of the software systems used to implement corporate intranets, including Worldwide Web ("WWW") browsers, WWW servers, e-mail clients, e-mail servers and database servers, can run on NCD WINCENTER and can be accessed from NCD thin clients and other X-capable devices such as a UNIX workstation, a competing brand of X terminal, or a personal computer with X display server software. SOFTWARE PRODUCTS PC CONNECTIVITY SOFTWARE. Personal computer users who wish to obtain access to UNIX or VMS applications, but who also desire to maintain local DOS or Windows application processing, are potential customers for the Company's PC-XWARE software. A PC running X Window System software can match the performance of a low-end X-based thin client, and can be useful for PC users who need less frequent access to thin client computing resources. 3 WINDOWS SERVER SOFTWARE. Users of thin clients, UNIX workstations and older PCs who want to run the latest Windows applications on their existing hardware, comprise the target market for NCD WINCENTER, the Company's Windows application server software. This product is an enterprise-oriented solution designed to accommodate growth in large, heterogeneous computing environments. PRODUCTS THIN CLIENT SYSTEMS The Company offers a broad line of thin client products that provide businesses and other enterprises with an open systems approach to network computing based on the Company's Network Computing Architecture. The Company's thin client systems include NCD EXPLORA desktop devices, NCDWARE operating system software and NCD WINCENTER, the Company's Windows application server software. THIN CLIENTS. The Company's thin client products are desktop devices that are used to access information and applications residing on compute servers on a local area or wide area network. The Company's thin clients offer graphical multi-window interfaces for users in various operating system environments. Thin clients provide a cost-effective high-performance alternative to network workstations and personal computers. Although the Company's initial X-based thin clients (referred to as "X terminals") were used primarily in UNIX and other large computer-based environments, the recent introduction of multi-user versions of the WINDOWS NT operating system and the Company's NCD WINCENTER Windows application server software allows thin clients to be used in network environments including environments using Windows application software. The Company's thin clients product line includes models with various screen sizes and a range of software extensions and network interfaces. Hardware platforms are based on different microprocessors, addressing a wide range of price/performance requirements. Custom ASICs used in the design of most of the Company's products help reduce the cost of connection logic and provide hardware acceleration for certain graphics functions. NCD's thin clients feature single-board electronics and incorporate current ergonomic standards in monitor technology. NCD's thin clients come with a full line of peripherals, including mouse and several keyboard options. The Company's NCD EXPLORA 700 and NCD HMXPRO24 products are high-performance network computers that are targeted at the UNIX workstation market and customers with Java requirements. The NCD HMXPRO24 supports up to 24-bit color and up to 1600-by-1200 pixel screen resolution on 15, 17, 19 and 21-inch monitors. Suggested list prices start at $1,695 for the NCD EXPLORA 700 and $2,895 for the NCD HMXPRO24. The NCD EXPLORA 400 and the NCD EXPLORA 450 are the Company's low-end thin client products. The target markets for these products include the legacy desktop replacement market (when sold in conjunction with NCD WINCENTER), the terminal replacement market and the intranet market. The NCD EXPLORA is based on the 32-bit PowerPC RISC processor. The NCD EXPLORA 400 Series can accommodate up to 128 megabytes of memory. Display resolution is adjustable from 640-by-480 to 1280-by-1024 pixel screen resolution, with 15, 17, 19 and 21- inch monitors available. The NCD EXPLORA 400 and the NCD EXPLORA 450 thin clients are packaged in a compact and attractive space saving case that is extremely quiet due to the lack of a noise-producing fan, as well as in a monitor support package that fits nicely underneath the monitor. Suggested list prices for the NCD EXPLORA family currently range from $695 to $940. NCDWARE. The Company's thin clients run NCDWARE, NCD's proprietary operating system. NCDWARE incorporates extensive enhancements to the basic X server software to improve performance, system manageability and robustness. A key aspect of NCDWARE is its capability to support both X and Citrix Systems' ICA protocols. NCDWARE supports a wide variety of communications protocols. NCDWARE provides Network Audio System for audio applications, capability for running local window managers and local terminal emulation sessions and network management capability. NCD WINCENTER. NCD WINCENTER PRO is Windows application server software that runs on Intel-based computers, typically Pentium-class systems. NCD WINCENTER includes Microsoft NT as the base operating system and WINFRAME, Microsoft- authorized multi-user software that the Company licenses from Citrix Systems, Inc. ("Citrix"). See "Proprietary Rights and Licenses." NCD WINCENTER also includes NCD-developed graphics and network features that make NCD WINCENTER compatible with the X Window protocol supported by NCD thin clients and UNIX workstations. NCD WINCENTER allows a single server to provide Windows applications to many users simultaneously. NCD WINCENTER is compatible with off-the-shelf applications software for WINDOWS 3.1, WINDOWS 95 and WINDOWS NT and can typically serve up to 50 users, depending 4 upon server performance, applications and usage. NCD WINCENTER can be used to add Windows applications to existing UNIX network environments, to create multi-user Windows systems, or to implement intranets within enterprises. Users can access NCD WINCENTER from any NCD thin client (including older model X terminals), competing brands of X terminals, UNIX and VAX workstations that support X Windows and personal computers with X display server software. Suggested list prices for NCD WINCENTER start at $459 per user with a five-user minimum. PC CONNECTIVITY PRODUCTS NCD MARATHON. NCD MARATHON is a suite of TCP/IP products for Windows-based personal computers. NCD MARATHON includes important networking functionality that is not currently available from Microsoft, including graphical client and server support, Network File System (NFS) client and server support and multiple terminal emulation modes. Versions of NCD MARATHON are available for WINDOWS 3.1, WINDOWS 95 and WINDOWS NT. The WINDOWS 3.1 version includes the Company's proprietary TCP/IP stack as well as a dialer for remote TCP/IP applications. Suggested list prices start at $195. NCD PC-XWARE. NCD PC-XWARE is a family of PC X server software products for Windows PCs that provide connectivity to X Windows applications running on UNIX and other multi-user host systems. There are versions of NCD PC-XWARE for WINDOWS 3.1, WINDOWS 95 and WINDOWS NT. NCD PC-XWARE includes all the basic capabilities of MARATHON and adds high performance X server software. NCD PC- XWARE is based on the Company's NCDWARE network computing software and offers many of the same local application and network management features. NCD PC- XWARE also allows personal computer users to access application software running on the Company's NCD WINCENTER application server. Suggested list prices start at $395. PRODUCT DEVELOPMENT The Company believes that its ability to maintain its position as a major supplier of thin client solutions and expand the market for this style of computing and information access products will depend in large part upon its ability to enhance its existing line of thin client and software products, and to continue developing new hardware and software products that incorporate the latest improvements in technology. Accordingly, the Company is committed to investing significant resources in software and hardware development activities. The Company's current research and development programs include: - Server and client side emulation products for thin clients and multi-user Windows NT environments; - A new Intel Pentium-Registered Trademark- based lean client for Windows applications access in the terminal replacement market; - Enhanced NCD PC-XWARE for Windows 98; - French, German and Spanish versions of NCD WINCENTER; and - Advanced terminal platform concepts considering increased levels of logic integration. There can be no assurance that any of these development efforts will result in the introduction of new products or that any such products will be commercially successful. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Future Performance and Risk Factors -- New Product Development and Timely Introduction of New and Enhanced Products." During 1997, 1996 and 1995, the Company's research and development expenditures were $14,179,000, $14,930,000 and $13,119,000, respectively. THE FOREGOING DISCUSSION CONCERNING THE COMPANY'S PRODUCT DEVELOPMENT PROGRAM INCLUDES FORWARD-LOOKING STATEMENTS. ACTUAL PRODUCT DEVELOPMENT RESULTS MAY DIFFER SUBSTANTIALLY DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED UNDER "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- FUTURE PERFORMANCE AND RISK FACTORS." MARKETING AND SALES The principal objectives of the Company's marketing strategy are to increase awareness of the benefits of network oriented computing, maintain the Company's position as a recognized leader in the thin client industry and differentiate the Company's hardware and software products from competing products. The Company's marketing activities include participation in trade 5 shows, conferences and seminars, advertising and press relations with leading trade publications, publication of technical articles and a telemarketing program. In addition, the Company is increasing its focus on the use of value-added resellers and the OEM channel of distribution; marketing programs are being put in place to train and support the indirect channel. Much of the Company's work is done in cooperation with major strategic partners, such as IBM, Microsoft, Intel and Citrix. The Company's marketing team is responsible for strategies and joint programs with these companies who are very important to our success. The Company regards its technical support and system engineering personnel as an integral part of its marketing strategy because of the technical nature of the sales process and the strategic change that thin client computing represents to our customers. These personnel participate directly in the sales cycle by educating prospective customers on the advantage of network computing and assisting in system planning, configuration and the integration of thin clients into the information technology strategies of our customers. The Company has moved away from a direct domestic sales model towards the use of resellers, distributors and systems integrators, as well as OEMs. Substantially all of the Company's international sales are delivered through the indirect channel. Besides the U.S. organization, the Company has established subsidiaries in Australia, France, the United Kingdom, Germany and Sweden, which provide sales and technical support to the Company's distributors in those regions. NCD's direct sales force has been retrained and their compensation base changed to encourage them to work through the indirect channel. These highly skilled technical sales specialists will manage the channel in their geographic territory and assist their partners in building their business. International sales, including sales to foreign OEM customers, represented approximately 34%, 33% and 33% of the Company's net revenues during 1997, 1996 and 1995, respectively. International sales may be subject to government controls and other risks, including export licenses, federal restrictions on the export of critical technology, changes in demand resulting from currency exchange fluctuations, political instability, trade restrictions and changes in tariffs. To date, the Company has experienced no material difficulties due to these factors. The Company also sells its PC connectivity software products through an internal telesales team that fulfills orders through the indirect channel. The Company also sells its products to OEMs who combine the Company's products with computers and peripherals, add application software and sell complete computer systems to end-users. OEM sales represented approximately 26%, 15% and 15% of the Company's revenues for the years ended December 31, 1997, 1996 and 1995, respectively. IBM accounted for 26% of the Company's net revenues in 1997. No single customer of the Company accounted for more than 10% of the Company's net revenues during 1996 and 1995. SERVICE AND SUPPORT The Company believes that its ability to provide service and support is and will continue to be an important element in the marketing of its products. The Company maintains in-house repair facilities and also provides telephone and electronic mail access to its technical support staff. The Company's technical support engineers not only provide assistance in diagnosing problems but work closely with customers to address system integration issues and to assist customers in increasing the efficiency and productivity of their systems. The Company provides system level software support through its factory-based technical maintenance organization and field system engineers, and also offers software update services that allow customers to purchase subsequent releases of its software products. Eurographics Industries Ltd., a leading European service organization, provides certain repair services for the Company's European distributors and OEM customers. 6 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. The Company is a major supplier of thin client computing systems and products. Competitive X-based network computing products are offered by a number of established computer manufacturers which have substantially greater name recognition, engineering, manufacturing and marketing capabilities and greater financial resources than those available to the Company. The Company also competes with a number of other manufacturers of network computing products, including Tektronix, Inc. ("Tektronix") and Wyse Technology, Inc. ("Wyse"). The Company believes that the principal competitive factors among thin client suppliers include price, breadth of product line, product performance, software features, network expertise, service and support, and market presence. Price competition is particularly intense among suppliers of lower-priced, lower-margin thin clients such as the Company's NCD EXPLORA 400 and NCD EXPLORA 450 models. Workstation manufacturers who offer thin client products, may have advantages over independent thin client vendors, including the Company, based on their ability to "bundle" their network computers, workstations and personal computers in certain large system sales. The Company and other manufacturers of thin clients also face significant competition from established computer manufacturers whose personal computer and workstation products offer alternatives to thin clients for most applications. In the high-performance, technical segment of the desktop computer market, thin clients compete with workstation networks offered by such manufacturers as HP, Digital Equipment Corporation ("DEC"), IBM and Sun Microsystems, Inc. Because thin client computing does not require application processing capability on every desktop, thin client computing systems compete favorably on a price/performance basis with workstation networks and offer cost advantages in initial system installation, as well as subsequent system upgrading and administration. However, the significant market presence and reputation of the larger workstation manufacturers, and customer perceptions regarding their need for desktop application processing capability, constitute obstacles to the penetration of this market segment by thin client manufacturers. At the low end of the commercial segment of the computer market, the Company competes with suppliers of lower cost ASCII and 3270 terminals. These products do not offer the graphics and windowing capabilities offered by NCD's thin client systems, but are still appealing to certain price sensitive customers. Moreover, PC networks offer an alternate means of upgrading from ASCII and 3270 terminal systems in many commercial applications. The introduction of the Company's NCD WINCENTER multi-user Windows application server software and lower-priced NCD EXPLORA thin clients allowed the Company to offer thin client computing systems that provide access to Windows applications. Other network computing companies, including Tektronix and Wyse, currently offer systems competitive with the Company's, but only Tektronix offers multi-user Windows NT server software similar to the Company's. Moreover, a number of other companies are offering, or have announced their intention to offer, network computing products and systems based on other technologies. There can be no assurance that the Company's new thin client products will compete successfully with competitive network computing products or that the thin client computing model will be widely adopted in the rapidly evolving Windows market. The Company also sells its NCD WINCENTER multi-user Windows application server software on a stand-alone basis to customers who wish to configure thin client computing systems using desktop devices offered by other manufacturers. The Company is experiencing intense competition in this new and rapidly evolving market from vendors who have introduced competitive products. These competitors include a product from Tektronix which is also based on software provided by Citrix which makes a multi-user product out of WINDOWS NT software. The Company believes that the principal competitive factors in this new market include price, performance, features, network compatibility and support. Competition in the thin client computing market has intensified over the past several years, resulting in price reductions, reduced profit margins and increased efforts to maintain market share, which have adversely affected the Company's operating results. In addition, intense competition from alternative desktop computing products, particularly personal computers, has slowed the growth of the thin client computing market. The Company expects this intense competition to continue. 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. 7 NCD PC-XWARE software products face direct competition from several software companies that offer similar products, including Hummingbird Communications, Ltd., a Canadian company, Visionware, a subsidiary of The Santa Cruz Operation, Inc., NetManage, Inc., FTP Software, Inc. and Walker, Ritchie, Quinn, a privately-held company. In addition, several large system companies, including DEC and IBM, offer PC X server software. MANUFACTURING AND SUPPLIES The Company conducts certain thin client production activities at its Mountain View, California facility. These operations consist primarily of final assembly and configuration, testing and quality control of material, components, sub-assemblies and systems. The Company utilizes a manufacturing control system which includes purchasing, inventory control and cost accounting functions. The Company tests each thin client in a network environment using a Company-developed, computer integrated manufacturing ("CIM") system. In addition, the Company employs a statistical process control system ("SPC") and conducts regular on-site inspections at its vendors' facilities to maintain quality control. The Company relies largely on one independent contractor for the sub-assembly of the Company's thin client products. The Company's reliance on 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 foreign suppliers also 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 substantially all of the sub- assemblies used for its thin client 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. 