10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

ý	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	for the quarterly period ended March 31, 2002
o	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)

Delaware	77-0177255
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
301 Ravendale Drive, Mountain View, California	94043
(Address of principal executive offices)	(Zip Code)

(650) 694-0650
(Registrant’s telephone number, including area code)

Common Stock, $0.001 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 ý       No o

As of April 30, 2002, 17,613,237 shares of the registrant’s Common Stock were outstanding.

NETWORK COMPUTING DEVICES, INC.

INDEX

Description

Cover Page

Index

NETWORK COMPUTING DEVICES, INC.

Part I:  Financial Information

Item 1.  Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

ASSETS
	(unaudited) March 31, 2002		December 31, 2001
Current assets:
Cash	$	615	$	484
Accounts receivable, net of allowances of $1,400 and $1,681as of March 31, 2002 and December 31, 2001, respectively	5,363		7,298
Inventories	3,242		4,930
Prepaid expenses and other current assets	1,219		928
Total current assets	10,439		13,640
Property and equipment, net	544		649
Intangible assets	1,512		1,613
Other assets	150		165
Total assets	$	12,645	$	16,067

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,957		$	6,840
Accrued expenses	2,741			2,378
Deferred revenue	442			194
Notes payable	4,390			6,506
Accrued income taxes	76			72
Total current liabilities	12,606			15,990
Shareholders’ equity:
Preferred stock	3,500			3,500
Common stock	18			18
Capital in excess of par	62,380			62,380
Accumulated deficit	(65,859		)	(65,821		)
Total shareholders’ equity	39			77
Total liabilities and shareholders’ equity	$	12,645		$	16,067

See accompanying notes

3

NETWORK COMPUTING DEVICES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

	Three Months Ended March 31,
	2002			2001
Net revenues:
Hardware products	$	4,036		$	8,679
Software products	530			787
Services	125			1,013
Total net revenues	4,691			10,479
Cost of revenues:
Hardware products	3,762			6,420
Software products	168			273
Services	53			442
Total cost of revenues	3,983			7,135
Gross Margin	708			3,344
Operating expenses:
Research and development	636			611
Marketing and selling	1,951			3,297
General and administrative	1,112			1,112
Gain on sale of product line	(3,450		)	—
Business restructuring	278			—
Total operating expenses	527			5,020
Operating income (loss)	181			(1,676		)
Interest expense, net	(215		)	(145		)
Loss before income taxes	(34		)	1,821
Provision for income taxes	4			7
Net loss	$	(38	)	$	(1,828	)
Net loss per share
Basic and diluted	$	(0.00	)	$	(0.10	)
Shares used in per share computations
Basic and diluted	17,613			17,613

See accompanying notes

4

NETWORK COMPUTING DEVICES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended March 31,
	2002			2001
Cash flow from operations:
Net loss	$	(38	)	$	(1,828	)
Reconciliation of net loss to cash used in operations:
Depreciation	127			337
Amortization of intangible assets	101			101
Gain on sale of product line	(3,450		)	—
Provision for doubtful accounts, sales returns and allowances, net	281			728
Changes in:
Accounts receivable, net	1,654			(839		)
Inventories	1,688			1,287
Prepaid expenses	(291		)	1,094
Accounts payable	(1,883		)	(1,044		)
Accrued expenses	363			(600		)
Deferred revenue	(52		)	(711		)
Deferred gain on sale of product line	300			—
Income taxes payable	4			(26		)
Cash provided by (used in) operations	(1,196		)	(1,501		)
Cash flows from investing activities:
Sales and maturities of short-term investments	—			339
Changes in other assets	15			226
Net proceeds from sale of product line	3,450			—
Property and equipment purchases	(22		)	(17		)
Cash provided by (used in) investing activities	3,443			548
Cash flows from financing activities:
Proceeds from line of credit	5,397			9,727
Principal payments on line of credit	(7,513		)	(10,873		)
Proceeds from issuance of stock, net	—			1,500
Cash provided by (used in) financing activities	(2,116		)	354
Increase (decrease) in cash and equivalents	131			(599		)
Cash and equivalents:
Beginning of period	484			1,419
End of period	$	615		$	820

See accompanying notes.

5

NETWORK COMPUTING DEVICES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Basis of Presentation

The unaudited condensed consolidated financial information of Network Computing Devices, Inc. and its wholly-owned subsidiaries (the “Company” or “NCD”) furnished herein reflects all adjustments, consisting only of normal recurring entries, which in the opinion of management are necessary to fairly state our consolidated financial position, results of operations and cash flows for the periods presented. The functional currency for the Company is the U.S. dollar.  All significant intercompany balances and transactions have been eliminated in consolidation. This Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in our 2001 Annual Report on Form 10-K.  The consolidated results of operations for the three-month period ended March 31, 2002 are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending December 31, 2002.

Sale of Windows-based Terminal Product Line

In March 2002, the Company sold its ThinSTAR Windows-based terminal product line (“ThinSTAR Product Line”) to Neoware Systems, Inc. (“Neoware”) for cash of up to $4.25 million.  The assets sold consisted of customer records, trademark rights and other intellectual property and contract rights used in the business of designing, developing and manufacturing the products sold. The Company recorded a net gain on this sale of approximately $3.45 million.  Included in the $4.25 million purchase price is $300,000 that is being held in an escrow to satisfy any indemnification claims that may arise and $250,000 that is contingent upon NCD meeting specified sales targets for ThinSTAR products in Europe, the Middle East and Africa. In connection with the acquisition, Neoware received an option to acquire substantially all of NCD’s European operations, which serve those markets. The $300,000 held in escrow has been recorded as deferred revenue until such time when all conditions of the escrow agreement are satisfied. Also related to the sale, eleven NCD sales and support personnel subsequently joined Neoware.

Going Concern Uncertainty

The Company has incurred losses of approximately $9.7 million for the year ended December 31, 2001 and a relatively insignificant loss ($38,000) for the three months ended March 31, 2002. At March 31, 2002, the Company had a working capital deficit of $2.2 million.   The Company’s ability to continue as a going concern is dependent upon its ability to obtain additional financing and ultimately attain profitability.

The Company believes that it will be required to obtain additional financing during the next three to six months in order to sustain its current operations. The Company is pursuing both bank financing and potential equity investors. Management believes that the Company will require additional financing of approximately $1.0 million in order to fund its operations during the next 12 months.  However, no assurance can be given that additional financing will be available, or that if available, will have terms acceptable to the Company or its shareholders.  If adequate funds are not available to satisfy its capital requirements, the Company may be required to limit its operations significantly. NCD’s financial statements do not include any adjustments relating to the recoverability and classification of reported asset amounts or the amount and classification of liabilities that might be necessary should NCD be unable to continue as a going concern.

Revenue Recognition

Hardware revenues consist primarily of revenues from the sale of thin client terminals and related hardware. Hardware revenues are recognized when the products are shipped following receipt of a valid purchase order. With respect to sales through certain international distributors, revenue is recognized when the shipment is made available at a third party logistics center and the buyer is notified of the availability. The Company warrants its hardware products for defects in materials for a period of three years. During this warranty period, the customer may return defective product to the Company for repair or replacement, at the Company’s option.  In the event the Company is unable to repair or replace the defective product, it may refund the customer the corresponding purchase price. The Company reduces revenues and cost of sales by an amount representing returns estimated by the Company based upon historical experience factors.  Warranty costs are accrued based upon actual units sold and historical failure rates.

6

Software revenues consist primarily of revenues from the sale of (i) NCD ThinPATH, (ii) NCD PC-Xware, the Company’s thin client software for PCs, and (iv) NCDware, the Company’s proprietary operating system software. Software revenues are recognized when the software license is sold and the software is delivered. The Company does not offer free software upgrades and because itprovides 30-day complimentary telephone support for software, there is no undelivered element related to software sales.

Service revenues are generated from the sale of hardware service contracts. The Company’s Extended Warranty Program extends the Company’s three-year standard warranty, and its Express Exchange Program provides for the shipment of a replacement unit within 24 to 48 hours, upon customer request.  Service revenues are recognized ratably over the term of the hardware service contract. The Company’s deferred revenue includes all unrecognized service revenue.

Estimated reductions to revenue for sales and marketing programs including special price quotes, price protection, promotions and marketing development activities and other volume related incentives are recorded throughout the period and fluctuate based on market conditions.  If market conditions decline, then the Company may increase these incentives, which would result in additional declines in revenue.  The adjustments are charged to income in the period in which the information that gave rise to the adjustment becomes known.  An allowance for doubtful accounts is maintained for estimated losses that would result from the customers’ inability to make payments. Should the financial condition of the Company’s customers deteriorate, additions to the allowance account may be required, which would also result in additional decreases in revenue.

Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net loss per share is computed using the weighted-average number of common shares and potential common shares from stock options and warrants outstanding, when dilutive, using the treasury stock method. At March 31, 2002 and 2001 there were 5,953,421 and 4,630,381 options and warrants outstanding, respectively. There were also 750,000 shares of convertible preferred stock (convertible into 7,500,000 shares of common stock) outstanding at March 31, 2002. Such options, warrants and convertible preferred shares could potentially dilute earnings per share (“EPS”) in the future, but they were not included in the computation of diluted EPS because to do so would have been antidilutive for those periods The Company’s loss per share for the three months ended March 31, 2002 was less than $0.01.

Inventories

Inventories stated at the lower of standard costs, which approximates actual cost on a first-in, first-out basis, or market, consisted of (in thousands):

	March 31, 2002			December 31, 2001
Purchased components and sub-assemblies	$	5,306		$	5,838
Work in process	771			488
Finished goods	2,846			4,360
Reserve for obsolete inventory	(5,681		)	(5,756		)
	$	3,242		$	4,930

7

Interest and tax payments

Interest payments, primarily interest on notes payable, were approximately $215,000 and $145,000 for the three months ended March 31, 2002 and 2001, respectively.  Income tax payments, primarily taxes due in foreign jurisdictions, were approximately $0 and $36,000 for the three months ended March 31, 2002 and 2001, respectively.

Operating Segments and Major Customers

The company has one operating segment, sales of thin client hardware and software.

The percentages of total net revenues represented by sales to major customers are as follows:

	Three Months Ended March 31
	2002		2001
GTS Gral *	15	%	9	%
Ingram Micro	13	%	2	%
AKS Information Systems AB	11	%	—
Alternative Technology	10	%	1	%
Tech Data	4	%	19	%
Adtcom	6	%	15	%

*      GTS Gral is a European reseller substantially owned by a director of the Company.  At March 31, 2002, the Company had approximately $1.2 million of accounts receivable from GTS Gral.

A substantial portion of the Company’s sales is to customers located outside the United States, primarily in Europe.  International revenues represent 57% and 43% of total revenue of the Company for each of the quarters ended March 31, 2002 and 2001.

Restructuring Charges

During the first quarter of 2002, the Company undertook restructuring actions involving a general reduction in workforce affecting all classes of employees and discontinuing development activities related to its ThinSTAR Product Line. Approximately 30 employees were terminated during the quarter. In connection with these actions, the Company recorded restructuring charges of $0.3 million consisting of expected cash charges for employee separation costs. Approximately $0.2 million remains unpaid and is included in accrued liabilities as of March 31, 2002. In addition, the Company is currently in the process of consolidating all of its U.S. operations into the Portland, Oregon facility and is also attempting to identify a subtenant for its Mountain View facility, which will be substantially vacated in May 2002.  The Company will continue to be obligated for the rent payments under the Mountain View lease until such time that a subtenant is found. Costs associated with this relocation have not been recognized as of the quarter ended March 31, 2002.  The total cost committed by the Company through the end of the lease term (February 2003) is approximately $512,000. Management expects the restructuring plan to be completed in the third quarter of 2002.

Notes Payable

In October 2001, a line of credit from Silicon Valley Bank (“SVB”) was obtained.  This line of credit entitled the Company to borrow amounts up to 60% of domestic accounts receivable and up to 60% of foreign accounts receivable from which the Company had secured credit insurance, in each case subject to certain eligibility requirements and compliance with specified financial covenants. The line of credit was secured by substantially all of the Company’s assets and bore interest at the rate of prime plus 2%. In connection with the line of credit, the Company issued warrants to SVB to purchase 650,000 shares of its Common Stock at a price of $.50 per share, expiring on October 29, 2006.

8

The line of credit was terminated in March 2002, and all amounts outstanding thereunder, totaling approximately $1.6 million were repaid at the time of the sale of the ThinSTAR Product Line. As of December 31, 2001, the total amount available and outstanding under the line of credit was $2,116,000.

The Company’s line of credit with Foothill Capital was terminated when the line of credit was obtained from SVB. As of the date of termination, the total amount outstanding under the line of credit was approximately $0.8 million and borrowings bore interest at a rate of prime plus 6.75%, including a covenant default rate of 4%, for a total of 12.75%.

In August 2000, an agreement was reached with SCI to convert $3.3 million of accounts payable to SCI into a 13-month convertible note (the “Convertible Note”). The Convertible Note bore interest at 6.5% per annum and each $1.00 of the outstanding principal was convertible into one share of Common Stock at any time during the term of the Convertible Note at $.75 per shares.  In August 2001, the Convertible Note was extended for an additional year (due September 30, 2002)) with an increase in the interest rate to 8% per annum, computed on the unpaid balance beginning October 1, 2001, and the conversion price was reduced to $.62 per share.

In October 2001, the Company concluded an agreement with SCI to convert an additional $1.0 million of accounts payable to them into a note which matures on September 29, 2002 and bears interest at a rate of 8% per annum.  The note is not convertible.