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. A number of components and parts used in the Company's products, including certain semiconductor components, also are currently available from single or limited sources of supply. The Company has no long-term purchase agreements or other guaranteed supply arrangements with suppliers of these single or limited source components. The Company has generally been able to obtain adequate supplies of parts and components in a timely manner from existing sources under purchase orders and endeavors to maintain inventory levels adequate to guard against interruptions in supplies. However, the Company's inability to obtain sufficient supplies of these parts and components from existing suppliers or to develop alternate supply sources would adversely affect the Company's operating results. The Company has, from time to time, experienced delays in the receipt of monitors from certain of its suppliers. In addition, the Company is required to place orders for monitors several months in advance of its anticipated requirements, and its ability to react to short-term increases or decreases in customer demand is, therefore, limited. Prolonged or repeated delays in the receipt of monitors could have a material adverse effect on the Company's operations. The Company's products incorporate memory components, such as video random access memory chips ("VRAMs"), that are available from multiple sources but have been subject to substantial fluctuations in availability and price. Certain other components, including microprocessors and ASICs, though generally available from multiple sources, are subject to industry-wide demand which could result in limited availability or significant fluctuations in pricing. To date, these fluctuations have not had a material effect on the Company's operating results and the Company has been able to obtain an adequate supply of such components. There can be no assurance that the Company will be able to obtain adequate supplies of these components in the future or that price fluctuations will not adversely affect the Company's operating results. The Company currently outsources the reproduction and packaging of its software to domestic vendors located in California and Oregon. BACKLOG The Company assembles its thin client products based upon its projections of near-term demand. Orders from large end-users and OEMs are generally placed by the customer on an as-needed basis, and products are typically shipped by the Company within 45 days after receipt of a firm purchase order. The Company does not generally have a significant backlog, and its 8 backlog at any particular time, or fluctuations in backlog from time to time, may not be representative of actual sales for any succeeding period. Because of the ease of manufacturing software products, the Company is able to effect the manufacture and shipment of these products quickly in response to customer orders without maintaining significant inventories, and, as a result, has historically had little, if any, backlog at any particular time. The Company does not, therefore, consider backlog for these products to be a significant measure of actual sales for any succeeding period. PROPRIETARY RIGHTS AND LICENSES The Company relies primarily on a combination of copyright, trademark and trade secret laws, employee and third-party non-disclosure agreements and other intellectual property protection methods to protect its proprietary technology. The Company holds six U.S. patents. Although management intends to pursue a policy of obtaining patents for appropriate inventions, the Company believes that its success will depend primarily on the innovative skills, technical competence and marketing abilities of its personnel rather than upon the ownership of patents. There can be no assurance that patents will issue from any pending or future patent applications or that any claims allowed will be sufficiently broad to protect the Company's technology. In addition, there can be no assurance that any patents issued to the Company will not be challenged, invalidated or circumvented, or that any rights granted thereunder will provide adequate protection to the Company. 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 are now a significant component of total software cost of sales. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." Generally, such licenses grant to the Company non-exclusive, worldwide rights with respect to the subject technology and terminate only in the event of material breach. In March 1996, the Company entered into a license agreement with Citrix pursuant to which the Company was granted the right to incorporate WINFRAME, Citrix's Microsoft-authorized multi-user software, into the Company's WINCENTER PRO Windows application server software and other related products. The Company is required to pay Citrix a per-copy royalty, subject to certain specified minimum royalty obligations. Under the license agreement, the Company was also granted an option to license additional software for bundling in future WINCENTER products in exchange for the payment of a one-time license fee. The license agreement has an initial term of two and one half years, subject to automatic renewal for successive one-year terms unless notice of nonrenewal is provided 60 days in advance by the Company or six months in advance by Citrix. The Company's software products are generally licensed on a right-to-use basis. The Company relies primarily on "shrink wrap" or "break the seal" licenses. Certain provisions of such licenses, including provisions protecting against unauthorized copying and reverse engineering, may not be enforceable under the laws of some jurisdictions. In addition, the laws of some foreign countries in which the Company's software products are distributed do not protect the Company's intellectual property rights to the same extent as U.S. law. There can be no assurance that third parties will not assert infringement claims against the Company or its suppliers with respect to current or future products. Although the Company has historically been able to resolve all asserted claims on terms which have not had a material effect on the Company's operations, there is no assurance that any future claims may not require the Company to enter into unfavorable royalty arrangements or result in costly litigation. EMPLOYEES As of December 31, 1997, the Company had 352 full-time employees, of whom 79 were primarily engaged in research and development, 54 in technical support, 113 in marketing and sales, 59 in manufacturing and 47 in administration and finance. None of the Company's employees is represented by a collective bargaining agent. The Company has experienced no work stoppages and believes that its employee relations are good. Competition for employees in the computer and software industries is intense. The Company believes that its future success will depend, in part, on its ability to continue to attract and retain highly skilled technical, marketing and management personnel. 9 EXECUTIVE OFFICERS OF THE COMPANY The following sets forth certain information with respect to the executive officers of the Company, and their ages as of March 27, 1998:
Name Age Position ---- --- -------- Robert G. Gilbertson 56 President and Chief Executive Officer Rudolph G. Morin 60 Executive Vice President, Operations & Finance and Chief Financial Officer Cecil M. Dye 57 Senior Vice President, Worldwide Sales Lorraine J. Hariton 44 Senior Vice President, Marketing and Business Development
Mr. Gilbertson has served as President and Chief Executive Officer of the Company since May 1996. Prior to joining the Company, Mr. Gilbertson served as Chairman of Avidia Systems, Inc., a manufacturer of ATM switching systems, and also as President and Chief Executive Officer of CMX Systems, Inc., a manufacturer of precision measurement and positioning products from 1993 to 1996. In 1994, CMX ranked No. 103 on the Inc. Magazine list of the 500 fastest growing privately held companies in the U.S. Prior thereto, he served as President and Chief Executive Officer of Data Switch Corporation, which was named turnaround company of the decade by CFO Magazine. Mr. Gilbertson holds an MBA from the University of Chicago, served as Chairman of the Board of the American Electronics Association, and was a member of the faculty of Harvard Business School for five years. Mr. Morin has served as Executive Vice President, Operations & Finance and Chief Financial Officer since June 1996. Prior to joining the Company, Mr. Morin served as Senior Vice President, Finance and Administration for Memorex Telex Corporation from 1993 to 1996. Prior thereto, he worked with Mr. Gilbertson at Data Switch, where he was Executive Vice President. Mr. Morin's background also includes more than ten years with Thyssen Bornemisza Inc. as head of corporate development and general manager of several of its subsidiaries. Mr. Morin holds MBAs from INSEAD and Harvard. Mr. Dye has served as Senior Vice President, Worldwide Sales since March 1997 and served as Senior Vice President, Sales and Marketing from September 1996 to March 1997. Prior to joining the Company, Mr. Dye served as the Senior Vice President of Worldwide Sales and Service for Wyse Technology from 1994 to 1996. Prior thereto, Mr. Dye spent 24 years with Digital Equipment Corp., most recently as vice president and general manager of the western region. Mr. Dye holds an MBA from Xavier University. Ms. Hariton has served as an executive officer of the Company since September 1993 and was appointed Senior Vice President, Marketing and Business Development in March 1997. Ms. Hariton joined the Company as Vice President, Marketing, and in 1996 was appointed to the position of Vice President, Business Development. From 1992 to 1993, Ms. Hariton was employed by Verifone Corporation as Director of Marketing. From 1986 to 1992, she was employed by ROLM Corporation in a variety of sales and marketing positions. Ms. Hariton holds an MBA from Harvard University. ITEM 2. PROPERTIES. The Company's principal administrative, marketing, manufacturing and research and development operations are located in adjacent buildings in Mountain View, California. These facilities consist of approximately 178,000 square feet and are occupied under leases which expire between February 1999 and February 2003. Approximately 28,000 square feet in these facilities are currently being sublet to a third party. The annual gross rent for these facilities currently approximates $1,700,000. The Company's PC X software operations are located in a 30,000 square foot facility in Beaverton, Oregon, under a lease expiring in October 2000, with gross rent of approximately $246,000 for 1997. The Company also leases a 20,000 square foot facility in Novato, California, under a lease expiring in July 2001 which is currently being subleased to third parties. The Company believes that its existing facilities are adequate for its present requirements and that suitable 10 additional space will be available as needed. The Company's field sales and service offices worldwide consist of leased office space totaling approximately 23,000 square feet, with current aggregate gross rents of approximately $767,000 for 1997. ITEM 3. LEGAL PROCEEDINGS. In April 1996, two purported class action complaints, WOODWARD, ET AL V. BRADLEY, ET AL and CURLEY, ET AL V. MARINARO, ET AL, were filed in the United States District Court for the Northern District of California, and a third purported class action complaint, MAIZEL, ET AL V. MARINARO, ET AL, was filed in the Superior Court of the State of California for the County of Santa Clara. In May 1996, a fourth purported class action complaint, CLEVELAND, ET AL V. MARINARO, ET AL, was filed in the United States District Court for the Northern District of California. The plaintiffs in the MAIZEL, CURLEY and CLEVELAND actions claimed to be suing on behalf of a class of persons who purchased the Company's Common Stock during the period February 2, 1995 to March 21, 1996; the plaintiffs in the WOODWARD action claimed to be suing on behalf of a class of persons who purchased the Company's Common Stock during the period February 1, 1996 to March 21, 1996. Certain named current and former officers and a director of the Company were named as defendants in the actions. The MAIZEL complaint also named as defendants Morgan Stanley & Co. and Stephen Milunovich, an employee of Morgan Stanley & Co. The complaints alleged, among other things, that the Company issued false and misleading statements to the public about the Company's financial performance and prospects, in violation of California and federal securities laws. The complaint in the MAIZEL action alleged that the officer and director defendants sold or otherwise disposed of the Company's Common Stock in violation of California securities laws. The parties entered a settlement agreement during the first quarter of 1997. As part of the settlement arrangement, the Company agreed to contribute $1.1 million toward the $12 million in costs to settle all pending securities litigation. The Company anticipates that no further charges related to such settlement will be incurred in the future. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matter was submitted to a vote of security holders during the fourth quarter of the Company's fiscal year ended December 31, 1997. 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS. MARKET PRICE DATA The Company's Common Stock has been traded on the Nasdaq National Market under the symbol "NCDI" since the Company's initial public offering in June 1992. The following table sets forth, for the periods indicated, the high and low closing sale prices for the Common Stock on such market:
High Low ------- ------ 1997: First Quarter $15.375 $9.375 Second Quarter 13.50 9.375 Third Quarter 11.875 8.25 Fourth Quarter 10.875 6.25 1996: First Quarter $ 8.00 $3.75 Second Quarter 7.00 2.9375 Third Quarter 6.1875 3.125 Fourth Quarter 10.75 6.25
The closing sale price for the Common Stock on February 27, 1998 was $12.625. As of February 28, 1998, the Company had approximately 236 holders of record of its Common Stock and 16,354,169 shares of Common Stock were outstanding. The market price of the Company's Common Stock has fluctuated significantly and is subject to significant fluctuations in the future. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Future Performance and Risk Factors." DIVIDEND POLICY The Company has never paid cash dividends on its capital stock. The Company currently expects that it will retain its future earnings for use in the operation and expansion of its business and does not anticipate paying any cash dividends in the foreseeable future. 12 ITEM 6. SELECTED FINANCIAL DATA. The following selected consolidated financial data should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and the notes thereto included in "Item 8. Financial Statements and Supplementary Data."
Years Ended December 31, 1997 1996 1995 1994 1993 ----------- ----------- ----------- ----------- ----------- (In Thousands, Except Per Share Data) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Net revenues $133,400 $120,608 $139,328 $160,871 $144,265 Operating income (loss) 1,736 (17,241) (7,657) (15,507) 12,925 Income (loss) before income taxes and cumulative effect of accounting change 3,831 (8,721) (6,205) (7,285) 13,758 Net income (loss) 2,681 (5,232) (4,029) (10,843) 9,241 Net income (loss) per share - basic 0.16 (0.32) (0.25) (0.68) 0.59 Net income (loss) per share - diluted 0.15 (0.32) (0.25) (0.68) 0.59 CONSOLIDATED BALANCE SHEET DATA: Cash, cash equivalents and short-term investments $ 31,480 $ 35,671 $ 36,150 $ 31,220 $ 35,632 Working capital 53,811 60,981 57,470 62,802 67,481 Total assets 86,514 85,693 97,537 101,029 94,169 Capital lease obligations, less current portion 160 314 991 1,497 1,990 Total shareholders' equity 60,519 67,425 68,014 71,889 76,537
13 ITEM 7. 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." Network Computing Devices, Inc. provides thin client hardware and software that delivers simultaneous, high-performance, easy-to-manage access to any application from thin client, UNIX and PC desktops. The Company's product lines include the NCD EXPLORA and family of thin clients, NCD WINCENTER PRO-TM- multi-user WINDOWS NT-Registered Trademark- application server software, and NCD PC-XWARE-Registered Trademark- software that delivers PC access to UNIX and multi-user WINDOWS NT PCs. 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 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 thin client 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. 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 thin client computing products 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 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 an amount of $1.1 million in related accruals was determined to be 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. 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 14 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. The above results notwithstanding, 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. Notwithstanding the foregoing provisions, a material shortfall in IBM's orders from the quantity levels anticipated by the Company for any period will have a material adverse effect on the Company's operating results. See "Item 7. Management's Discussion and Analysis of Financial Position and Results of Operations -- Future Performance and Risk Factors -- Fluctuations in Operating Results." During 1997 the Company continued to implement cost and hiring controls initiated in the 1996 "turnaround" and was able to report four profitable quarters, despite short-falls in orders related to the Company's "thin client" systems. Assuming this trend will continue until the new Microsoft Windows-based software and systems are in the final stages of development, the Company anticipates lower revenues and a modest loss in the first half of 1998 and expects the ramp-up of orders to begin by the third quarter of 1998. During the first quarter of 1998, the Company signed a three-year agreement with Intel Corporation under which the Company and Intel will collaborate to produce desktop devices based on guidelines for Lean Client systems outlined by Intel in December 1997. Under the terms of the non-exclusive agreement, the Company will develop a "reference platform design" that consists of Pentium-based lean client hardware integrated with software technology from both companies. Intel will supply the Company with Pentium microprocessors, associated logic components and related software. The Company will create, manufacture and market lean client systems and operating software. 15 RESULTS OF OPERATIONS The following table sets forth certain items in the Company's consolidated statements of operations as a percentage of net revenues for the periods indicated. Figures are rounded to the nearest whole percentage, and line items presenting subtotal and total percentages may therefore differ, due to rounding, from the sum of the percentages for each line item.
Years Ended December 31, ------------------------ 1997 1996 1995 ----- ----- ----- Net revenues: Hardware products and services 75% 79% 79% Software licenses and services 25% 21% 21% ----- ----- ----- Total net revenues 100% 100% 100% Cost of revenues: Hardware products and services 53% 60% 59% Software licenses and services 7% 6% 3% ----- ----- ----- Total cost of revenues 61% 67% 62% ----- ----- ----- Gross profit 39% 33% 38% Operating expenses: Research and development 11% 12% 9% Marketing and selling 23% 27% 25% General and administrative 5% 9% 6% Charge (credit) for business restructuring -- (1)% 3% Litigation settlement (0)% 1% -- ----- ----- ----- Total operating expenses 38% 48% 43% ----- ----- ----- Operating income (loss) 1% (14)% (5)% Non-operating income and gains, net 2% 7 % 1% ----- ----- ----- Income (loss) before income taxes 3% (7)% (4)% Provision for income taxes (income tax benefit) 1% (3)% (2)% Net income (loss) 2% (4)% (3)% ----- ----- ----- ----- ----- -----
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 for 1997 were $133.4 million, an increase of 11% from 1996 net revenues of $120.6 million. Net revenues for 1996 decreased by 13% compared to 1995 net revenues of $139.3 million. International revenues were 34% of total net revenues for 1997, representing a slight increase from 33% in 1996 and 1995. Sales to IBM accounted for 26% of revenues in 1997. No single customer of the Company accounted for more than 10% of the Company's net revenues during 1996 or 1995. HARDWARE REVENUES Hardware revenues consist primarily of revenues from the sale of thin client products, related hardware, and to a lesser extent, fees for related service activities. Hardware revenues were $100.6 million for 1997, an increase of 6% compared to revenues 16 of $95.0 million in 1996. Hardware revenues for 1996 decreased 13% compared to revenues of $109.7 million in 1995. The increase in revenues in 1997 reflects the increased shipments related to the IBM Agreement, offset by lower average selling prices ("ASPs"). The decline in revenues for 1996 was due to a decline in units shipped and a decline in the ASPs of the Company's hardware products due to the Company's introduction of lower-priced EXPLORA thin clients and pricing competition. 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-TM-, the Company's multi-user WINDOWS NT application server software, PC-XWARE, the Company's thin client software for PCs, and NCDWARE-Registered Trademark-, the Company's proprietary thin client software. Through the first quarter of 1996, Software revenues also included revenues from the development and licensing of the Company's MARINER Internet connectivity product line (which was sold in the first quarter of 1996), and the Z-MAIL product line (which was sold during the second quarter of 1996). Revenues from software and related services were $32.8 million for 1997, an increase of 28% compared to revenues of $25.6 million in 1996. The increase in 1997 software revenues compared to 1996 resulted from increased sales of WINCENTER and related support services. Revenues from software and related services of $25.6 million for 1996 decreased by 13% compared to revenues of $29.6 million in 1995. The decrease in 1996 software revenues when compared to 1995 software revenues was primarily due to reductions in revenues of $3.9 million related to the Company's former Z-MAIL product line, and $6.4 million related to the Company's former MARINER product line. In addition, PC-XWARE revenues declined by $6.0 million during a period in which its sales force was in transition. These revenue declines were offset in part by higher WINCENTER revenues. GROSS MARGIN ON HARDWARE REVENUES The Company's gross margin percentages on Hardware revenues were 29%, 23% and 25% for the years ended December 31, 1997, 1996 and 1995, respectively. The increase in margin for 1997 relates to lower 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 1997 while no such purchasing benefits were realized in 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. The slight decline in margin in 1996 compared to 1995 is primarily due to increased sales of lower-priced EXPLORA thin clients, which generally carry lower margins, offset in part by comparatively lower sales discounts and material costs. Sales discounts during 1996 declined when compared to 1995 as a result of more stringent pricing controls, and material costs declined primarily as a result of market declines in the cost of certain semiconductor components. In 1996, the Company recorded a $3.0 million charge associated with the reduction of certain inventories to market value. This compares to a $2.7 million charge to cost of revenues in 1995 associated with business restructuring activities described above under "Overview." Exclusive of these charges, the gross margin percentages on Hardware revenues would have been 27% for both 1996 and 1995. GROSS MARGIN ON SOFTWARE REVENUES The Company's gross margin percentages on Software revenues were 70% for both years ended December 31, 1997 and 1996, and 88% for the year ended December 31, 1995. The decline in 1996 when compared to 1995 was due primarily to a higher mix of WINCENTER revenues in 1996, which carry a lower margin because of higher third-party royalty costs, and reduced revenues of other software products, including revenues associated with Z-MAIL and MARINER. Certain technology used in the Company's products is licensed from third parties on a royalty-bearing basis. Accordingly, royalties are now a significant component of total software cost of sales for 1997 and 1996. RESEARCH AND DEVELOPMENT EXPENSES Research and development ("R&D") expenses were $14.2 million, $14.9 million and $13.1 million for the years ended December 31, 1997, 1996 and 1995, respectively. R&D expenses decreased in 1997 compared to 1996 primarily due to the absence of costs of $2.5 million related to the Z-MAIL and MARINER product lines which were sold in the first half of 1996. 17 Absent these costs, R&D expenses in 1997 increased 15% reflecting increased investment in the area of thin client computing products. Total R&D expenses increased in 1996 compared to 1995 due to additional spending related to thin client computing products. R&D expenses in 1995 included $2.2 million related to the Z-MAIL and MARINER product lines. As a percentage of net revenues, R&D expenses, excluding Z-MAIL and MARINER costs were 11%, 10% and 8% for 1997, 1996 and 1995, respectively. The Company plans to increase its investment in research and development in the area of thin client computing products through 1998. MARKETING AND SELLING EXPENSES Marketing and selling expenses were $30.5 million, $32.1 million and $34.1 million for the years ended December 31, 1997, 1996 and 1995, respectively. The decreases in all comparable periods reflect increased efficiencies related to 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 23%, 27% and 25% for 1997, 1996 and 1995, respectively, resulting from the combined impact of lower net revenues in 1996 and decreased spending in both 1997 and 1996. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative ("G&A") expenses were $6.1 million, $10.3 million and $8.5 million for the years ended December 31, 1997, 1996 and 1995, respectively. The decrease in 1997 when compared to 1996 primarily reflects increased efficiencies related to the reconsolidation in 1996 as well as continued cost controls related to personnel costs and outside service fees. The increase in 1996 over 1995 was primarily related to both severance costs associated with the elimination of certain positions within the Company and increased personnel costs during early 1996 that resulted from the division of the Company into two separate business units (Systems and Software). As mentioned above under "Overview," in June of 1996, the Company determined to recombine its remaining business units. As a percentage of net revenues, G&A expenses were 5%, 9% and 6% for 1997, 1996 and 1995, respectively, reflecting decreased spending in 1997 and the combined impact of increased spending and lower net revenues in 1996. BUSINESS RESTRUCTURING During 1995, the Company created and began implementing a plan to restructure the business in order to improve the Company's operating performance potential. The plan included substantial modifications to the Company's manufacturing processes, phasing out activities related to less profitable products, a reduction in facilities, and a reduction in the number of employees. During 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 1996, the Company substantially concluded such restructuring activities and an amount of $1.1 million in related accruals was determined to be in excess of amounts required. As a result, the Company recognized a $1.1 million credit for business restructuring during 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. See "Business Restructuring" in Note 4 of the "Notes to Consolidated Financial Statements" contained herein. LITIGATION SETTLEMENT The $1.1 million charge for litigation settlement that was recognized in 1996 represents the Company's voluntary contribution toward a total of $12 million in costs to settle all pending securities litigation. The settlement agreement was executed by all parties in 1997, and the Company anticipates that no further charges related to such settlement will be incurred in the future. A credit of $147,000 representing the excess of the $1.1 million accrual was recognized in 1997 when all expenses related to the litigation settlement were determined. INTEREST INCOME, NET Interest income, net of interest expense, was $1.9 million, $1.6 million and $1.4 million for the years ended December 31, 1997, 1996 and 1995, respectively. The increases were primarily due to higher average balances in interest-earning accounts in addition to lower interest expense related to declining capital lease obligations. This was partially offset by declining interest rates across the periods presented. 18 OTHER INCOME, NET Other income includes non-operating income, net of non-operating expense. Other income in 1997 reflects the receipt of insurance proceeds for certain legal expenses incurred in association with the securities litigation costs. No significant other income was produced during 1996 or 1995. GAIN ON SALE OF PRODUCT LINES The gain on sale of product lines in 1996 represents the net gain on the sale of the MARINER product line in February 1996, offset by a slight loss on the sale of the Z-MAIL product line in June 1996. (See "Overview.") INCOME TAXES AND INCOME TAX BENEFIT The Company recognized an income tax provision of $1.2 million in 1997 compared to income tax benefit of $3.5 million and $2.2 million in 1996 and 1995, respectively. At December 31, 1997, the Company's gross deferred tax assets are approximately $6.0 million. Based on the Company's expected operating results, management believes that it is more likely than not that the Company will realize the benefit of the deferred tax assets recorded and, accordingly, has established no asset valuation allowances. See "Note 6. Income Taxes -- Notes to Consolidated Financial Statements." FINANCIAL CONDITION Total assets of $86.5 million at December 31, 1997 increased from $85.7 million at December 31, 1996. The change in total assets reflects increases in inventories and accounts receivable of $5.6 million and $3.6 million, respectively, partially offset by decreases in cash and short-term investments, income tax assets and other current assets of $4.2 million, $3.5 million and $0.8 million, respectively. Total liabilities as of December 31, 1997 increased by $7.7 million, or 42%, from December 31, 1996. The increase was primarily related to increased accounts payable balances associated with increased inventory receipts in the last month of the year. CAPITAL REQUIREMENTS Capital spending requirements for 1998 are estimated at approximately $3.3 million, and at December 31, 1997, the Company had commitments for capital expenditures of approximately $400,000. These commitments are primarily related to manufacturing tooling and facilities. LIQUIDITY As of December 31, 1997, the Company had combined cash and equivalents and short-term investments totaling $31.5 million, with no significant debt. Cash provided by operations was $9.8 million in 1997 compared to cash used in operations of $9.2 million in 1996 and cash provided by operations of $11.2 million in 1995. Cash provided by operations in 1997 primarily reflects a net income of $2.7 million, depreciation of $3.3 million, increases in accounts payable of $6.8 million and decreases in refundable and deferred income taxes of $3.1 million partially offset by increases in inventories and accounts receivable of $5.6 million and $3.6 million, respectively. Cash used in operations in 1996 primarily reflects a net loss of $5.2 million, the gain on sale of product lines of $6.9 million, decreases in accounts payable of $9.5 million and increases in refundable and deferred income taxes of $3.2 million partially offset by depreciation of $4.6 million and decreases in accounts receivable and inventories of $7.0 million and $4.5 million, respectively. Cash provided by operations in 1995 primarily reflects decreases in inventories and accounts receivable of $9.2 million and $3.2 million, respectively, depreciation of $4.5 million and increases in income taxes payable and deferred revenue of $2.9 million and $2.3 million, respectively, partially offset by a net loss of $4.0 million, a decrease in accounts payable of $3.7 million and an increase in refundable and deferred income taxes of $2.2 million. Cash flows used in financing activities in 1997 reflects repurchases of $12.2 million of the Company's common stock. 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 THIN CLIENT COMPUTING MARKET The Company derives a majority of its revenues from the sale of thin client computing 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, 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 thin client computing products have allowed the Company to offer thin client 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 thin client computing model and the successful marketing of the Company's new thin client computing products. There can be no assurance that the Company's new thin client computing products will compete successfully with alternative desktop solutions or that the thin client computing model will be widely adopted in the rapidly evolving desktop computer market. The failure of new markets to develop for the Company's thin client computing products would have a material, adverse effect on the Company's business, operating results and financial condition. 19 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 thin client 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. 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 which 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 execution 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 potential OEM relationships for the Company's thin client computing products. This condition would likely lead to overall reduced gross margins 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 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 20 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. RELIANCE ON INDEPENDENT DISTRIBUTORS AND RESELLERS The Company 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. RELIANCE ON INDEPENDENT CONTRACTORS The Company relies on independent contractors for virtually all of the sub-assembly of the Company's thin client computing 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 thin client computing 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. 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. In the past, 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 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, President and Chief Executive Officer and Rudolph G. Morin, Executive Vice President of Operations & Finance and Chief Financial Officer. 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, 21 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. RISKS RELATED TO YEAR 2000 PROBLEM In the next two years, most companies could face a potentially serious information systems problem because many software applications and operational programs written in the past were designed to handle date formats with two-digit years and thus may not properly recognize calendar dates beginning in the Year 2000. This problem could result in computers either outputting incorrect data or shutting down altogether when attempting to process a date such as "01/01/00." The Company has examined all of its critical software and operational applications as well as the software products it has sold and found no potential problems related to the Year 2000 issue. However, the Company could experience reduced revenues resulting from other Companys' information systems budgets being allocated to solving Year 2000 issues, thus reducing amounts available to purchase the Company's products. In addition, the Company could be exposed to a potential adverse impact resulting from the failure of financial institutions and other third parties to adequately address the Year 2000 problem. The Company intends to devote necessary resources to identify and resolve Year 2000 issues that may exist with third parties. However, the Company cannot estimate the cost of this effort at this time, nor can any assurance be given that the Year 2000 problem will not have a material adverse effect on the Company's business, operating results or financial condition. 22 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Independent Auditors' Report 24 Consolidated Balance Sheets as of December 31, 1997 and 1996 25 Consolidated Statements of Operations for the Years Ended December 31, 1997, 1996 and 1995 26 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 27 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 28 Notes to Consolidated Financial Statements 29 Supplementary Data: Quarterly Financial Data (Unaudited) 38