9

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

This discussion includes forward-looking statements, including but not limited to statements with respect to our future financial performance, operating results, plans and objectives. Actual results may differ materially from those currently anticipated depending upon a variety of factors, including those described below under the sub-heading, “Future Performance and Risk Factors.”

The following discussion should be read in conjunction with the unaudited condensed consolidated interim financial statements and notes thereto included in Part I—Item 1 of this Quarterly Report on Form 10-Q, and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2001, contained in our 2001 Annual Report on Form 10-K.

Historically, NCD has provided thin client hardware and software delivering simultaneous, high-performance, easy-to-manage and cost effective access to all of the information on enterprise intranets and the Internet from thin client, UNIX and PC desktops. Our hardware product lines have included the NCD ThinSTAR line of Windows-based terminals (“ThinSTAR Product Line”) and the NCD NC900 network computers. On the software side we offered the NCD ThinPATH family of client and server software, developed to enhance the connectivity, management and features of the NCD thin clients as well as PCs in accessing information and applications on Windows servers. Our thin clients, NCD ThinPATH software, and installation and support services have been a combination delivering a fully integrated desktop solution to companies seeking a low-cost, easy to manage, simple to use, high performance user experience. Since introducing our first product in 1989, we have installed over 1,000,000 thin clients worldwide.

In March 2002, we sold our ThinSTAR Product Line to Neoware Systems, Inc. (“Neoware”) for cash of up to $4.25 million.  The assets sold consisted of customer records, trademark rights and other intellectual property and contract rights used in the business of designing, developing and manufacturing the products sold. We recorded a net gain on this sale of approximately $3.45 million.  Included in the $4.25 million purchase price is $300,000 that is being held in an escrow to satisfy any indemnification claims that may arise and $250,000 that is contingent upon NCD meeting specified sales targets for ThinSTAR products in Europe, the Middle East and Africa. In connection with the acquisition, Neoware received an option to acquire NCD’s European operations which serve those markets. The $300,000 held in escrow has been recorded as deferred revenue until such time when all conditions of the escrow agreement are satisfied.  Also related to the sale, eleven NCD sales and support personnel subsequently joined Neoware.

Going forward, we will focus on our worldwide NCD ThinPATH software business while continuing to market our NCD NC900 Network Computer product line worldwide.  In addition, the ThinSTAR Product Line will continue to be available from us in Europe the Middle East and Africa under an OEM agreement with Neoware.  As a result, our European customer offerings for these markets will be essentially unchanged.

Recent Developments

Debt Financing Activities

In October 2001, we obtained a line of credit from Silicon Valley Bank (“SVB”).  This line of credit entitled us to borrow amounts up to 60% of our domestic accounts receivable and up to 60% of our foreign accounts receivable from which we had secured credit insurance, in each case subject to certain eligibility requirements and compliance with specified financial covenants. The line of credit was secured by substantially all of our assets and bore interest at the rate of prime plus 2%. In connection with the line of credit, we issued warrants to SVB to purchase 650,000 shares of our Common Stock at a price of $.50 per share, expiring on October 31, 2006.  In connection with the sale of our ThinSTAR Product Line, the line of credit was terminated in March 2002, and all amounts outstanding thereunder, totaling approximately $1.6 million were repaid. As of December 31, 2001, the total amount available and outstanding under the line of credit was $2,116,000.

In March 2000 we obtained a line of credit from Foothill Capital.  This line of credit provided us with up to $15 million in credit, subject to certain conditions related to our accounts receivable from time to time.  As a result of these conditions, the actual amount that was available under the line of credit ranged from $.20 million to $6.0 million.  Borrowings under the line of credit were secured by substantially all of our assets and initially bore interest at a rate of prime plus 0.75%.  The line of

10

credit was amended several times prior to its termination.  In May 2001, the line of credit was amended to establish new financial covenants and eliminate the maximum ratio of borrowings against foreign accounts receivable.  Additionally, in May 2002, the line of credit was amended to modify the maturity date of the loan from March 30, 2003 to August 15, 2001, raise the interest rate from prime plus 0.75% to prime plus 2.75% and waive the early termination fee.  As of June 30, 2001, we were in default of the minimum EBITDA (Earnings Before Income Taxes, Depreciation and Amortization) covenant of $38,000 for the three-month period ended June 30, 2001.  In July 2001, the line of credit was further amended to reduce the maximum amount of the credit line from $15.0 million to $3.5 million.  In August 2001, the maximum credit line was further reduced to $3.25 million and the maturity date was extended to September 15, 2001 to provide additional time for SVB to complete its due diligence work and make a final determination regarding its preliminary proposal to extend a new revolving credit facility to us.

Our line of credit with Foothill Capital was terminated when we obtained our line of credit from SVB. As of the date of termination, the total amount outstanding under the line of credit was approximately $0.8 million. Prior to its termination, our borrowings during the third quarter of 2001 bore interest at a rate of prime plus 6.75%, which included a covenant default rate of 4% for a total of 12.75% at September 30, 2001.

In August 2000, we concluded an agreement with SCI to convert $3.3 million of our accounts payable to SCI into a 13-month convertible note (the “Convertible Note”).  The Convertible Note bore interest at 6.5% per annum and each $1.00 of the outstanding principal was convertible into one share of our Common Stock at any time during the term of the Convertible Note.  In August 2001, the $3.3 million Convertible Note issued to SCI was extended for an additional year with an increase in the interest rate to 8% per annum, computed on the unpaid balance beginning October 1, 2001, and the conversion price was reduced to $.62 per share.

In October 2001, we concluded an agreement with SCI to convert an additional $1.0 million of our accounts payable to them into a note, which matures on September 29, 2002 and bears interest at a rate of 8% per annum.  This note is not convertible.

Equity Financing Activities

In October 2001, we received $2,000,000 in capital through a private placement of 530,000 shares of Series C Convertible Preferred Stock (“Series C Preferred”). The Series C Preferred shares were issued on November 13, 2001. The Series C Preferred shares are entitled to dividends of $.23 per annum, when and if declared by the Board of Directors and accrue semi-annually if not paid. No dividends have been declared.  Each share of the Series C Preferred is convertible into ten shares of Common Stock at the election of the holder, subject to the amendment of the Company’s Certificate of Incorporation to increase the number of authorized shares of Common Stock by not less than 5,300,000 shares.  In connection with this private placement, the purchaser also received warrants to purchase 1,200,000 shares of Common Stock at $.50 per share.  The warrants expire on August 29, 2006.

Restructuring Activities

During the first quarter of 2002, we undertook restructuring actions involving a general reduction in workforce affecting all classes of employees and discontinuing development activities related to our ThinSTAR Product Line.  Approximately 30 employees were terminated during the quarter.  In connection with these actions, we recorded restructuring charges of $0.3 million for employee separation costs. Approximately $0.2 million remains unpaid and is included in accrued liabilities as of March 31, 2002. In addition, we are currently in the process of consolidating all of our U.S. operations into the Portland, Oregon facility. We are also attempting to identify a subtenant for our Mountain View facility, which will be substantially vacated in May 2002.  We will continue to be obligated for the rent payments under the Mountain View lease until such time that a subtenant is found. Costs associated with this relocation have not been recognized as of the quarter ended March 31, 2002. The total cost committed by the Company through the end of the lease term (February 2003) is approximately $512,000. Management expects the restructuring plan to be completed by the third quarter of 2002.