23 Independent Auditors' Report The Board of Directors Network Computing Devices, Inc. We have audited the accompanying consolidated balance sheets of Network Computing Devices, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Network Computing Devices, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Mountain View, California January 27, 1998, except as to Note 10 which is as of March 16, 1998 24 NETWORK COMPUTING DEVICES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
December 31, -------------------------- 1997 1996 ------------ ------------ Assets: Current assets: Cash and cash equivalents $ 21,240 $ 23,832 Short-term investments 10,240 11,839 Accounts receivable, net of allowances of $2,606 and $2,603 as of December 31, 1997 and 1996, respectively 25,148 21,549 Inventories 15,412 9,776 Refundable and deferred income tax assets 4,763 8,287 Other current assets 2,843 3,652 --------- --------- Total current assets 79,646 78,935 Property and equipment, net 4,424 4,895 Other assets 2,444 1,863 --------- --------- Total assets $ 86,514 $ 85,693 --------- --------- --------- --------- Liabilities and Shareholders' Equity: Current liabilities: Accounts payable $ 11,211 $ 4,383 Accrued expenses 8,955 8,977 Deferred revenue 4,918 3,486 Income taxes payable 597 360 Current portion of capital lease obligations 154 748 --------- --------- Total current liabilities 25,835 17,954 Long-term portion of capital lease obligations 160 314 Commitments and contingencies Shareholders' equity: Undesignated preferred stock: 3,000,000 shares authorized; no shares issued and outstanding - - Common stock, no par value: 30,000,000 shares authorized; 16,283,772 and 17,037,369 shares issued and outstanding as of December 31, 1997 and 1996, respectively 58,630 68,217 Retained earnings (accumulated deficit) 1,889 (792) --------- --------- Total shareholders' equity 60,519 67,425 --------- --------- Total liabilities and shareholders' equity $ 86,514 $ 85,693 --------- --------- --------- ---------
See accompanying notes. 25 NETWORK COMPUTING DEVICES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Years Ended December 31, --------------------------------------- 1997 1996 1995 ---------- --------- ---------- Net revenues: Hardware products and services $ 100,555 $ 94,973 $ 109,723 Software licenses and services 32,845 25,635 29,605 ---------- --------- ---------- Total net revenues 133,400 120,608 139,328 Cost of revenues: Hardware products and services 71,118 72,715 82,778 Software licenses and services 9,957 7,769 3,607 ---------- --------- --------- Total cost of revenues 81,075 80,484 86,385 ---------- --------- --------- Gross profit 52,325 40,124 52,943 Operating expenses: Research and development 14,179 14,930 13,119 Marketing and selling 30,455 32,117 34,147 General and administrative 6,102 10,270 8,502 Charge (credit) for business restructuring - (1,052) 4,832 Litigation settlement (credit) (147) 1,100 - ---------- --------- --------- Total operating expenses 50,589 57,365 60,600 ---------- --------- --------- Operating income (loss) 1,736 (17,241) (7,657) Interest income 1,946 1,656 1,557 Interest expense (51) (68) (198) Other income, net 200 - 93 Gain on sale of product lines - 6,932 - ---------- --------- --------- Income (loss) before income taxes 3,831 (8,721) (6,205) Provision for income taxes (income tax benefit) 1,150 (3,489) (2,176) ---------- --------- --------- Net income (loss) $ 2,681 $ (5,232) $ (4,029) ---------- --------- --------- ---------- --------- --------- Basic earnings per share: Net income (loss) per share $ 0.16 $ (0.32) $ (0.25) ---------- --------- --------- ---------- --------- --------- Shares used in per share computations 16,725 16,579 15,832 ---------- --------- --------- ---------- --------- --------- Diluted earnings per share: Net income (loss) per share $ 0.15 $ (0.32) $ (0.25) ---------- --------- --------- ---------- --------- --------- Shares used in per share computations 18,313 16,579 15,832 ---------- --------- --------- ---------- --------- ---------
See accompanying notes. 26 NETWORK COMPUTING DEVICES, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
Retained Common Stock Net Unrealized Earnings Total ---------------- Gain (Loss) on (Accumulated Shareholders' Shares Amount Securities Deficit) Equity ------ ------- -------------- ------------ ------------- Balances as of December 31, 1994 15,637 $63,420 $ - $8,469 $71,889 Issuance of common stock under Stock Option Plan and Employee Stock Purchase Plan, including related tax benefit 1,053 4,150 - - 4,150 Repurchase of common stock (571) (4,027) - - (4,027) Net unrealized gain on securities - - 31 - 31 Net loss - - - (4,029) (4,029) ------ ------- -------------- ------ ------- Balances as of December 31, 1995 16,119 63,543 31 4,440 68,014 Issuance of common stock under Stock Option Plan and Employee Stock Purchase Plan, including related tax benefit 928 4,763 - - 4,763 Repurchase of common stock (10) (89) - - (89) Net unrealized loss on securities - - (31) - (31) Net loss - - - (5,232) (5,232) ------ ------- -------------- ------ ------- Balances as of December 31, 1996 17,037 68,217 - (792) 67,425 Issuance of common stock under Stock Option Plan and Employee Stock Purchase Plan, including related tax benefit 438 2,634 - - 2,634 Repurchase of common stock (1,191) (12,221) - - (12,221) Net income - - - 2,681 2,681 ------ ------- -------------- ------ ------- Balances as of December 31, 1997 16,284 $58,630 $ - $1,889 $60,519 ------ ------- -------------- ------ ------- ------ ------- -------------- ------ -------
See accompanying notes. 27 NETWORK COMPUTING DEVICES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Years Ended December 31, ------------------------------------- 1997 1996 1995 --------- ---------- ----------- Cash flows from operating actitivites: Net income (loss) $ 2,681 $ (5,232) $ (4,029) Reconciliation of net income (loss) to net cash provided by (used in) operating activities: Gain on sale of product lines - (6,932) - Non-cash restructuring charges (credit) - (1,052) 2,474 Depreciation and amortization 3,287 4,559 4,505 Changes in: Accounts receivable, net (3,599) 7,042 3,152 Inventories (5,636) 4,455 9,224 Refundable and deferred income taxes 3,130 (3,166) (2,227) Other current assets and other 809 (378) (1,450) Accounts payable 6,828 (9,510) (3,743) Income taxes payable 897 (1,446) 2,856 Accrued expenses (22) 1,856 (1,900) Deferred revenue 1,432 578 2,325 --------- ---------- ----------- Net cash provided by (used in) operating activites 9,807 (9,226) 11,187 --------- ---------- ----------- Cash flows from investing activities: Purchases of short-term investments (12,649) (3,684) (192,090) Sales and maturities of short-term investments 14,248 14,600 193,148 Changes in other assets (187) (58) (200) Capitalization of software costs - - (436) Net proceeds from sale of product lines - 8,625 - Property and equipment purchases, net (2,816) (2,273) (3,217) --------- ---------- ----------- Net cash provided by (used in) investing activities (1,404) 17,210 (2,795) --------- ---------- ----------- Cash flows from financing activities: Principal payments on capital lease obligations (748) (1,175) (1,535) Repurchases of common stock (12,221) (89) (4,027) Proceeds from issuance of stock, net 1,974 3,748 3,127 --------- ---------- ----------- Net cash provided by (used in) financing activities (10,995) 2,484 (2,435) --------- ---------- ----------- Increase in cash and cash equivalents (2,592) 10,468 5,957 Cash and cash equivalents: Beginning of year 23,832 13,364 7,407 --------- ---------- ----------- End of year $ 21,240 $ 23,832 $ 13,364 --------- ---------- ----------- --------- ---------- ----------- Noncash investing and financing activities: Property and equipment acquired under capital leases $ - $ - $ 929 --------- ---------- ----------- --------- ---------- ----------- Income tax benefit from employee stock transactions $ 660 $ 860 $ 1,023 --------- ---------- ----------- --------- ---------- -----------
See accompanying notes. 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Network Computing Devices, Inc. ("the Company") was incorporated on February 17, 1988. The Company provides thin client hardware and software that delivers high-performance, easy-to-manage, simultaneous access to any application from thin client, UNIX and PC desktops. The Company's product lines include the NCD EXPLORA and family of thin clients, NCD WINCENTER PRO multi-user WINDOWS NT application server software, and NCD PC-XWARE software that delivers PC access to UNIX and multi-user WINDOWS NT PCs. CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company has invested in a joint venture in Japan (Nihon NCD), which is accounted for at cost. The functional currency for the Company and its subsidiaries is the U.S. dollar. All significant intercompany balances and transactions have been eliminated in consolidation. CASH EQUIVALENTS The Company considers all highly liquid investments purchased with a maturity date of three months or less to be cash equivalents. SHORT-TERM INVESTMENTS The Company has classified all of its short-term investments as "available-for-sale" securities. The carrying value of such securities is adjusted to fair market value, with unrealized gains and losses, net of deferred taxes, being excluded from earnings and reported as a separate component of shareholders' equity. Cost is determined by specific identification for purposes of computing realized gains or losses. INVENTORIES Inventories are stated at the lower of standard cost, which approximates actual cost on a first-in, first-out basis, or market (net realizable value). PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Equipment under capital leases is stated at the lower of fair value or the present value of the minimum lease payments at the inception of the lease. Depreciation is computed using the straight-line method. Useful lives of three to five years are used for equipment and furniture; demonstration equipment is depreciated over an 18-month period. Leasehold improvements and equipment under capital leases are amortized over the shorter of the lease term or the useful lives of the respective assets. REVENUE RECOGNITION Revenues on the sale of hardware products and from the licensing of software products are generally recognized upon shipment, provided that no significant obligations remain and collection of the resulting receivable is deemed probable. Product warranty costs and an allowance for sales returns are accrued at the time the related revenues are recognized. Service contract revenues are recognized ratably over the contract period. RESEARCH AND DEVELOPMENT COSTS Research and development costs are charged to engineering expense when incurred. Costs incurred in the development of new software products and enhancements to existing software products are also expensed as incurred until the technological feasibility of the product has been established. After technological feasibility has been established, any additional costs are capitalized in accordance with Statement of Financial Accounting Standards ("SFAS") No. 86. Capitalized software technology is amortized to cost of goods sold over eighteen months to three years, based on the expected life of the product. INCOME TAXES Under the asset and liability method of SFAS No. 109, "Accounting for Income Taxes," deferred tax assets and liabilities are established to recognize the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. USE OF ESTIMATES Management of the Company has made a number of estimates and assumptions relating to the valuation and reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. 29 FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of the Company's cash and cash equivalents, short-term investments, accounts receivable, and accounts payable approximate their respective fair values. IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Adoption of this statement did not have a material impact on the Company's consolidated financial position or results of operations. NET INCOME (LOSS) PER SHARE Basic net income (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed using the weighted-average number of common shares and common equivalent shares from stock options (1,588,000 shares in 1997) outstanding, when dilutive, using the treasury stock method. In 1996 and 1995 there were 3,236,208 and 2,784,154 options outstanding, respectively, that could potentially dilute basic earnings per share ("EPS") in the future that were not included in the computation of diluted EPS because to do so would have been antidilutive for those years. In 1998, the Company issued 750,000 shares that will dilute basic EPS in the future. STOCK-BASED COMPENSATION The Company accounts for its employee stock-based compensation plans using the intrinsic value method. As such, compensation expense is recorded on the date of grant if the current market price of the underlying stock exceeded the exercise price. RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components in the consolidated financial statements. It does not, however, require a specific format for the statement, but requires the Company to display an amount representing total comprehensive income for the period in that financial statement. The Company is in the process of determining the preferred format. This statement is effective for fiscal years beginning after December 15, 1997. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for the way public business enterprises report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to stockholders. SFAS No. 131 is effective for financial statements for periods beginning after December 31, 1997. The Company has not yet determined whether it has any separately reportable business segments. RECLASSIFICATION Certain items in the accompanying 1995 consolidated financial statements have been reclassified in order to conform to the current year's presentation. NOTE 2. SHORT-TERM INVESTMENTS Short-term investments consisted of the following as of December 31, 1997 (in thousands):
Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- ---------- ---------- ------- Corporate debt securities $ 7,491 $ -- $ -- $ 7,491 Commercial paper 981 -- -- 981 Certificates of deposit 1,768 -- -- 1,768 ------- ---------- ---------- ------- $10,240 $ -- $ -- $10,240 ------- ---------- ---------- ------- ------- ---------- ---------- -------
30 The maturities of available-for-sale securities as of December 31, 1997 were as follows (in thousands):
Within One to One Year Two Years -------- --------- Corporate debt securities $5,478 $2,013 Commercial paper 981 -- Certificates of deposit 1,768 -- ------ ------ $8,227 $2,013 ------ ------ ------ ------
Short-term investments consisted of the following as of December 31, 1996 (in thousands):
Gross Gross Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- ---------- ---------- ------- Corporate debt securities $ 5,355 $ -- $ -- $ 5,355 Commercial paper 4,808 -- -- 4,808 U.S. Treasury Notes 1,676 -- -- 1,676 ------- ---------- ---------- ------- $11,839 $ -- $ -- $11,839 ------- ---------- ---------- ------- ------- ---------- ---------- -------
NOTE 3. CONSOLIDATED BALANCE SHEET AND STATEMENT OF CASH FLOWS COMPONENTS
1997 1996 ------- ------ Inventories as of December 31 consisted of (in thousands): Purchased components and sub-assemblies $13,178 $8,396 Work in process 545 240 Finished goods 1,689 1,140 ------- ------ $15,412 $9,776 ------- ------ ------- ------
1997 1996 ------- ------- Property and equipment as of December 31 consisted of (in thousands): Office equipment $13,077 $11,700 Machinery and equipment 6,108 4,936 Demonstration equipment 3,708 3,756 Furniture and fixtures 2,068 2,064 Leasehold improvements 2,003 1,778 ------- ------- 26,964 24,234 Less accumulated depreciation and amortization 22,540 19,339 ------- ------- $ 4,424 $ 4,895 ------- ------- ------- -------
Included in property and equipment is approximately $870,000 and $1,840,000 of equipment under capital leases as of December 31, 1997 and 1996, respectively. Accumulated amortization related to this equipment is approximately $616,000 and $1,674,000 as of December 31, 1997 and 1996, respectively.
1997 1996 ------- ------- Accrued expenses as of December 31 consisted of (in thousands): Payroll-related costs $2,882 $3,472 Royalties 2,061 1,887 Warranty 631 495 Other accrued expenses 3,381 3,123 ------ ------ $8,955 $8,977 ------ ------ ------ ------
31 Income taxes paid were $262,000, $223,000 and $204,000 for 1997, 1996 and 1995, respectively. Interest paid was $51,000, $119,000 and $46,000 for 1997, 1996 and 1995, respectively. NOTE 4. BUSINESS RESTRUCTURING In 1995, the Company began implementing a strategic restructuring plan. The restructuring costs were accrued in 1995. Such costs have been segregated into two fundamentally different classifications within the consolidated statements of operations for the year ended December 31, 1995: cost of hardware revenues, and operating expenses. Included in cost of hardware revenues is $2.7 million related to products in inventory that are being phased out as part of the business restructuring. Included in 1995 operating expenses under the caption, "Charge (credit) for business restructuring" is $4.8 million related to severance of employees, the write-down of assets impaired by the restructuring plan, and exit costs for leased facility obligations. In 1996, the Company determined that the restructuring plan was substantially complete, and an operating credit of $1.1 million was recorded during that period, as shown in the Statements of Operations under the caption "Charge (credit) for business restructuring." A description of the types and amounts (in thousands) of accruals made for restructuring costs in 1995, and the cumulative amounts charged against such accruals, is presented below.
Initial Re-classes December 31, Amounts Asset Cash to Other Credit 1996 Accrued Write-offs Payments Accruals Recognized Balance ------- ---------- -------- ---------- ---------- ------------ Reserve for the write-down of phase-out inventories $2,706 $(2,706) $ -- $ -- $ -- $ -- Employee termination benefits 1,580 -- (1,327) (171) (82) -- Exiting facilities-related obligations 2,256 -- (1,341) (126) (789) -- Asset impairment & other 996 (815) -- -- (181) -- ------ ------- ------- --------- --------- --------- Total $7,538 $(3,521) $(2,668) $ (297) $ (1,052) $ -- ------ ------- ------- --------- --------- --------- ------ ------- ------- --------- --------- ---------
32 NOTE 5. SHAREHOLDERS' EQUITY STOCK REPURCHASE PROGRAM In October 1994, the Company's Board of Directors adopted a program to repurchase up to 1,500,000 shares of the Company's common stock during the twelve-month period ending October 31, 1995. At October 31, 1995, the Company had repurchased 790,000 shares for a total cost of $4,973,000 under this program. In April 1997, the Company's Board of Directors adopted a program to repurchase up to 1,000,000 shares of the Company's common stock during the 12-month period ending April 30, 1998. 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 September 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 up to 1,000,000 shares of the Company's common stock during the 12 month period ending October 31, 1998. Repurchases of 191,400 shares were made in 1997 under the second program at prices ranging from $7.19 to $8.75 at a total aggregate price of $1.5 million. Total repurchases of 1,191,400 shares were made in 1997 at prices ranging from $7.19 to $12.00 per share for a total purchase price of $12.2 million. STOCK PURCHASE PLAN In 1992, the Company established the 1992 Employee Stock Purchase Plan and has reserved 1,250,000 shares of common stock for issuance thereunder. The plan permits eligible employees to purchase common stock through payroll deductions of up to 10 percent of their base earnings. The purchase price of the stock is equal to the lesser of 85% of the fair market value of such shares at the beginning of each six-month offering period (or the commencement of the employee's participation, if later) or the end of such offering period. As of December 31, 1997, 1,116,436 shares have been issued under this plan, of which 211,280 were issued in 1997. The per share weighted-average fair value of employee stock purchases during 1997, 1996 and 1995 was $2.77, $2.18 and $2.82, respectively, on the date of grant using the Black-Scholes model with the following weighted-average assumptions: 1997 -dividend yield of 0%, expected volatility of 84%, risk-free interest rate of between 5.22% and 5.85%, and an expected life of 1 year; 1996 - dividend yield of 0%, expected volatility of 77%, risk-free interest rate of between 5.0% and 5.74%, and an expected life of 1 year; 1995 - - dividend yield of 0%, expected volatility of 73%, risk-free interest rate of between 5.43% and 5.92%, and an expected life of 1 year. STOCK OPTION PLANS As of December 31, 1997, the Company had reserved 5,605,850 shares and 250,000 shares of common stock for issuance under its 1989 Stock Option Plan and the 1994 Outside Directors' Stock Option Plan, respectively ("the Plans"). Under the 1989 Stock Option Plan, options are granted to employees, officers, directors and consultants to purchase shares of the Company's common stock at not less than the fair market value of common stock at the grant date (for incentive stock options) or 85% of the fair market value of such common stock (for nonstatutory stock options). Options generally vest and become exercisable to the extent of 25% one year from grant date with the remainder vesting ratably over the 36-month period thereafter. Prior to August 1994, the options generally expired five years from grant date. Since August 1994, the options expire ten years from grant date. Under the 1994 Outside Directors' Stock Option Plan, options are granted to outside directors to purchase shares of the Company's common stock at not less than the fair market value of common stock at the grant date. Options vest and become exercisable to the extent of 25% on the first anniversary of the grant date with the remainder vesting 25% on each of the following three anniversary dates. As of December 31, 1997, 1,747,546 options were exercisable under the Plans. The per share weighted-average fair value of stock options granted during 1997, 1996 and 1995 was $6.37, $2.39 and $3.41, respectively, on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: 1997 - dividend yield of 0%, expected volatility of 84%, risk-free interest rate of between 5.71% and 6.75%, and an expected life of 33 between 3 and 5 years; 1996 - dividend yield of 0%, expected volatility of 77%, risk-free interest rate of between 5.27% and 6.65%, and an expected life of between 3 and 5.25 years; 1995 - dividend yield of 0%, expected volatility of 73%, risk-free interest rate of between 5.25% and 7.89%, and an expected life of between 2.5 and 9 years. The Company applies Accounting Principles Board ("APB") Opinion No. 25 in accounting for its Stock Option and Stock Purchase Plans and, accordingly, no compensation cost has been recognized for its stock plans in the accompanying consolidated financial statements. Had the Company determined compensation cost based on the fair value at the grant dates for its stock plans under SFAS No. 123, the Company's net income (loss) and income (loss) per share would have been increased to the pro forma amounts indicated below:
1997 1996 1995 ------ ------- ------- Net income (loss) (in thousands): As reported $2,681 $(5,232) $(4,029) Pro forma (554) (7,222) (5,045) Basic income (loss) per share: As reported $ 0.16 $ (0.32) $ (0.25) Pro forma (0.03) (0.44) (0.32) Diluted income (loss) per share: As reported $ 0.15 $ (0.32) $ (0.25) Pro forma (0.03) (0.44) (0.32)
The effects of applying SFAS No. 123 in this pro forma disclosure is not indicative of the effects on reported results for future years. SFAS No. 123 does not apply to awards prior to 1995, and additional awards in future years are anticipated. In November 1997, upon approval by the Board of Directors, the Company repriced 316,120 options originally issued at prices ranging from $11.13 to $14.75. The options were repriced at $8.50, the then current market value of the Company's stock. The 1997 cancellations and grants in the summary below and pro forma amounts above include the 316,120 options. A summary of option transactions under the Plans follows:
Weighted- Options Average Available Options Exercise For Grant Outstanding Price ----------- ----------- --------- Balances as of December 31, 1994 1,006,668 2,747,626 $4.15 Options authorized 200,000 -- -- Options granted (1,295,000) 1,295,000 5.16 Options forfeited or expired 565,194 (565,194) 5.01 Options exercised -- (693,278) 3.27 ----------- ----------- ----- Balances as of December 31, 1995 476,862 2,784,154 4.66 Options authorized 1,265,000 -- -- Options granted (2,339,570) 2,339,570 3.78 Options forfeited or expired 1,170,090 (1,170,090) 4.55 Options exercised -- (717,426) 3.95 ----------- ----------- ----- Balances as of December 31, 1996 572,382 3,236,208 $4.23 Options authorized 250,000 -- -- Options granted (1,207,175) 1,207,175 9.85 Options forfeited or expired 619,574 (619,574) 9.67 Options exercised -- (226,523) 4.18 ----------- ----------- ----- Balances as of December 31, 1997 234,781 3,597,286 $5.18 ----------- ----------- ----- ----------- ----------- -----
34 The following table summarizes information about options outstanding as of December 31, 1997:
Options Outstanding Options Exercisable - ---------------------------------------------------------------------- ----------------------- Weighted- Weighted- Weighted- Range of Average Average Average Exercise Remaining Exercise Exercise Prices Number Contractual Life Price Number Price - ----------- --------- ---------------- --------- --------- --------- $3.50 to 3.81 1,614,556 8.43 $ 3.50 873,999 $ 3.50 3.88 659,072 7.40 3.88 518,285 3.88 4.00 to 7.25 617,136 8.31 6.49 310,129 6.58 7.38 to 9.88 643,882 9.48 8.70 30,183 8.51 11.38 to 17.75 62,640 7.69 12.85 14,950 14.51 --------- ---- ----- --------- ------ $3.50 to 17.75 3,597,286 8.40 $5.18 1,747,546 $ 4.34 --------- --------- --------- ---------
NOTE 6. INCOME TAXES The components of the Company's provision for income taxes as of December 31 are as follows (in thousands):
1997 1996 1995 ------ ------- ------- Current Federal $ 582 $(4,210) $ (972) State and other 312 301 -- ------ ------- ------- Total current 894 (3,909) (972) ------ ------- ------- Deferred Federal (355) (440) (2,036) State and other (49) -- (191) ------ ------- ------- Total deferred (404) (440) (2,227) ------ ------- ------- Charge in lieu of income taxes associated with the exercise of stock options 660 860 1,023 ------ ------- ------- $1,150 $(3,489) $(2,176) ------ ------- ------- ------ ------- -------
Total income tax expense (benefit) differs from the expected tax expense (computed by applying the U.S. federal income tax rate of 34% to loss before income taxes) as follows (in thousands):
Tax expense (benefit) at federal statutory rate $1,303 $(2,967) $(2,110) State income taxes, net of federal benefit 30 24 -- Tax exempt investment income (53) (364) (136) Research and experimental credit (63) -- -- Other (67) (182) 70 ------ ------- ------- $1,150 $(3,489) $(2,176) ------ ------- ------- ------ ------- -------
35 The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of December 31 are as follows (in thousands):
1997 1996 ------ ------ Net deferred tax assets: Accruals, allowances and reserves $4,914 $5,552 Property and equipment, principally due to differences in depreciation and capitalized leases 1,035 792 ------ ------ Total gross deferred tax assets 5,949 6,344 Less valuation allowance -- -- ------ ------ Net deferred tax assets 5,949 6,344 ------ ------ Net deferred tax liabilities (151) (142) ------ ------ $5,798 $6,202 ------ ------ ------ ------
Based on the Company's expected operating results, management believes that it is more likely than not that the Company will realize the benefit of the deferred tax assets recorded and, accordingly, has established no asset valuation allowances. NOTE 7. CUSTOMERS AND CREDIT CONCENTRATIONS Sales to IBM accounted for 26% of net revenues for the year ended December 31, 1997. No sales to any one customer accounted for greater than 10% of net revenues for the years ended December 31, 1996 and 1995. Export sales to the Company's international customers outside North America, primarily Europe, comprised approximately 34%, 33% and 33% of net revenues for the years ended December 31, 1997, 1996 and 1995, respectively. Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash equivalents, short-term investments and trade receivables. The Company places its cash equivalents and short-term investments with high-credit qualified financial institutions and, by policy, limits the amount of credit exposure to any one financial institution. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base and their dispersion across many different industries and geographies. The identifiable assets, operating income, and net income of the Company's foreign subsidiaries are not significant to the Company's consolidated financial statements. NOTE 8. SALE OF PRODUCT LINES In February 1996, the Company sold its MARINER product line to FTP Software ("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 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. 36 NOTE 9. COMMITMENTS AND CONTINGENCIES The Company leases its principal facilities under noncancellable operating lease agreements that expire through 2003. The Company also leases office facilities in several locations in the United States, and one location each in Australia, Canada, France, Germany, Japan, Sweden and the United Kingdom, which are used as sales offices. Rent expense was approximately $2,552,000, $2,832,000 and $3,083,000 for the years ended December 31, 1997, 1996 and 1995, respectively. The Company also leases certain equipment under capital leases. As of December 31, 1996, minimum lease payments under all noncancellable lease agreements were as follows (in thousands):
Capital Operating Leases Leases ------- --------- Year Ending December 31, 1998 $ 160 $2,943 1999 93 2,511 2000 69 2,053 2001 -- 1,017 Thereafter -- 793 ----- ------ Total minimum lease payments 322 $9,317 ------ ------ Less amounts representing interest 8 ----- Present value of minimum lease payments 314 Less current portion 154 ----- Long-term capital lease obligations $ 160 ----- -----
The above future operating lease payments are anticipated to be offset by the following sublease contract income:
1998 $803 1999 821 2000 665 2001 288 ------ Total sublease income $2,577 ------ ------
NOTE 10. SUBSEQUENT EVENT During the first quarter of 1998, the Company signed a three-year agreement with Intel Corporation under which the Company and Intel will collaborate to produce desktop devices based on guidelines for Lean Client systems outlined by Intel in December 1997. Under the terms of the non-exclusive agreement, the Company will develop a "reference platform design" that consists of Pentium-based lean client hardware integrated with software technology from both companies. Intel will supply the Company with Pentium microprocessors, associated logic components and related software. The Company will create, manufacture and market lean client systems and operating software. In addition, Intel purchased, subject to registration, 750,000 shares of the Company's common stock. 37 QUARTERLY FINANCIAL DATA (Unaudited - in thousands, except per share data)
Quarters Ended --------------------------------------- March 31 June 30 Sept. 30 Dec. 31 --------- ------- -------- ------- 1997 - ---- Hardware products and services $22, 927 $26,889 $26,532 $24,208 Software licenses and services 8,173 7,473 8,114 9,120 -------- ------- ------- ------- Total net revenues 31,064 34,362 34,646 33,328 Gross profit 13,003 14,045 12,303 12,974 Operating income (loss) 753 612 (354) 725 Income before income taxes 1,421 1,161 81 1,168 Net income 852 697 51 1,081 Net income per share: Basic 0.05 0.04 0.00 0.07 Diluted 0.05 0.04 0.00 0.06 Shares used in per share computations: Basic 17,089 17,121 16,355 16,345 Diluted 18,889 18,820 17,848 17,625 1996 - ---- Hardware products and services $24,907 $22,193 $22,642 $25,231 Software licenses and services 5,532 7,135 5,309 7,659 -------- ------- ------- ------- Total net revenues 30,439 29,328 27,951 32,890 Gross margin 8,339 6,526 11,297 13,962 Operating income (loss) (7,847) (10,422) (310) 1,338 Income (loss) before income taxes (449) (10,064) 33 1,759 Net income (loss) (260) (6,047) 20 1,055 Net income (loss) per share: Basic (0.02) (0.37) 0.00 0.06 Diluted (0.02) (0.37) 0.00 0.06 Shares used in per share computations: Basic 16,260 16,504 16,615 16,933 Diluted 16,260 16,504 17,122 18,404