Other Recent Developments

In January 2002, we entered into a Settlement Agreement with Pencom Systems, Inc., a former customer who filed a lawsuit against us in March 2001, in the Superior Court of the State of California, County of Santa Clara, alleging among other things, that the products we delivered pursuant to our sales contract did not perform as required by the contract.  The complaint sought monetary damages in excess of $250,000. Pursuant to the settlement agreement we agreed to pay Pencom $90,000 in the form of a promissory note payable over 18 months beginning in April 2002.  The note bears no interest. As part of the settlement, we also agreed to issue the customer 75,000 shares of our Common Stock.

11

Results of Operations

Total Net Revenues

Total net revenues for the first three months of 2002 were $4.7 million, a decrease of 55% from 2001 first quarter net revenues of $10.5 million. Sales to GTS Gral, a related party, and Ingram Micro accounted for 15% and 13%, respectively, of net revenues in the first quarter of 2002.  Sales to Tech Data and Adtcom accounted for 19% and 15%, respectively, of net revenues in the first quarter of 2001.  The decrease in revenues is explained below.

Hardware Revenues

Hardware revenues consist primarily of revenues from the sale of thin client terminals and related peripheral equipment. Hardware revenues were $4.0 million for the first three months of 2002, a decrease of 54% from $8.7 million for the first three months of 2001. The decrease in hardware revenues was due to lower customer demand further aggravated by lower sales to distributors as we strove to reduce channel inventories of our NCD ThinSTAR units prior to the sale of that product line to Neoware in March 2002.

Software Revenues

Software products that are included in revenue for the periods presented are (i) NCD ThinPATH, (ii) NCD PC-Xware, our thin client software for PCs, and (iii) NCDware, our proprietary operating system software. Revenues from software were $0.5 million for the first three months of 2002, a decrease of 38% from $0.8 million for the first three months of 2001.  The decrease in software revenues resulted from the drop in sales of our related hardware products.

Service Revenues

Services revenues are generated from the sale of hardware service contracts.  Service revenues were $0.1 million for the first three months of 2002, a decrease of 90% from $1.0 million for the first three months of 2001. Service revenues have declined as a result of the decline in the purchase or renewal of long-term service contracts, as more customers are opting to purchase spare units with their initial orders to serve as replacements while damaged units are returned to us for repair under warranty.

Gross Margin on Hardware Revenues

Gross margin on hardware revenues represents revenues less cost of revenues related to hardware products. Our gross margins on hardware revenues were $0.3 million and $2.3 million for the first three months of 2002 and 2001, respectively. Our gross margin percentages on hardware revenues were 7% and 26% for the first three months of 2002 and 2001, respectively.  The reduction in hardware gross margins was primarily attributable to a significant increase in costs other than our direct standard product costs.  Low volume resulted in about $370,000 of unabsorbed production and distribution costs, and increases in our hardware inventory reserves amounted to $600,000.  Without these two large expenses, our gross margin percentages on hardware revenues would actually have increased over those of the prior year.

Gross Margin on Software Revenues

Gross margin on software revenues represents revenues less cost of revenues related to software products. Our gross margins on software revenues were $0.4 million and $0.5 million for the first three months of 2002 and 2001, respectively.  This decrease was across all product lines.  The reduction in gross margin dollars on software revenues was due to lower volume as our gross margin percentages on that revenue stream actually increased from 65% for the first three months of 2001 to 68% for the first three months of 2002.

Gross Margin on Service Revenues

Gross margin on service revenues represents revenues less cost of revenues related to services. Our gross margins on service revenues were $0.1 million and $0.6 million for the first three months of 2002 and 2001, respectively.    The reduction in gross margin dollars on service revenues was due to lower volume as gross margin percentages on service revenues increased modestly from 56% for the first three months of 2001 to 58% for the first three months of 2002.

12

Research and Development Expenses

Research and development (“R&D”) expenses consist principally of personnel expenses associated with employees engaged in hardware and software R&D. R&D expenses were $0.6 million for both the first three months of 2002 and 2001.

Marketing and Selling Expenses

Marketing and selling expenses consist principally of personnel expenses associated with our U.S. and European sales force, as well as a limited amount of marketing and promotional materials. Marketing and selling expenses were $2.0 million and $3.3 million for the first three months of 2002 and 2001, respectively representing a decrease of 41%. The decrease in 2002 resulted from the implementation of our cost reduction plans, including the closure of a number of our U.S. and foreign sales offices and a significant reduction in our marketing programs.

General and Administrative Expenses

General and administrative expenses (“G&A”) consist of executive, financing, human resources personnel expenses and expenses associated with outside professional services.  G&A expenses were $1.1 million for both the first three months of 2002 and 2001. G&A expenses also include $101,000 in amortization expense for intangible assets for the first three months of both 2002 and 2001.

Interest Expense, Net

Interest expense, net, was $215,000 and $145,000 for the first three months of 2002 and 2001, respectively. The change reflects a $70,000 increase in interest expense due to loan fees of $50,000 paid to SVB, the write off of prepaid loan fees of approximately $25,000 related to the terminated loan with SVB and the interest charges on the issuance of a $1.0 million note payable to SCI in September 2001.

Income Taxes

The provision for income taxes for the first three months of 2002 is for income taxes in foreign jurisdictions.  We continue to generate tax net operating loss carryforwards for the United States federal and state jurisdictions.  However, no deferred tax assets have been recognized in respect of these carryforwards because continued losses create uncertainty about our ability to generate sufficient taxable income to realize the related benefits.

Financial Condition

At March 31, 2002, we had total assets of $12.6 million, representing a decrease from $16.1 million at December 31, 2001. The change in total assets reflects decreases in accounts receivable of $0.3 million and inventory of $1.7 million. In the first quarter of 2002, accounts payable decreased by $1.9 million as a result of applying a portion of the proceeds from the sale of our ThinSTAR Product Line to reduce our accounts payable.  Reduced accounts receivable and inventory are a result of our reduced operations.

Capital Requirements

Capital equipment spending requirements for the remainder of 2002 is estimated at approximately $50,000.

Liquidity

As of March 31, 2002, we had cash totaling $0.6 million and $4.4 million in notes payable, consisting of $4.3 million in notes payable to SCI and $0.1 million in other debt. We also have negative working capital of approximately $2.2 million. Cash used in operations was $0.9 million in the first three months of 2002 compared to cash used in operations of $1.5 million for first three months of 2001.  In the first three months of 2002, the net loss of $38,000 was offset by decreases in accounts receivable of $1.7 million, inventories of $1.7 million, accounts payable of $1.9 million and increases of prepaid expenses of $0.4 million.  In the first three months of 2001, a net loss of $1.8 million was offset by a decrease in inventories of $1.3 million, prepaid expenses of $1.1 million, accounts payable of $1.0 million, accrued expenses of $0.7 million and deferred revenues of $0.7 million.