38 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not Applicable. 39 PART III Certain information required by Part III is omitted from this report because the Registrant will file a definitive proxy statement within 120 days after the end of its fiscal year pursuant to Regulation 14A (the "Proxy Statement") for its annual meeting of shareholders to be held June 3, 1998, and the information included therein is incorporated herein by reference to the extent detailed below. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information with respect to directors of the Registrant is incorporated by reference to the information under the caption "Election of Directors - Nominees" in the Registrant's Proxy Statement. Information with respect to executive officers of the Registrant is set forth in "Item 1. Business - Executive Officers of the Company" in this Annual Report on Form 10-K. Information required by Item 405 of Regulation S-K is incorporated by reference to the information under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Registrant's Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION. The information required by this Item is incorporated by reference to the information under the captions "Executive Compensation - Summary of Cash and Certain Other Compensation," "Executive Compensation - Stock Option Grants," "Executive Compensation - Option Exercises and Year-End Holdings," "Executive Compensation - Compensation of Directors," "Executive Compensation - Employment, Severance and Change of Control Arrangements" and "Executive Compensation - Compensation Committee Interlocks and Insider Participation" contained in the Registrant's Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this item is incorporated by reference to the information under the caption "Principal Shareholders and Share Ownership by Management" contained in the Registrant's Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference to the information under the caption "Executive Compensation - Employment, Severance and Change of Control Agreements", "Executive Compensation - Compensation Committee Interlocks and Insider Participation" and "Certain Transactions" contained in the Registrant's Proxy Statement. The Company's Bylaws provide that the Company shall indemnify its directors and officers to the full extent permitted by California law. The Company has entered into indemnification agreements with its officers and directors containing provisions that may require the Company, among other things, to indemnify such officers and directors against certain liabilities that may arise by reason of their status or service as officers or directors (other than liabilities arising from willful misconduct of a culpable nature), to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified and to obtain directors' and officers' insurance if available on reasonable terms. The Company maintains insurance policies covering officers and directors under which the insurer has agreed to pay the amount of any claim made against the officers or directors of the Company for wrongful acts that such officers or directors may otherwise be required to pay or for which the Company is required to indemnify such officers and directors, subject to certain exclusions. 40 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) The following documents are filed as a part of this Report: (1) Financial Statements: See Index to Consolidated Financial Statements at page 25 of this Report. (2) Financial Statement Schedule: Page Schedule Title ---- -------- ----- S-1 II Valuation and Qualifying Accounts and Reserves S-2 Independent Auditors' Report on Schedule All other financial statement schedules are omitted because they are not applicable or not required, or because the required information is included in the Consolidated Financial Statements and Notes thereto which are included herein. (3) Exhibits: The exhibits listed on the accompanying Exhibit Index are filed as part of, or are incorporated by reference into, this Report. (b) Reports on Form 8-K during the quarter ended December 31, 1997: None. 41 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. NETWORK COMPUTING DEVICES, INC. By: /s/ Robert G. Gilbertson ------------------------- Robert G. Gilbertson, President and Chief Executive Officer Dated: March 30, 1998 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert G. Gilbertson his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him in his name, place and stead, in any and all capacities to sign any and all amendments to this Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date /s/ Robert G. Gilbertson President, Chief Executive Officer March 30, 1998 - --------------------------- and Director (Principle Executive Officer) Robert G. Gilbertson /s/ Rudolph G. Morin Executive Vice President, Operations & March 30, 1998 - --------------------------- Finance, Chief Financial Officer and Director Rudolph G. Morin (Principal Financial and Accounting Officer) /s/ Peter Preuss Chairman of the Board of Directors March 30, 1998 - --------------------------- Peter Preuss /s/ Philip Greer Director March 30, 1998 - --------------------------- Philip Greer /s/ Douglas Klein Director March 30, 1998 - --------------------------- Douglas Klein /s/ Paul R. Low Director March 30, 1998 - --------------------------- Paul R. Low /s/ Stephen A. MacDonald Director March 30, 1998 - --------------------------- Stephen A. MacDonald
42 SCHEDULE II NETWORK COMPUTING DEVICES, INC. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Additions ------------------------------- Charged to Balance at Charged to Other Balance Beginning Costs and Accounts - Deductions - at End of Period Expenses Describe Describe of Period -------------- -------------- -------------- ---------------- ------------ 1997 - ---- Allowance for doubtful accounts 2,603 645 - 642(1) 2,606 Warranty reserve 495 615 - 479(2) 631 1996 - ---- Allowance for doubtful accounts 1,976 645 - 18(1) 2,603 Warranty reserve 510 791 - 806(2) 495 1995 - ---- Allowance for doubtful accounts 1,224 1,100 - 348(1) 1,976 Warranty reserve 834 729 - 1,053(2) 510
(1) Accounts written off. (2) Warranty costs incurred. S-1 Independent Auditors' Report on Schedule The Board of Directors Network Computing Devices, Inc. Under date of January 27, 1998, except as to Note 10 which is as of March 16, 1998, we reported on the consolidated balance sheets of Network Computing Devices, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997, which are listed in the accompanying index. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule in the annual report on Form 10-K. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG PEAT MARWICK LLP Mountain View, California January 27, 1998 S-2
INDEX TO EXHIBITS Exhibit Number Description - --------- ----------- 3.1(1) Amended and Restated Articles of Incorporation of Registrant. 3.2(3) Bylaws of Registrant, as amended. 4.2(2) Specimen Common Stock Certificate of Registrant. 4.3 Reference is made to Exhibits 3.1 and 3.2. 10.5(2) Restated Investor Rights Agreement dated May 2, 1990. 10.6(4) Purchase Agreement dated April 25, 1990, between Registrant and The Motorola Computer Group and correspondence relating thereto (3) and Amendment thereto dated August 31, 1993. 10.7(2) Master Maintenance Agreement dated September 4, 1990, between Registrant and the Field Service Division of Motorola Inc.'s Computer Group. 10.8(2) Lease Agreement dated August 18, 1988, as amended, between Registrant and Mountain View Industrial Associates for premises at 350-360 North Bernardo Avenue, Mountain View, California. 10.9(2) Lease Agreement dated September 21, 1989, as amended, between Registrant and Mountain View Industrial Associates for premises at 380 North Bernardo Avenue, Mountain View, California. 10.11(5)* 1989 Stock Option Plan, as amended. 10.12(2)* Form of Stock Option Agreements for use with the 1989 Stock Option Plan. 10.13(2)* Employee Stock Purchase Plan (revised). 10.14(2)* Form of Indemnification Agreement between the Registrant and its officers and directors. 10.15(2)* Registrant's 401(k) Retirement Plan. 10.18(2) Software Agreement dated March 30, 1990, between Registrant and AT&T Information Systems, Inc. 10.19(4) Credit Agreement dated March 15, 1994, between Registrant and Union Bank. 10.20(2) Lease Agreement dated April 29, 1985, as amended, between Graphic Software Systems, Inc. and Beaverton-Redmond Tech Properties, a Joint Venture. 10.21(2) Agreement to Form New Distribution Company dated July 23, 1990, between Registrant and Software Research Associates, Inc. 10.22(2) Distributorship and OEM Agreement and related Trademark License Agreement, each dated July 23, 1990, between Registrant and Nihon NCD K.K. 10.23(2) Form of Registrant's standard purchase order. 10.24(7)* Registrant's Incentive Bonus Plan. 10.29(4) Full Service Lease dated October 20, 1993 between Z-Code and Novato Gateway Associates for premises at 101 Rowland Way, Suite 300, Novato, California. 10.31(5)* 1994 Outside Directors Stock Option Plan. 10.32(5)* Form of Nonstatutory Stock Option Agreement for Outside Directors. 10.34(6) Lease agreement by and between Registrant and Ravendale Investments dated September 20, 1995. 10.36(6)+ Client/Server Software License Agreement dated March 29, 1996 between Registrant and Citrix Systems, Inc. 10.37(6)+ Software Licensing Agreement dated as of June 30, 1995 between Registrant and Evans & Sutherland Computer Corporation. 10.38(6)+ License and Development Agreement dated December 18, 1995 between Registrant and Software.com, Inc. 10.39(6)+ Cooperative Hardware Marketing Agreement dated November 29, 1995 between Registrant and IBM Corporation ("IBM"), as amended December 20, 1995. 10.40(6)+ X-Station Terminal Transition Agreement dated November 29, 1995 between Registrant and IBM, as amended December 13, 1995. 10.41(7)+ Asset Purchase Agreement dated February 20, 1996 by and between the Registrant and FTP Software, Inc. 10.42(7)+ Alliance Agreement dated June 27, 1996 by and between the Registrant and International Business Machines Corporation. 10.43(7)+ Asset Purchase Agreement dated June 3, 1996 by and between the Registrant and NetManage, Inc. 10.44(8) IBM Letter of Intent and Funding Agreement. 10.45# Attachment 2 to Article 1 - Development of the Alliance Agreement dated November 4, 1997 between Registrant and IBM Corporation ("IBM") 10.46 Attachment 3 to Article 2 - Manufacturing of the Alliance Agreement dated November 4, 1997 between Registrant and IBM Corporation ("IBM") 21.1 List of subsidiaries of Registrant. 23.1 Consent of KPMG Peat Marwick LLP. 24.1 Power of Attorney. Reference is made to page 42 of this Report. 27.1 Financial Data Schedule. * Constitutes a management contract or compensatory plan or arrangement equired to be filed pursuant to Item 14(c) of Form 10-K. + Confidential treatment has been granted as to a portion of this exhibit. # Confidential treatment has been requested as to a portion of this exhibit. (1) Incorporated by reference to identically numbered exhibit to Registrant's Form 10-K Report for the year ended December 31, 1992. (2) Incorporated by reference to identically numbered exhibit to Registrant's Form S-1 Registration Statement (No. 33-47246) which became effective on June 4, 1992 (the "1992 Registration Statement"). (3) Incorporated by reference to Exhibit 3.3 to the 1992 Registration Statement. (4) Incorporated by reference to identically numbered exhibit to Registrant's Form 10-K Report for the year ended December 31, 1993. (5) Incorporated by reference to identically numbered exhibit to Registrant's Form 10-K Report for the year ended December 31, 1994. (6) Incorporated by reference to identically numbered exhibit to Registrant's Form 10-K Report for the year ended December 31, 1995. (7) Incorporated by reference to identically numbered exhibit to Registrant's Form 10-K Report for the year ended December 31, 1996. (8) Incorporated by reference to identically numbered exhibit to Registrant's Form 10-Q Report for the quarter ended June 30, 1997.
EX-10.45 2 EXHIBIT 10.45 EXHIBIT 10.45 Attachment 2 to Article 1 - Development of the Alliance Agreement between Network Computing Devices, Inc. and IBM Corporation This Attachment is entered into by and between Network Computing Devices, Inc. ("NCD") and International Business Machines Corporation ("IBM"). RECITALS 1. NCD and IBM have entered into an Alliance Agreement effective June 27, 1996 (the "Agreement") in the area of a network application terminal ("thin client") product. 2. NCD and IBM now desire to supplement and modify Articles 1 and 2 of the Agreement. This Attachment modifies Article 1, and a related Attachment (Attachment 3 to Article 2 - Manufacturing) modifies Article 2 of the Agreement. The provisions of this Attachment are entered into by the parties in consideration of the provisions of both new Attachments, and this Attachment shall become effective only when both such Attachments are executed by the parties. Except as explicitly described herein, this Attachment, together with the related Attachment described above, supersede and replace the Letter of Intent between IBM and NCD, dated June 5, 1997. I. HARDWARE AND SOFTWARE DEVELOPMENT A. GENERAL DESCRIPTION This Attachment (1) provides for development of certain versions of Products and software not specifically described in the initial Development Article, (2) provides additional implementation details for software and hardware development described in the Development Article, and (3) provides schedules for such development. NCD agrees to perform the tasks and provide the Deliverables described in this Attachment and in the Exhibits reference herein according to the schedules described in this Attachment and its Exhibits, provided IBM fulfills those dependencies described in this Attachment and its Exhibits that are necessary for NCD to complete such development work. B. TASKS AND DELIVERABLES NCD will develop for IBM the Products for Release 2.5 and Release 3.0 as described in Exhibit A to this Attachment, the terms of which are incorporated herein by reference. CERTAIN INFORMATION IN THIS EXHIBIT 10.45 HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. Except where specific items are designated as IBM's responsibility, NCD shall implement and provide as Deliverables to IBM all the functions and product features described in Exhibit A. NCD shall perform all tasks necessary to develop, implement, and test all such function and product features in a high quality manner, and shall perform other tasks described in such Exhibit. C. SCHEDULES Deliverables shall be provided according to the schedules set forth in Exhibit A, unless the parties' Development Article Coordinators agree to different schedules. II. COMPENSATION FOR ADDITIONAL DEVELOPMENT WORK The parties acknowledge that certain of the development tasks and Deliverables described or referenced in this Attachment were not described in the initial Development Article of the Agreement, and represent additional requirements by IBM. In consideration for this additional work, IBM shall pay to NCD an NRE amount of $200,000 per calendar month for development work and resources applied to perform the work and provide the Deliverables described in this Attachment. Payment of such amount shall be subject to NCD's application of key resources to accomplish the work described in the Attachment, and reasonable demonstration that NCD's total development work performed as described in this Attachment for the applicable calendar month equalled or exceeded $200,000 in cost (using a rate of $200,000 per person/year for purposes of this Attachment only.) IBM's obligation for such payments shall end on March 31, 1998, regardless of whether all required tasks have been performed, or Deliverables provided, by that date. NCD may invoice IBM for the amount described herein no earlier than the final business day of the calendar month for which the payment was earned, and shall submit with the invoice a summary of key milestones completed in support of the IBM/NCD Build Plan and a similar summary in support of hardware development. Copies of such summaries shall be sent to IBM's Development Article Coordinator. IBM's payment shall be made no later than 30 days after receipt of the invoice and summary report. The parties acknowledge that $200,000 per calendar month in NRE is currently being paid to NCD under the terms of the Letter of Intent between IBM and NCD, dated June 5, 1997. The payment described herein shall replace the payment specified in the Letter of Intent, and shall become effective for the first calendar month that begins after this Attachment is executed. Nothing herein shall require IBM to pay any additional amount for the work described in this Attachment. III. ADDITIONAL DEVELOPMENT SUPPORT PROVIDED BY IBM In addition to IBM other responsibilities as described in this Attachment and the Development Article, IBM will provide NCD with the following to support the development of Products described in this Attachment: A. IBM will provide NCD with an additional Sun SPARC server as soon as possible for use in product builds and similar development tasks, for the time reasonably necessary to complete such tasks. IBM will provide this server at no charge to NCD, but may do so under reasonable lease terms or other terms deemed necessary by IBM to protect its asset. B. IBM will pay for the IBM-unique board layouts for the BENGAL-derivative products as requested and authorized by IBM under a separate Purchase Order. IV. MAJOR ENHANCEMENTS FOR CITRIX ICA CLIENT SUPPORT After initially porting the Citrix ICA client support to the NCDware platform, NCD plans to make future enhancements to such ICA client support. IBM and NCD agree that such future enhancements may be considered "Major Enhancements" within the meaning such term in the Alliance Agreement even if the enhancements do not meet the requirements of subsection (b) of the definition of Major Enhancements, provided that the remainder of the definition is satisfied (i.e., the enhancement provides substantial additional value and utility, and is not a Custom Enhancement), and provided further that NCD shall offer such Major Enhancements to IBM in accordance with section 6.2 of the Development Article, with the following modifications to section 6.2 to apply to these Major Enhancements only: For all Major Enhancements to the Citrix ICA client support offered by NCD to IBM in 1998, NCD and IBM shall negotiate a cumulative total price that does not exceed the lesser of (1) $100,000, or (2) 50% of NCD's cost of development for such Major Enhancements; For all Major Enhancements to the Citrix ICA client support offered by NCD to IBM in 1999, NCD and IBM shall negotiate a cumulative total price that does not exceed the lesser of (1) $75,000, or (2) 50% of NCD's cost of development of such Major Enhancements; For all Major Enhancements to the Citrix ICA client support offered by NCD in 2000, NCD and IBM shall negotiate a cumulative total price that does not exceed the lesser of (1) $75,000, or (2) 50% of NCD's cost of development of such Major Enhancements. The initial basic support/port for the Citrix ICA Client provided by NCD to IBM (initial version for NCDware 5.0X) shall be provided to IBM as part of Release 3 of the product development plan (Exhibit A to this Amendment), and shall not be considered a Major Enhancement. IBM shall be required to pay the negotiated price for each of the Major Enhancement to the Citrix ICA client support when IBM accepts the first offered Major Enhancement for the applicable year. In addition to the prices negotiated above, IBM shall be responsible for paying any pass-thru per copy or per unit royalties that NCD must pay