13

Cash provided by investing activities of $3.1 million in the first three months of 2002 resulted principally from the net proceeds from the sale of the ThinSTAR Product Line of $3.7 million.  Cash provided by investing activities of $0.5 million in the first three months of 2001 resulted from the maturity of short-term investments of $0.3 million and a reduction in other assets of $0.2 million.

Cash used in financing activities of $2.1 million in the first three months of 2002 reflects the proceeds of $5.4 million from borrowings under the line of credit and a principal reduction on the line of credit of $7.5 million. Cash proceeds from financing activities of $.4 million in the first three months of 2001 resulted from the net reduction of the outstanding balance under our line of credit of $1.1 million offset by the receipt of $1.5 million through the sale of convertible preferred stock.

On October 29, 2001, we secured a $5.0 million line of credit with Silicon Valley Bank (“SVB”). In March 2002, we paid off this line of credit with proceeds from the sale of our ThinSTAR Product Line.  The line was secured by substantially all of our assets and bore interest at a rate of prime plus 2%. Based on terms of the financing agreement and assuming that we were in compliance with specified financial covenants, we could borrow up to 60% of our domestic accounts receivable and up to 60% of our foreign accounts receivable in which we had secured credit insurance. As of December 31, 2001, the total amount available and outstanding to SVB was $2,116,000. In January 2002, we violated a covenant with SVB, which stopped further advances until a new agreement was concluded which reduced the maximum amount available to $2.0 million from the existing $5.0 million and reduced the advance rate on eligible domestic and foreign accounts receivable to 50% from the original 60%. Also, in connection with this line of credit, we issued warrants to SVB to purchase 650,000 shares of our Common Stock at a price of $.50 per share. The warrants expire on October 29, 2006.

Going forward, we believe that we will be required to obtain additional financing during the next three to six months in order to sustain our current operations. We are diligently pursuing both bank financing and potential equity investors. Furthermore, we believe that we will require additional financing of approximately $1.0 million in order to fund our operations during the next 12 months. However, no assurance can be given that additional financing will be available, or that if available, it will be available on the terms acceptable to our shareholders or us.  If adequate funds are not available to satisfy our short-term or long-term capital requirements we may be required to limit our operations significantly. Our financial statements do not include any adjustments relating to the recoverability and classification of reported asset amounts or the amount and classification of liabilities that might be necessary should we be unable to continue as a going concern.

Our Board of Directors has not declared any dividends on our Series B or Series C Preferred Shares.  Accumulated dividends on those shares are approximately $163,000 at March 31, 2002.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (“FASB”) finalized Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” (“SFAS 141”), and No. 142, “Goodwill and Other Intangible Assets” (“SFAS 141”). SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that we recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS 141 applies to all business combinations initiated after June 30, 2001 and for purchase business combinations completed on or after July 1, 2001. It also requires, upon adoption of SFAS 142 that we reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141.

SFAS 142 requires, among other things, that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires us to identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized. We are also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS 142. As of March 31, 2002, all intangible assets consist of customer lists, non-compete agreements, workforce and technology and continue to be amortized over 7 years.  We have no recorded goodwill at March 31, 2002.  In addition, we were not affected financially from our adoption of SFAS 141 and 142.

In June 2001, FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.”  SFAS No. 143 is effective for fiscal years beginning after June 15, 2002.  SFAS No. 143 requires that any legal obligation related to the retirement of long-lived assets be quantified and recorded as a liability with the associated asset retirement cost capitalized on the balance sheet in the period it is incurred when a reasonable estimate of the fair value of the liability can be made.

14

In August 2001, FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS 144”).  SFAS No. 144 is effective for fiscal years beginning after December 15, 2001.  SFAS No. 144 provides a single, comprehensive accounting model for impairment and disposal of long-lived assets and discontinued operations.

We expect that SFAS Nos. 143 and 144 will be adopted on their effective dates and that the adoption will not result in any material effects to our financial statements.

As of March 31, 2002, the net carrying amount of intangibles remaining after the purchase of the Network Displays Business unit of Tektronix in December 1998 was approximately $1.5 million. We believe there is no impairment at March 31, 2002 and will continue to monitor the value.

Future Performance and Risk Factors

Our future business, operating results and financial condition are subject to various risks and uncertainties, including those described below.

Liquidity

As of March 31, 2002, we had cash totaling $0.6 million and $4.4 million in notes payable, consisting of $4.3 million in notes payable to SCI and $0.1 million in other debt.

Going forward, we believe that we will be required to obtain additional financing during the next three to six months in order to sustain our current operations. We are pursuing both bank financing and potential equity investors. Furthermore, we believe that we will require additional financing of approximately $1.0 million in order to fund our operations during the next 12 months. However, no assurance can be given that additional financing will be available, or that if available, it will be available on the terms acceptable to our shareholders or us.  If adequate funds are not available to satisfy our short-term or long-term capital requirements we may be required to limit our operations significantly. Our financial statements do not include any adjustments relating to the recoverability and classification of reported asset amounts or the amount and classification of liabilities that might be necessary should we be unable to continue as a going concern.

Competition

The market for thin client products and similar products is characterized by rapidly changing technology and by evolving industry standards. We experience significant competition from other thin client manufacturers, from suppliers of personal computers and workstations and from software developers.

In the ThinSTAR Windows-based terminal market, our major competition has come from Wyse Technology, Inc., a larger company with well-established channels, and, more recently, Compaq Computer Corp.  As a full-fledged PC and server manufacturer, Compaq has been able to “bundle” its thin clients with other products and services to gain an advantage in certain larger sales opportunities.  To compete, we have relied heavily on our integrated hardware and software offerings, our networking core competency and our recognized product reliability.  We also formed marketing partnerships with other important desktop vendors. As competition in this market has intensified, we have responded by narrowing our focus and selling our Windows-based terminal product line to Neoware.

Our NCD ThinPATH family of products faces competition primarily from other terminal vendors that continually strive to enhance their network management software offerings. While we believe that our product features give us a competitive advantage, we believe the gap is narrowing and thus are seeking to add capabilities to our products to maintain our competitive edge.

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., and Walker, Ritchie, Quinn, a privately-held company.

NCD NC900 family of products faces direct competition from PCs that run a local X server, such as from Hummingbird Communications, Ltd.

15

In general, competition in the thin client computing market has intensified over the past few years, resulting in price reductions, reduced profit margins and increased efforts to maintain market share, which have adversely affected our operating results. In addition, intense competition from alternative desktop computing products, particularly PCs, has slowed the growth of the thin client computing market. We expect this intense competition to continue. There can be no assurance that we will be able to continue to compete successfully against current and future competitors as the desktop computer market evolves and competition increases.