to Citrix based on IBM's distribution of Citrix ICA client code included in the Major Enhancements, provided that such royalties are identified prior to IBM accepting a Major Enhancement that requires such royalties. Alternatively, IBM may obtain its own license with Citrix for distribution of such code. Nothing herein requires IBM to accept any Major Enhancements offered by NCD, nor prohibits IBM from preparing its own enhancements. IV. CHANGE IN DEVELOPMENT ARTICLE COORDINATOR NCD hereby notifies IBM that its Article 1 Coordinator has been changed to the following: John Gilbert NCD, Inc. 350 North Bernardo Ave. Mountain View, CA 94043-4207 TELEPHONE: (650) 919-2835 FACSIMILE: (650) 961-6289 IN WITNESS WHEREOF, each party has reviewed this Article and each party has executed this Article by signature of its authorized representative. NETWORK COMPUTING DEVICES, INC. INTERNATIONAL BUSINESS MACHINES CORPORATION Signature Lorraine Hariton Signature Steven R. Villanueva ------------------ ---------------------- Lorraine Hariton Printed Name Lorraine Hariton Printed Name Stephen R. Villanueva Printed Title Sr. V.P. of Marketing Printed Title Director, OEM Procurement & Business Development Date 11/4/97 Date 11/4/97 -------------------------------- -------------------------------- EXHIBIT A TO ATTACHMENT 2 TO ARTICLE 1 - DEVELOPMENT The Release 2.5 Product deliverables will be comprised of: 603 POWERPC PLATFORM - Technical support for PowerPC 603 porting work (Actual porting of OS to 603 is an IBM Austin deliverable) - Access to BENGAL device driver Code on common 603 components - Access to HMX device driver Code on common 603 components - Consultation on boot monitor Code and NCD OS kernel Code - QA (quality assurance) test bucket data - Consulting for QA testing on PowerPC 603 Product (Kernel QA testing on PowerPC 603 Product is an IBM Austin responsibility) - Build and regression test support - Manufacturing article amendment to include PowerPC 603 Product - Maintenance and support article to include PowerPC 603 Product KERNEL QA TESTING ON POWERPC 403 PRODUCT JVM 1.1.2 BASED ON SUN MICROSYSTEMS MODIFIED JVM 1.1.2 - Port JAE (Java Applet Environment) 1.1.2 to the PowerPC 403 target. Resultant port must run on PowerPC 403 and PowerPC 603 Products. - JVM 1.1.2 compliance testing for PowerPC 403 and PowerPC 603. (IBM Hursley will complete certification tests and apply for certification) (NCD is responsible to provide support for NCD Code provided) (IBM is responsible to provide support for IBM inner loop Code) - NCD to integrate Inner loop optimization of JVM (Inner loop Code provided by IBM Austin) - Modify JVM 1.1.2 to operate correctly with Motif 1.2.2 - Consultation in making JVM 1.1.2 work with PowerPC 603 Product - Identify JVM 1.1.2 API's (eg. International locales, IP multi-cast and loading applets via TFTP) not supported. - Add Java print API to existing NCD OS kernel serial / parallel API's for KONA (initial Code on 12/5/97 and PTF on 1/5/98) (IBM Austin will develop the Java print API) - Provide fixes required for problems related to JVM 1.1.2. Change to the PowerPC 403 kernel to support changes to the PowerPC flash boot monitor and changes to incorporate JVM 1.1.2 EXHIBIT A TO ATTACHMENT 2 TO ARTICLE 1 - DEVELOPMENT Changes (if necessary) to the PowerPC 403 boot monitor to load only the PowerPC 403 kernel. BUILD SUPPORT - Integration of Release 2.5 mods into NCD library to get PowerPC 603 Product changes (4.5 Code branch) - Weekly Code drops to IBM Rochester until "Golden Master" coordinated with Release 3.0 builds. (Original bi-weekly Code drops for Release 2.5 are weekly and take priority over Release 3.0 Code drops during September and October 1997. - Provide build process to Rochester for PowerPC 403 and PowerPC 603 Products. - NCD is responsible for supporting the 4.5 Code branch. Although the NCD WinCenter application is not a Deliverable under Release 2.5, compatibility shall be provided with the NCD WinCenter application for the Release 2.5 and follow-on Products. RELEASE 3.0 VERSION (LAN VERSION) The Release 2.5 Product deliverables will be comprised of: BENGAL HARDWARE AND SOFTWARE BENGAL Derivatives (PowerPC 40x based Products) - 10/100 Ethernet Products - Token Ring Product - Twinax Product (IBM to provide twinax drivers and design) - BENGAL Source Code in Code tree and in build process. The above derivative Products are derived from NCD's BENGAL design. NCD re-layed out its BENGAL design to fit the ensuing product into IBM's mechanical form factor and customized the user interfaces for the Derivative Product to meet IBM's requirements. If IBM requests any additional features or functionality beyond NCD's BENGAL product (existing as of the parties' execution of Attachment 2 to the Article 1) and any other functions that are listed herein, IBM and NCD agree that deliverables outside of this Agreement will require negotiation EXHIBIT A TO ATTACHMENT 2 TO ARTICLE 1 - DEVELOPMENT and may require additional NRE. IBM Procurement will authorize this work in writing prior to NCD commencing the work and prior to IBM undertaking any obligation for additional NRE. SOFTWARE FUNCTIONS / ENHANCEMENTS - Document and number all NCD messages - Provide miniconsole for application launching with translated messages (Actual translation will be provided by IBM.) - Continued support for touch screen, flash memory boot, PCMCIA file, and VT320 emluator. - DHCP enhancements as defined in the Release 3.0 SAI specification (eg. config, retry, multiservers, get config from server, options 26,43,60) - Support and consultation for implementing currently supported VT320 emulator launch via login / utilities. (Use VT320 support currently resident in BENGAL Code base, English only version, that currently exists in NCD Code.) (IBM Network Station Manager (NSM) team in Rochester will provide configuration support through the user platform) - Self update of token ring interface Code. - Broadcast boot TFTP support - Support for XDM login from ACT login utility. - Serial printer support - Print APIs support and JVM interface (provided by IBM Austin) - Local administered MAC address - Additional SNMP traps and changes as defined in the Release 3.0 SAI specification. - Change to the kernel to support the PowerPC 403 and PowerPC 603 processor based Product flash boot monitor Code. - Porting and integration of Citrix Native 32-bit Windows ICA client protocol (Initial port and integration at NCDware 5.0x level). JAVA VM ENHANCEMENTS - JVM 1.1.4 FROM SUN MICROSYSTEMS - Port JAE (Java Applet Environment) 1.1.4 to the PowerPC 403 target. Resultant port must run on PowerPC 403 and PowerPC 603 Products. - JVM 1.1.4 compliance testing for PowerPC 403 and PowerPC 603. (IBM Hursley will complete certification tests and apply for certification) EXHIBIT A TO ATTACHMENT 2 TO ARTICLE 1 - DEVELOPMENT (NCD is responsible to provide support for NCD Code provided) (IBM is responsible to provide support for IBM inner loop Code) - NCD to integrate Inner loop optimization of JVM (Inner loop Code provided by IBM Austin) - Modify JVM 1.1.4 to operate correctly with Motif 1.2.5 - Consultation in making JVM 1.1.4 work with PowerPC 603 Product NATIONAL LANGUAGE SUPPORT (NLS) - Plan defined for BiDi support (NLS and DBCS completed) - Support and consultancy for NLS implementation. - Support and consultancy for Motif library support (1.2.5) - Support and consultancy for Motif window manager support (1.2.5) PROVIDE KERNEL SUPPORT FOR INCLUSION OF THE OMRON INPUT METHOD. - NCD will provide, within the NRE already provided for in this Amendment, two person months of consultancy support to help specify and size the effort required to support the inclusion of the Omron input method. - Upon completion of the sizing and consultation, IBM and NCD will negotiate separately for additional effort or deliverables required. - IBM is licensing and contracting for Omron input method under separate Omron Agreement. Kernel API support for Navio (now NCI) NC Navigator browser version 4. Although the NCD WinCenter application is not a Deliverable under Release 3.0, compatibility shall be provided with the NCD WinCenter application for the Release 3.0 and follow-on Products. PRODUCT SCHEDULES It is intended that General Availability of the Release 2.5 hardware and software will occur in [*] for the Ethernet version of the 603-based Product, and [*] for the Token Ring verions It is intended that the General availability of the Release 3.0 hardware and software will occur in [*]. CERTAIN INFORMATION IN THIS EXHIBIT 10.45 HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION. CONFIDENTIAL TREATMENT HAS BEEN REQUESTED WITH RESPECT TO THE OMITTED PORTIONS. [*]=CONFIDENTIAL TREATMENT REQUESTED - EDITED COPIES. EXHIBIT A TO ATTACHMENT 2 TO ARTICLE 1 - DEVELOPMENT The parties technical teams will continue to work toward meeting the mutually agreed-to dates for code drops, test plans, and other detailed items to meet these GA dates, with adjustments as appropriate to take into account unforseen development issues or changes to release schedules. EX-10.46 3 EXHIBIT 10.46 EXHIBIT 10.46 Attachment 3 to Article 2 - Manufacturing of the Alliance Agreement between Network Computing Devices, Inc. and IBM Corporation This Attachment is entered into by and between Network Computing Devices, Inc. ("NCD") and International Business Machines Corporation ("IBM"). RECITALS 1. NCD and IBM have entered into an Alliance Agreement effective June 27, 1996 (the "Agreement") in the area of a network application terminal ("thin client") product. 2. NCD and IBM now desire to supplement and modify Articles 1 and 2 of the Agreement. This Attachment modifies Article 2, and a related Attachment (Attachment 2 to Article 1 - Development) modifies Article 1 of the Agreement. The provisions of this Attachment are entered into by the parties in consideration of the provisions of both new Attachments, and this Attachment shall become effective only when both such Attachments are executed by the parties. Except as explicitly described herein, this Attachment, together with the related Attachment described above, supersede and replace the Letter of Intent between IBM and NCD, dated June 5, 1997. I. ADJUSTMENT TO PRICE FORMULA FOR POWERPC 603 "PHANTOM" PRODUCT NCD shall manufacture the Products as described in Article 1 - Development and its Attachments (including Attachment 2 to Article 1) in accordance with all the terms and conditions of Article 2 - Manufacturing. Such Products shall be considered "Products" for all purposes under the terms of the Alliance Agreement, provided, however that in determining the B/M cost of the PowerPC 603 "Phantom" Product described in Attachment 2 to Article 1, the following costs shall be added to the B/M for such Product: A. Incremental Packaging and Freight Costs NCD's actual Incremental Costs of the following items shall be added to the B/M costs for the PowerPC 603 "Phantom" Product: Product Packaging Freight Costs For the purposes of this Attachment, "Incremental Costs" shall mean the actual difference in charges paid by NCD for the above listed items between the existing 403-based IBM Network Station Products and the PowerPC 603 "Phantom" Product due to unique characteristics of the PowerPC 603 "Phantom" Product (i.e., size, weight). B. Manufacturing/Engineering Support Costs A Manufacturing/Engineering Support Cost of $1.00 per unit shall be added to the B/M cost for the initial release of the PowerPC 603-based Product, known as the PowerPC 603 "Phantom" Product, and for any follow-on or derivative PowerPC 603-based Products (collectively "PowerPC 603 Family Products"), but such charge shall apply only until (1) IBM has purchased 100,000 units of such PowerPC 603 Family Products, or (2) December 31, 1998, whichever occurs earlier. In the event IBM fails to purchase at least 100,000 units of PowerPC 603 Family Products from NCD by December 31, 1998, IBM will be required to pay NCD a lump sum equal to $1.00 times the difference between 100,000 and the actual number of PowerPC 603 Family Products purchased by IBM, so that the total amount of Manufacturing/Engineering Costs paid to NCD equals $100,000. In the event a lump sum is due, NCD may invoice IBM for such lump sum no earlier than January 1, 1999 and no later than March 31, 1999. IBM shall remit payment on NCD's invoice no later than 60 days after receiving such invoice. C. Additional Product Warranty Costs An additional charge of $1.50 shall be added to the B/M cost for the PowerPC 603 "Phantom" Product to cover the potential increase in NCD's cost of providing the warranty service for such Product. This additional warranty charge shall not be subject to the Quarterly Price Reviews and Adjustments described in section 4.2 of the Manufacturing Article, but such charge will cease to apply in the event IBM notifies NCD in writing that it is waiving its right to obtain Product Warranty service (as described in section 12.2 of the Manufacturing Article) for the PowerPC 603 "Phantom" Product. Following execution of this Attachment, the parties shall work in good faith to update the PSPL to reflect the price and related details of the Products covered by this Attachment. II. TOOLING FOR POWERPC 603 "PHANTOM" PRODUCT The provisions of section 8 "Tooling" of the Manufacturing Article shall apply to the tooling for the Products covered by this Attachment. The parties agree, however, that soft tooling and the initial production-level tooling (or "hard tooling") for the PowerPC 603 "Phantom" Product shall be considered Tooling required by IBM due solely to an IBM mechanical design change, and IBM shall therefore pay for such Tooling" If requested by IBM, NCD shall negotiate in good faith with IBM for the amortization of such Tooling costs over the projected volumes of Products for which such Tooling would be used. III. RENEWAL OF MANUFACTURING ARTICLE Pursuant to section 7.1 of the Base Agreement, the parties hereby agree that the Agreement shall be, and hereby is, renewed through December 31, 2000. IV. AMENDMENT TO IBM VOLUME PERCENTAGE REQUIREMENTS FOR 1999 AND 2000 The parties hereby agree to amend section 14.1 of Article 2 of the Agreement by making the following modifications: A. Second unnumbered paragraph, first line, remove "or 100,000 units." B. Second unnumbered paragraph, third line, remove "or 50,000 units. V. AMENDMENT TO SECTION 12.2 (PRODUCT WARRANTY) OF ARTICLE 2 AND ADDITIONAL IMPLEMENTATION DETAIL Pursuant to Section 12.2 of Article 2, the parties have agreed to additional implementation details for handling warranty returns and service. These details are contained in Exhibit A to this Attachment, and are hereby incorporated into this Attachment by reference. The parties' Manufacturing Article Coordinators may modify, or waive compliance with, such details by mutual written agreement. VI. IBM DESIGNATED AS IMPORTER OF RECORD FOR SHIPMENTS OUTSIDE UNITED STATES The parties agree that, effective January 1, 1998, IBM shall be designated as the importer of record for shipment of IBM-ordered Products to IBM-designated locations outside of the United States. Accordingly, IBM shall be responsible for paying the applicable import duties to the governmental authority of the country into which such Products are imported, and for providing such governmental authority with the required documentation and certifications necessary for importation and customs clearance. The "F.O.B. IBM Location" provision of Article 2 shall remain intact, and NCD shall continue to be responsible for shipment and delivery of Products to the IBM-designated delivery point. NCD shall retain the title and the risk of loss for such Products until they are delivered to the IBM-designated delivery point, except that if the law of any country into which IBM requests importation of the Products requires that the importer of record hold legal title to the Products, then title shall pass to IBM at the last moment necessary for IBM to comply with such law and become importer of record. In all cases, risk of loss and responsibility for shipment shall remain with NCD until the Products are delivered to the IBM-designated location. NCD shall diligently execute all documents necessary for IBM to become importer of record for shipments to non-U.S. locations on or after January 1, 1998, and shall cooperate fully with IBM throughout the term of the Alliance Agreement in providing all information and certifications necessary for customs clearance and importation, including but not limited to certifications and information as to the country of origin of such Products. NCD shall remain responsible for complying with all labelling specifications requested by IBM to ensure compliance with import and export laws. In addition, effective January 1, 1998, the last paragraph of section 4.1 of Article 2 - Manufacturing shall be deleted in its entirety and replaced with the following: NCD agrees that it will reimburse IBM for the excess portion of any duty paid by IBM resulting from the shipment of IBM-ordered Products to any IBM-location outside of the United States that is greater than the amount of duty that would have been paid for shipment of the Products form the United States to the same IBM-designated location on the same date. Upon being notified in writing by IBM of such duty excess, NCD shall make such reimbursement by applying a credit reflecting the excess duty