Fluctuations in Operating Results

Our 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 us and our 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. Our operating results may fluctuate in the future as a result of these and other factors, including our success in developing and introducing new products, our product and customer mix, licensing costs, the level of competition which we experience and our ability to develop and maintain strategic business alliances.

We operate 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. Our expense levels are based in part on our forecast of future revenues. If revenues are below expectations, our operating results may be adversely affected. We have experienced a disproportionate amount of shipments occurring in the last month of our fiscal quarters. This trend increases the risk of material quarter-to-quarter fluctuations in our revenues and operating results.

New Product Development and Timely Introduction of New and Enhanced Products

The markets for our products are characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and short product life cycles. Our future results will depend to a considerable extent on our ability to continuously develop, introduce and deliver in quantity new hardware and software products that offer our 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, we 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 us 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 we are continuously engaged in this product development and transition process, our operating results may be subject to considerable fluctuation, particularly when measured on a quarterly basis. The inability to finance important research and development projects, delays in the introduction of new and enhanced products, the failure of such products to gain market acceptance, or problems associated with new product transitions could adversely affect our operating results.

Reliance on Independent Distributors and Resellers

We rely significantly on independent distributors and resellers for the distribution of our products. However, there can be no assurance that our distributors and resellers will continue their current relationships with us or that they will not give higher priority to the sale of other products, which could include products of our competitors. A reduction in sales effort or discontinuance of sales of our products by our distributors and resellers could lead to reduced sales and could adversely affect our operating results. In addition, there can be no assurance as to the continued viability or the financial stability of our distributors and resellers, our ability to retain our existing distributors and resellers or our ability to add distributors and resellers in the future.

Reliance on Independent Contractors

We rely on independent contractors for virtually all of the manufacture of our thin client computing products and accessories. Our reliance on these independent contractors limits our control over delivery schedules, quality assurance and product costs. In addition, a number of our independent suppliers are located abroad. Our reliance on these foreign suppliers subjects us to risks such as the imposition of unfavorable governmental controls or other trade restrictions, changes in tariffs and political instability. We currently obtain all of our thin client computing products from a single supplier located in Thailand. Any

16

significant interruption in the supply of products from this contractor would have a material, adverse effect on our business and operating results. Disruptions in the provision of components by our other suppliers, or other events that would require us to seek alternate sources of supply, could also lead to supply constraints or delays in delivery of our products and adversely affect our operating results. However, the manufacturing process could be relocated to one of their other factories if necessary within a few weeks.

A number of components and parts used in our products, including certain semiconductor components, also are currently available from single or limited sources of supply. We have no long-term purchase agreements or other guaranteed supply arrangements with suppliers of these single or limited source components. We have generally been able to obtain adequate supplies of parts and components in a timely manner from existing sources under purchase orders and endeavor to maintain inventory levels adequate to guard against interruptions in supplies. However, our inability to obtain sufficient supplies of these parts and components from existing suppliers or to develop alternate supply sources would adversely affect our operating results.

International Sales

Beginning in 2001, all of our international sales have been denominated in U.S. dollars.  Prior to this date, substantially all of our international sales were denominated in Euros. These sales were subject to exchange rate fluctuations, which adversely affected our operating results. 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 our 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 our future international sales and, consequently, on our operating results.

Volatility of Stock Price

On March 20, 2001, our Common Stock was delisted from the Nasdaq National Market due to the failure to maintain a minimum bid price of $1.00 per share. Our Common Stock is now trading on the OTC Bulletin Board, which is considered to be less liquid and more volatile than the Nasdaq National Market.

The market price of our common stock has fluctuated significantly over the past several years and is subject to material fluctuations in the future in response to announcements concerning us or our competitors or customers, quarterly variations in operating results, announcements of technological innovations, the introduction of new products or changes in product pricing policies by us or our competitors, general conditions in the computer industry, developments in the financial markets and other factors. In particular, shortfalls in our 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. We 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 our common stock.

17

Item 3.  Quantitative and Qualitative Disclosure About Market Risk

We are exposed to interest rate risks for our bank and vendor borrowing arrangements. Because of the short-term maturities of these instruments, a 100 basis point change in related interest rates would not have a material effect on their fair value.

Effective January 2001 all of our international sales are denominated in U.S. dollars. We have minimal Euro denominated accounts receivable as of March 31, 2002 which are subject to exchange rate fluctuations when the customer pays in Euros. This will affect our operating results negatively or positively, depending on the value of the U.S. dollar against the Euro.

18

NETWORK COMPUTING DEVICES, INC.

PART II - OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K.

        (a)   The following is a list of exhibits filed as part of this Report on Form 10-Q.  Where indicated by footnote, exhibits that were previously filed are incorporated by reference.

Exhibit Number	Description
2.1†(1)	Asset Purchase Agreement, dated March 22, 2002, by and between Network Computing Devices, Inc. and Neoware Systems, Inc.
4.3	Amended Certificate of Designations, Preferences and rights of the Series B, Series B1, Series C, Series C1 and Series D Preferred Stock
10.72(1)	Limited Waiver and Amendment to Loan Documents, dated March 4, 2002, by and between Network Computing Devices, Inc. and Silicon Valley Bank.
10.731(1)	Asset Purchase Agreement, dated March 22, 2002, by and between Network Computing Devices, Inc. and Neoware Systems, Inc.  (Reference is made to Exhibit 2.1)
10.741(1)	OEM Supply Agreement, dated March 22, 2002, by and between Network Computing Devices, Inc. and Neoware Systems, Inc.
10.75(1)	Non-Competition and Confidentiality Agreement, dated March 22, 2002, by and between Network Computing Devices, Inc. and Neoware Systems, Inc.

_______________

†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 for the year ended December 31, 2001.

        (b)   The Company filed no reports on Form 8-K during the three-month period ended March 31, 2002.

19

NETWORK COMPUTING DEVICES, INC.

SIGNATURE

Pursuant to the requirements 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. (Registrant)
Date:  May 24, 2002
	By:	/s/  Rudolph G. Morin
		Rudolph G. Morin
		Chief Financial Officer and Secretary
		(Duly Authorized and Principal Financial and Accounting Officer)

20

EX-4.3

Exhibit 4.3

NETWORK COMPUTING DEVICES, INC.

AMENDED CERTIFICATE OF DESIGNATIONS, PREFERENCES AND RIGHTS OF THE TERMS OF THE SERIES B, SERIES B1, SERIES C, SERIES C1 AND SERIES D PREFERRED STOCK

(Pursuant to Section 242 of the General Corporation Law of the State of Delaware)

The undersigned Chief Financial Officer of Network Computing Devices, Inc., organized and existing under the General Corporation Law of the State of Delaware, in accordance with the provisions of Section 103 thereof, DOES HEREBY CERTIFY:

1.             That, on April 11, 2002, the Board of Directors of the Corporation adopted the following resolution creating a series of 290,000 shares designated as Series B1 Preferred Stock, a series of 530,000 shares designated as Series C1 Preferred Stock and a series of 266,129 shares designated as Series D Preferred Stock:

RESOLVED, that three new series of Preferred stock of the Corporation, designated Series B1 Preferred Stock, Series C1 Preferred Stock and Series D Preferred Stock, are hereby created, and that the designation and amount of the Series B Preferred Stock, Series B1 Preferred Stock, Series C Preferred Stock, Series C1 Preferred Stock and Series D Preferred Stock and the powers, preferences and relative, participating, optional and other special rights of the shares of such series, and the qualifications, limitations or restrictions thereof, are as follows:

Section 1:               DESIGNATION AND AMOUNT.

The shares of such series shall be designated as “Series B Preferred Stock” (“Series B Preferred Stock”), par value $.001 per share, “Series B1 Preferred Stock” (“Series B1 Preferred Stock”), par value $.001 per share, “Series C Preferred Stock” (“Series C Preferred Stock”), par value $.001 per share, “Series C1 Preferred Stock” (“Series C1 Preferred Stock”), par value $.001 per share, and “Series D Preferred Stock” (“Series D Preferred Stock”), par value $.001 per share.  The number of shares initially constituting the Series B Preferred Stock, Series B1 Preferred Stock, Series C Preferred Stock, Series C1 Preferred Stock and Series D Preferred Stock shall be 290,000 shares, 290,000 shares, 530,000 shares, 530,000 shares and 266,129 shares, respectively.  The Series B Preferred Stock, Series B1 Preferred Stock, Series C Preferred Stock, Series C1 Preferred Stock and Series D Preferred Stock are sometimes referred to together as the “Senior Preferred Stock.”

Section 2:               DIVIDENDS AND DISTRIBUTIONS.

(a)           Dividends. The holders of the Series B Preferred Stock (the “Series B Holders”), the holders of the Series B1 Preferred Stock (the “Series B1 Holders”), the holders of the Series C Preferred Stock (the “Series C Holders”), the holders of the Series C1 Preferred Stock (the “Series C1 Holders”) and the holders of the Series D Preferred Stock (the “Series D Holders” or, collectively with the Series B Holders, the Series B1 Holders, the Series C Holders and the Series C1 Holders, the “Senior Holders”) shall be entitled to receive when, as and if declared by the Board of Directors, out of any assets legally available therefor, dividends not less

than, and in preference and priority to any payment of, any dividend or distribution on the Common Stock or any other class or series of stock of the Corporation ranking junior to the Senior Preferred Stock and pro rata with payment of any dividend on any class or series of stock of the Corporation ranking on a parity with the Senior Preferred Stock as to dividends.  Such dividends on the Series B Preferred Stock, Series B1 Preferred Stock, Series C Preferred Stock, Series C1 Preferred Stock and Series D Preferred Stock shall accrue at the rate of $.41 per share, $.55 per share, $.23 per share, $.23 per share and $.50 per share, respectively, per annum from the date of issuance to the date of payment, based on the actual number of days elapsed, and shall be payable on the payment date fixed by the declaration or, if no payment date is fixed, shall accrue semi-annually on May 31^st and November 30^th of each year, and upon any Liquidation (as hereinafter defined). In the event dividends in less than the full preferential amount shall be paid to the holders of the Senior Preferred Stock, such dividends shall be distributed ratably among such holders in proportion to the full preferential amount that each such holder is otherwise entitled to receive under this Section 2(a).

(b)           Distributions. As used in this Section 2, the term “distribution” shall mean a transfer of cash, property or securities without consideration, whether by way of dividend or otherwise, or the purchase or redemption of shares of the Corporation.

(c)           Necessary Actions. The Corporation shall take any and all corporate action necessary to declare and pay the dividends required.

Section 3:               LIQUIDATION.

(a)           Liquidation Defined. “Liquidation” means any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Corporation, other than any dissolution, liquidation or winding up in connection with any reincorporation of the Corporation in another jurisdiction.  A Corporate Transaction (as hereinafter defined) shall be deemed to be a Liquidation.  As used herein, “Corporate Transaction” shall mean (i) any consolidation or merger of the Corporation with or into any other corporation or other entity or person, or any other corporate reorganization, in which the stockholders of the Corporation immediately prior to such consolidation, merger or reorganization own less than fifty percent (50%) of the Corporation’s voting power immediately after such consolidation, merger or reorganization, or (ii) a sale, lease, transfer or other disposition of all or substantially all of the assets of the Corporation.

(b)           Rights. Upon a Liquidation, as hereinabove defined, after payment or provision for payment of the debts and other liabilities of the Corporation, and prior to any distribution to the holders of Series A Participating Preferred Stock or Common Stock of the Corporation, the Senior Holders shall be entitled to receive, out of the remaining assets of the Corporation available for distribution to its stockholders, an amount equal to $7.00 per share plus accrued and unpaid dividends, if any, with respect to each share of Series B Preferred Stock or Series B1 Preferred Stock (the “Series B Liquidation Preference”), an amount equal to $3.80 per share plus accrued and unpaid dividends, if any, with respect to each share of Series C Preferred Stock or Series C1 Preferred Stock (the “Series C Liquidation Preference”) and an amount equal to $6.20 per share plus accrued and unpaid dividends, if any, with respect to each share of Series D Preferred Stock (the “Series D Liquidation Preference”).  Following the payment of the full amount of the Series B Liquidation Preference, the Series C Liquidation Preference and the

2

Series D Liquidation Preference and any preference that is payable to the holders of any other series of Preferred Stock, the holders of Senior Preferred Stock and Common Stock and, to the extent provided for in the Certificate of Incorporation of the Corporation, such other series of Preferred Stock, shall receive their ratable and proportionate share, on a per share and as-converted to Common Stock basis, of the remaining assets to be distributed with respect to such Senior Preferred Stock, such other series of Preferred Stock and Common Stock, respectively.  If upon any Liquidation the assets of the Corporation available for distribution to its stockholders shall be insufficient to pay to the Senior Holders and the holders of any other class of capital stock ranking on a parity with the Senior Preferred Stock (“Parity Holders”) the full Series B Liquidation Preference, Series C Liquidation Preference, Series D Liquidation Preference and liquidation preference payable to such Parity Holders (“Parity Preference”), respectively, the Senior Holders and Parity Holders shall share pro rata in any distribution of assets in accordance with such full Series B Liquidation Preference, Series C Liquidation Preference, Series D Liquidation Preference and Parity Preference amounts, respectively.

Section 4:               VOTING RIGHTS.

In addition to other rights provided herein or by law, the Senior Holders shall be entitled to vote on all matters submitted to the stockholders of the Corporation for vote or consent and, except when a single class vote is required, will vote with the holders of Common Stock as one class.  Each of the Senior Holders shall be entitled to one vote per share of Common Stock issuable upon conversion of the shares of Senior Preferred Stock then held by such holder.

Section 5:               CONVERSION.