to the invoices submitted to IBM for such Products. NCD shall show this credit, and identify it as such, as a separate line item on the invoice, and shall indicate the total amount of the credit applicable to such invoice as well as the per unit amount of the credit and the number of units to which it applies. The duty paid by IBM shall continue to be considered part of the piece price of Products for purposes of evaluating price competitiveness under sections 13 and 14 of Article 2, except that any excess duty credit applied by NCD in accordance with this paragraph shall be considered to reduce the price by the amount of such credit for the purpose of sections 13 and 14 or Article 2. The parties agree that the intent of this change in the importer of record designation is to have IBM take administrative responsibility for import clearance in IBM-designated non-U.S. locations It should not be construed as altering the general responsibility of the parties with respect to shipment and risk of loss of the Products or altering the balance of financial obligations except for such expenses incidental to IBM assuming the administrative responsibility of importer of record. VII. PRODUCT FULFILLMENT/REPLENISHMENT PLAN DEVELOPMENT IBM and NCD both agree that the implementation of a competitive fulfillment/replenishment process is essential to meeting the demands and rigors of the netowork computing marketplace. NCD agrees to commence face-to-face discussions and telephonic meetings with IBM within 15 days after execution of Attachment 3 to Article 2 to dicsuss the parameters of implementing such a program. At a minimum, IBM and NCD will discuss the following: IBM's requirements for the fulfillment/replenishment process; IBM volume requirements; IBM's desired points of distribution; expenses and costs and which party bears such costs associated with program implementation; and a proposed timetable for implementation. IBM and NCD commit to working in good faith to establish a plan for executing a competitive fulfillment/replenishment process pursuant to a timetable mutually agreed to by both parties. VIII. CHANGE IN IBM'S MANUFACTURING ARTICLE COORDINATOR IBM hereby notifies NCD that IBM's Article 2 Coordinator is changed to the following: Glenn Gallagher IBM Corporation, Dept. U7JA P.O Box 12195 3039 Cornwallis Research Triangle Park, NC 27709-2195 PHONE: (919) 486-0835 FAX: (919) 546-7606 IX. BILL OF MATERIALS INFORMATION FOR POWERPC 603 "PHANTOM" PRODUCT NCD agrees to provide to IBM's Manufacturing Article Coordinator no later than Monday, November 10, 1997 a fully-costed Bill of Materials for the PowerPC 603 "Phantom" Product assuming an ordering process in accordance with the Manufacturing Article without any special expedite charges. Such Bill of Materials shall be separately itemized for each component, service and other charge that comprises the Bill of Materials, and shall represent the best comptetivie costs that NCD has been able to obtain for such items. The Bill of Materials shall be accompanied by reasonable justification/explanation for each of the charges. Where the contract requires the Bill of Materials to include cost differentials, or "deltas," the itemization of such delta costs shall be accompanied by the base costs from which such delta costs are the result. IN WITNESS WHEREOF, each party has reviewed this Article and each party has executed this Article by signature of its authorized representative. NETWORK COMPUTING DEVICES, INC. INTERNATIONAL BUSINESS MACHINES CORPORATION Signature /s/ Lorraine Hariton Signature /s/ Stephen R. Villanueva ---------------- --------------------- Printed Name Lorraine Hariton Printed Name Stephen R. Villanueva Printed Title Sr. V.P. of Printed Title Director, OEM Marketing & Procurement Business Development Date 11/4/97 Date 11/4/97 -------------------------- -------------------------- EXHIBIT A TO ATTACHMENT 3 TO ARTICLE 2 - MANUFACTURING - --------------------------------------------------------------------- REPAIR PROCESS FOR FACTORY FAILED PARTS: When a new 8361 unit fails in test at either Raleigh, Greenock, or other IBM manufacturing location; the manufacturing location will do the following: Manufacturing will accumulate the failed new units, fill out the IBM paperwork and send with the parts to the reclamation department who will fill out an RPR form and initiate a P.O. and route these to the buyer. The buyer, to get authorization to return the units, will send an e-mail(for either Greenock or Raleigh) to: srs@ncd.com with a copy to : pronto@ncd.com msm@ncd.com This e-mail will include: the IBM person to contact, where to ship the units back to, the serial numbers for all units covered by the RMA, and a problem description for each unit (if available). NCD will respond with a Return Material Authorization(RMA) number. The response will be no later than the end of the next work day. The buyer will provide this RMA number to the Reclamation department and will process a Purchase Order to get these parts returned and repaired. The buyer will also process a debit memo for the quantity of parts returned. This will cause the purchase price for the returned units to be subtracted from the next new build invoice(s) unless the failed parts are repaired and returned before any pending new build invoices are paid. The Raleigh Reclamation Department will ship the failed parts along with the RPR form to NCD at the following address: Attn: RMA number xxxxxxx fill in the RMA number here NCD INC. 301A Ravendale Ave. Mountain View, California 94043 The Greenock Reclamation Department will ship the failed parts along with the RPR form to NCD at the following address: Attn: RMA number xxxxxxx fill in the RMA number here Eurographics Industries Limited Unit 6, 24 Premier Way Abbey Park Industrial Estate EXHIBIT A TO ATTACHMENT 3 TO ARTICLE 2 - MANUFACTURING Romsey, Hampshire, England S051 9AQ Parts will be returned to NCD once per month or whenever a quantity of 20 to 50 is accumulated, or once per week if the failure rate exceeds 10 units/week. Parts will be returned in the original shipping material with an acceptable overpack. Shipping via ground transportation is acceptable. Shipping cost to NCD will be paid by IBM. NCD will: - - Repair or replace these systems within two weeks(ten working days not counting shipping time) of their receipt from IBM and ship them back to the IBM manufacturing location address indicated on the RPR form. Note: Systems that failed in the field cannot be sent to any IBM manufacturing site after repair; these units must be sent to the IBM field parts location. - - Provide failure/repair data to designated IBM person(s) within two weeks of completing lot repair. Failure data will be provided via e-mail in a mutually agreed format. - - Retest the units using the NCD Repair Process fo IBM M/T 8361 and 8362 - see attachment. - - Perform all of the same quality assurance processes used on new units. - - During repair, install any required E.C.'s that have occurred since the unit was first shipped. The individual E.C. will specify if it needs to be applied on factory/field returned product. - - Mark the repaired unit with a code that indicates it was repaired and the date it was repaired. The mark to be made with indelible ink. Mark to be located on the logic card inside the covers. - - Any unit that comes back for repair within six months of having been previously repaired must be scrapped and replaced. EXHIBIT A TO ATTACHMENT 3 TO ARTICLE 2 - MANUFACTURING - - The S/N of the unit does not need to change. - - Shipping these repaired units to IBM is at NCD cost. Shipping via ground transportation is acceptable. - --------------------------------------------------------------------------- REPAIR PROCESS FOR FIELD RETURNED UNITS IBM Mechanicsburg will return field failed units to the following address: Attn: RMA number xxxxxxx fill in the RMA number here NCD INC. 301A Ravendale Ave. Mountain View, California 94043 IBM Europe will return field failed units to the following address: Attn: RMA number xxxxxxx fill in the RMA number here Eurographics Industries Limited Unit 6, 24 Premier Way Abbey Park Industrial Estate Romsey, Hampshire, England S051 9AQ The failed units will be in their original shipping container with an acceptable overpack. When the field parts depot(Mechanicsburg or Someplace in Europe) has accumulated a quantity of failed parts, the Parts Analyzer (currently Dave Lebo in Mechanicsburg 717-795-4169, and Tony Rennie in Greenock) will generate a list of the serial numbers to be repaired. The analyzer will contact NCD via email(see e-mail address below) to determine which parts are covered by NCD's warranty and which are to be repaired at IBM's cost. The analyzer will list the serial numbers and a problem description for each unit(if available) in an RMA form along with the name of the IBM person to contact, and where to ship the units back to; and then contact the IBM buyer to arrange for repair. The buyer will process a P.O. based on the data in the RMA. The buyer will send an e-mail to NCD to get authorization to return the parts. The e-mail (for either EXHIBIT A TO ATTACHMENT 3 TO ARTICLE 2 - MANUFACTURING Europe or Raleigh) will be sent to: srs@ncd.com with a copy to : pronto@ncd.com and msm@ncd.com This e-mail will include: the IBM person to contact, where to ship the units back to, the serial numbers for all units covered by the RMA, and a problem description for each unit(if available). NCD will respond with a Return Material Authorization(RMA) number no later than the end of the next work day. The buyer will provide this RMA number to the analyzer. Mechanicsburg/Europe will ship failed parts along with the RMA form to NCD at the address(es) above. Shipping charge to NCD will be paid by IBM NCD will: - - Remove any extra memory SIMMs or Video memory left in the unit, record P/Ns and serial number on which this occurred. Record the serial number and missing parts of any system returned missing parts. Return the extra parts to IBM at IBM's request. - - Scrap and replace any unit that comes back for repair within six months of having been previously repaired. - - Clean the returned units. - - Covers must be in good working order and have same appearance as a new cover; or the cover must be replaced. - - Repair the failed units. Any unit that is not repairable and is still under warranty must be replaced with a new unit; if out of warranty, it will be returned to IBM to be scrapped and IBM will be charged a diagnostic fee. - - Repair or replace these systems within two weeks(ten working days not counting shipping time) of their receipt from IBM and ship them back to the IBM field location address indicated on the RPR form. If quantity to repair exceeds 100 units, the repair time must be negotiated at the time the P.O. is placed. - - During repair, install any required E.C.'s that have occurred since the unit was first shipped. The individual E.C. will specify if it needs to be applied on factory/field returned EXHIBIT A TO ATTACHMENT 3 TO ARTICLE 2 - MANUFACTURING product. - - Retest the units using an approved process. NCD Inc will submit their repair process for review. When approved that document will become part of this process. - - Perform all of the same quality assurance processes used on new units. - - The S/N of the unit does not change. - - Mark the repaired unit with a code that indicates it was repaired and the date it was repaired. The mark to be made with indelible ink. Mark to be located on the logic card inside the cover. - - Place repaired unit in a new shipping container marked per IBM specifications. - - Send repaired field returned cards at NCD Inc cost back to the Field location indicated on the RMA form - not to any manufacturing locations. Shipping via ground transportation is acceptable. - - Provide failure/repair data to IBM within two weeks of repair. - ------------------------------------------------------------------- - ------------------------------------------------------------------- NCD Repair Process for IBM M/T 8361 and 8362 NCD Receiving coordinator will; 1. Verify serial number and part number of unit against RMA # issued to customer. If the serial numbers do not match, the unit is put on hold until the issue can be resolved (customer service will contact the customer) 2. Receive the unit into the system. 3. Print a traveler (paperwork that accompanies the unit through the EXHIBIT A TO ATTACHMENT 3 TO ARTICLE 2 - MANUFACTURING process). 4. Checks s/n of unit for "second time back status" Any units coming back within 6 months of last repair date is sent to MRB. MRB must get approval of IBM quality engineering to reuse any second time back board. Without this approval, board cannot be sent back to IBM. 5. Units are sent to technicians for repair. Repair technicians will; 6. Verify data/configuration of the unit (boot prom version, Ethernet address, simms, etc.) and record information on traveler. 7. Any information regarding additional or missing parts will be forwarded to customer service. Customer service will contact customer for resolution of these issues. Invoicing required as a result of these issues will be handled by the Customer Service representative. 8. Write any upgrades required on the traveler. 9. Attempt to duplicate problem with manual "bench test" If problem is duplicated or a problem is found the unit is repaired and proceeds to the next process step. If there is no problem found, the unit is put through a two day burn-in test. If no problem is found during this burn-in the unit will continue through the process and if no other problem is found it will be classified as "NO Trouble Found". If the unit fails during this burn-in, it will be worked on until the problem is identified and repaired or the board will be replaced. 10. Required E.C. upgrades are installed on units. 11. Unit is put into overnight "burn-in test" (which is the same as the new build burn-in.) The overnight burn-in test; cycles power, cycles temp and does a continuous composite cycle test (~5 minutes) This looping test does a complete functional test; a minimum amount of passes are required in order to pass test, data is logged onto database automatically. 12. After successful completion of the overnight burn-in the manual EXHIBIT A TO ATTACHMNT 3 TO ARTICLE 2 - MANUFACTURING bench test is repeated. If the unit cannot pass the overnight burn-in and the manual bench test, the pcb or unit will be replaced. 13. Original configuration and factory defaults are loaded. Any extra parts (simms, etc.) are removed and all parts required to meet original configuration are installed. This unit will be exactly as it was originally shipped with the addition of any required E.C.'s 14. Complete inspection of rework and configuration of unit. 15. Mark date unit was repaired on the PCB. 16. All repair information is entered into the database. 17. Unit is sent to base packaging station. Base Packaging will; 18. Do a cosmetic inspection of the unit - replacing any parts which do not meet the cosmetic criteria. 19. Fill out the Repair Notification Form Any serial numbers that were changed, (pcb or unit) will be noted on this form. 20. Insure all labels are correct and package the unit. 21. Submit lot to Quality for inspection. Shipping; 22. Verify the quantity of parts ready for shipment against the quantity received for that RMA. Initially, no partial shipments will be made on Field Returned unit RMAs; any unit that was unrepairable will be replaced at a cost to IBM that is different than units that are repaired. As the product matures, IBM can elect to not have the unit replaced and just pay a screening cost that is different than the cost of units that are repaired. 23. Ship back any additional parts per customers requirements. EX-21.1 4 EXHIBIT 21.1 EXHIBIT 21.1 LIST OF SUBSIDIARIES Organization Jurisdiction Name ------------ ----------------- NCD Graphic Software Corporation Oregon Network Computing Devices Australia Australia Pty. Ltd. Network Computing Devices Canada (Canada), Inc. Network Computing Devices England (UK) Limited Network Computing Devices France (France) S.A.R.L. Network Computing Devices Germany (Germany) GmbH Network Computing Devices Sweden (Scandinavia) AB NCD International Inc. California EX-23.1 5 EXHIBIT 23.1 EXHIBIT 23.1 Consent of Independent Auditors The Board of Directors Network Computing Devices, Inc. We consent to incorporation by reference in the registration statements on Form S-8 (Nos. 33-51594 and 39-65638) of Network Computing Devices, Inc. of our reports dated January 27, 1998, except as to Note 10 which is as of March 16, 1998, relating to the consolidated balance sheets of Network Computing Devices, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997, and the related schedule, which reports appear in the December 31, 1997, annual report on Form 10-K of Network Computing Devices, Inc. KPMG PEAT MARWICK LLP Mountain View, California March 30, 1998 EX-27.1 6 EXHIBIT 27.1
5 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 21,240 10,240 27,754 2,606 15,412 79,646 26,964 22,540 86,514 25,835 0 0 0 58,630 1,889 86,514 133,400 133,400 81,075 81,075 50,589 26 51 3,831 1,150 2,681 0 0 0 2,681 0.16 0.15 INCLUDES REVENUES FROM LICENSING OF SOFTWARE AND SUPPORT REVENUES. INCLUDES COSTS FROM LICENSING OF SOFTWARE AND SUPPORT REVENUES.
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