(a)           Rate.  The Senior Preferred Stock shall be convertible, at the option of the holder thereof, at a rate of ten (10) shares of Common Stock for each share of Series B Preferred Stock, Series B1 Preferred Stock, Series C Preferred Stock, Series C1 Preferred Stock or Series D Preferred Stock, each subject to appropriate adjustment in the event of any stock split, stock dividend or reverse stock split affecting the Common Stock where the Series B Preferred Stock, Series B1 Preferred Stock, Series C Preferred Stock, Series C1 Preferred Stock or Series D Preferred Stock is not treated in an equivalent manner.

(b)           Limitations on Conversion Rights.  Notwithstanding the provisions of Section 5(a), the right of any holder of shares Series B1 Preferred Stock, Series C Preferred Stock or Series C1 Preferred Stock to convert such shares to Common Stock shall be subject to the following limitations:

(i)            the Series C Preferred Stock and the Series C1 Preferred Stock shall not be convertible unless and until the Certificate of Incorporation of the Corporation is amended to increase the number of authorized shares of Common Stock by not less than 5,300,000;

(ii)           the Series B1 Preferred Stock shall not be convertible (x) during any time when, if the Series B1 Preferred Stock were convertible, any holder of Series B1 Preferred Stock would be deemed to be an Acquiring Person, as such term is defined in the

3

Rights Agreement dated August 12, 1997 between the Corporation and ChaseMellon Shareholder Services, L.L.C., as the same may be amended from time to time, taking into account all equity securities beneficially owned by such holder, or (y) during any 60-day period following any disposition of securities of the Corporation by any person who, prior to such disposition, would have been deemed to be an Acquiring Person had the Series B1 Preferred Stock been convertible at such time; and

(iii)          the Series C1 Preferred Stock shall not be convertible (x) during any time when, if the Series C1 Preferred Stock were convertible, any holder of Series C1 Preferred Stock would be deemed to be an Acquiring Person, taking into account all equity securities beneficially owned by such holder, or (y) during any 60-day period following any disposition of securities of the Corporation by any person who, prior to such disposition, would have been deemed to be an Acquiring Person had the Series C1 Preferred Stock been convertible at such time.

During the time when the foregoing restrictions are in effect, the Series B1 Holders, the Series C Holders and the Series C1 Holders shall have the same rights upon a Liquidation under Section 3 and the same voting rights under Section 4 as they would have absent such restrictions.

(c)           Mechanics of Conversion.  Upon delivery to the Corporation of the certificate or certificates for the shares of Senior Preferred Stock to be converted, duly endorsed or assigned in blank to the Corporation (if required by it), the Corporation shall issue and deliver to or upon the written order of a Senior Holder, to the place designated by such holder, a certificate or certificates for the number of full shares of Common Stock to which such holder is entitled.

Section 6:               REDEMPTION.

The outstanding shares of a series of Senior Preferred Stock may not be redeemed by the Corporation without the consent of the holders of all of the then outstanding shares of such series.

Section 7:               NO REISSUANCE.

No shares of Senior Preferred Stock acquired by the Corporation by reason of exchange, conversion or otherwise shall be reissued and all such shares shall be canceled, retired and eliminated from the shares of Senior Preferred Stock which the Corporation shall be authorized to issue.

Section 8:               PROTECTIVE PROVISIONS.

(a)           Required Consents. In addition to any other vote or consent required herein or by law, the affirmative vote or written consent of the Series B Holders owning a majority of the outstanding Series B Preferred Stock, the Series B1 Holders owning a majority of the outstanding Series B1 Preferred Stock, the Series C Holders owning a majority of the outstanding Series C Preferred Stock, the Series C1 Holders owning a majority of the outstanding Series C1 Preferred Stock and the Series D Holders owning a majority of the outstanding Series D Preferred Stock, each voting as a separate class, shall be necessary for effecting or validating the following actions:

4

(i)            Any amendment, alteration, repeal, or waiver of any provision of the Certificate of Incorporation of the Corporation (including the filing of any Certificate of Designations), as in effect from time to time (the “Certificate of Incorporation”), or the Bylaws of the Corporation, that affects adversely the voting powers, preferences, priorities or other special rights or privileges, qualifications, limitations, or restrictions of such series of Preferred Stock;

(ii)           Any redemption or repurchase of capital stock of the Corporation (except for acquisitions of Common Stock by the Corporation under stock option or restricted stock agreements with employees approved by the Board of Directors);

(iii)          Any material disbursement of funds outside of the ordinary course of the Corporation’s business;

(iv)          Any consolidation or merger of the Corporation with or into any other Company or other entity or person, or the entering into any other corporate reorganization;

(v)           Any termination of the Corporation’s line of business as of the date of the first issuance of Series B Preferred Stock or substitution of an unrelated line of business as its principal focus of the Corporation’s activities;

(vi)          Any voluntary dissolution, liquidation winding-up or partial liquidation of the Corporation, or any distribution or transaction in the nature of a partial liquidation or distribution, or any sale or other transfer of all or substantially all of the assets of the Corporation (including shares, or all or substantially all of the assets, of any subsidiary of the Corporation); or

(vii)         Any increase or decrease in the authorized number of shares of any series or class of the Corporation’s capital stock.

(b)           Financial Reports. The Corporation will furnish to the Senior Holders, as soon as practicable, and in any case within 75 days after the end of each fiscal quarter, unaudited quarterly financial statements, and within 90 days after the end of each fiscal year, annual audited financial statements (all prepared in accordance with generally accepted accounting principles consistently applied).

5

Section 9:               NO IMPAIRMENT.

The Corporation will not, by amendment of its Certificate of Incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of the Senior Preferred Stock set forth herein, and will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the Senior Holders against impairment. Without limiting the generality of the foregoing, the Corporation will take all such action as may be necessary or appropriate in order that the Corporation may reserve for issuance, and validly and legally issue fully paid and non-assessable Company shares on the conversion of all Senior Preferred Stock from time to time outstanding.

Section 10:             NOTICES.

All notices, requests and other communications shall be in writing addressed to the Corporation at its principal office or to the Senior Holders at their addresses appearing on the stock ownership records of the Corporation and delivered by a nationally recognized overnight mail carrier, certified  mail return receipt requested or facsimile.  Any notice sent by nationally-recognized overnight mail carrier shall be deemed to be delivered on the expected date of delivery.  Any notice sent by certified mail, return receipt requested, shall be deemed to be delivered 3 days after mailing.  Any notice sent by facsimile shall be deemed delivered upon the receipt by sender of written confirmation of transmission.

2.             That the foregoing amendment has been duly adopted in accordance with Section 242 of the General Corporation Law of the State of Delaware.

[Remainder of page intentionally left blank.]

6

IN WITNESS WHEREOF, I have executed and subscribed this Certificate and do affirm the foregoing as true under the penalties of perjury this 1st day of May, 2002.

/s/ Rudolph G. Morin

Rudolph G. Morin, Chief Financial Officer

7