-----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, DxxfN98meCCRofyJQb3SqvgghC4zkc7g3gZq9C9bNahBxTwGYxXysj5QNc9bAwve kTmOeVQL+6t2F1IFIFsbcA== 0001047469-98-012943.txt : 19980401 0001047469-98-012943.hdr.sgml : 19980401 ACCESSION NUMBER: 0001047469-98-012943 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ENCAD INC CENTRAL INDEX KEY: 0000913599 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 953672088 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-23034 FILM NUMBER: 98582247 BUSINESS ADDRESS: STREET 1: 6059 CORNERSTONE COURT W CITY: SAN DIEGO STATE: CA ZIP: 92121 BUSINESS PHONE: 6196775179 MAIL ADDRESS: STREET 1: 6059 CORNERSTONE COURT WEST CITY: SANSAN DIEGO STATE: CA ZIP: 92122 10-K 1 10-K - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (MARK ONE) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE - --- ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1997 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES - --- EXCHANGE ACT OF 1934 (NO FEE REQUIRED) FOR THE TRANSITION PERIOD FROM __________________ TO __________________ COMMISSION FILE NUMBER 0-23034 ENCAD, INC. (Exact name of registrant as specified in its charter) DELAWARE 95-3672088 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 6059 CORNERSTONE COURT WEST 92121 SAN DIEGO, CA (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code: (619) 452-0882 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.001 PAR VALUE PREFERRED STOCK PURCHASE RIGHTS (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 the 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. _____ Aggregate market value of the voting stock held by non-affiliates of the registrant, computed using the closing price as reported by Nasdaq for the Company's Common Stock on February 27, 1998: $189,952,175.* Indicate the number of shares outstanding of the registrant's Common Stock as of the latest practicable date: Outstanding at Class February 27, 1998 ----- ----------------- Common Stock, $.001 par value 11,539,400 DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's Definitive Proxy Statement (the "Proxy Statement") to be filed with the Commission pursuant to Regulation 14A in connection with the 1998 Annual Meeting are incorporated herein by reference into Part III of this Report. Certain Exhibits filed with the Registrant's prior registration statements are incorporated herein by reference into Part IV of this Report . - --------------- * Excludes 3,786,250 shares of Common Stock held by executive officers, directors and stockholders whose ownership exceeds 5% of the Common Stock outstanding at February 27, 1998. Exclusion of such shares should not be construed to indicate that any such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant or that such person is controlled by or under common control with the Registrant. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I ITEM 1: BUSINESS THE DISCUSSION OF THE COMPANY'S BUSINESS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K MAY CONTAIN CERTAIN PROJECTIONS, ESTIMATES AND OTHER FORWARD-LOOKING STATEMENTS THAT INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED BELOW AT "RISKS AND UNCERTAINTIES." WHILE THIS OUTLOOK REPRESENTS MANAGEMENT'S CURRENT JUDGMENT ON THE FUTURE DIRECTION OF THE BUSINESS, SUCH RISKS AND UNCERTAINTIES COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM ANY FUTURE PERFORMANCE SUGGESTED BELOW. THE COMPANY UNDERTAKES NO OBLIGATION TO RELEASE PUBLICLY THE RESULTS OF ANY REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES ARISING AFTER THE DATE HEREOF. GENERAL ENCAD, Inc. ("ENCAD" or the "Company") designs, develops, manufactures and markets wide-format (up to 60"), color inkjet printer systems designed to increase productivity in computer applications requiring quality printed output. ENCAD's primary products, currently, are the NovaJet-Registered Trademark-, CADJET-Registered Trademark- , NovaCut-TM-, Croma24-TM-, and NovaJet PROe-TM- product lines(1). Typical uses for these printers and their related accessories and supplies are in graphic arts ("GA"), such as digital photo imaging, sign- making, three-dimensional renderings and presentation graphics; in computer- aided design ("CAD"), used by architects, engineers and construction designers; and in geographic information systems ("GIS"), such as surveying and mapping. To support its wide-format inkjet printers, ENCAD offers a variety of accessories and supplies, including specialty ink and media. The market for wide-format, color inkjet printers, supplies and accessories is relatively new and is still developing as a result of technological advancements in performance and quality and continuing improvements in price/performance ratios. ENCAD believes these advancements will make quality wide-format inkjet output more affordable, allowing its products to be more widely used in ENCAD's existing markets, as well as addressing potential new market applications, such as textiles, photography, fine art, and medical imaging. RECENT DEVELOPMENTS On March 16, 1998, the Company announced that lower than anticipated product sales, coupled with accelerated competitor-driven pressure on gross profits for its flagship products, could generate operating results ranging from break even to a loss for the first quarter of 1998 on sales significantly lower than the same quarter last year. Lower product sales for the first quarter of 1998 are expected to result from continued sales weakness in Asia and a severe slowdown in purchase decisions due to customer expectations of several new product announcements in the industry in March. First quarter 1998 net income is anticipated to be reduced due to lower sales and profits as the Company responds to attempts by competitors to capture market share. Due to the anticipated results for the first quarter, the likelihood of continued sales weakness in Asia, lower gross profit in its core business over the course of 1998, and increased marketing and selling expenses required to respond to competitive pressures, ENCAD also expects that net income for the year will fall well below comparable 1997 results, and that sales for full-year 1998 could be only slightly higher or equal to 1997 sales. MARKET The market for wide-format, color inkjet printers emerged in the early 1990s as a result of the rapid growth in the use of high-powered personal computers by a wide variety of technical professionals. More recently, GA professionals have begun to take advantage of the performance and cost features associated with wide-format inkjet printers as a result of expanded use of sophisticated graphics interface software programs. The market for wide-format, color inkjet printers, accessories, and supplies, such as inks, ink cartridges and print media, currently consists of three primary segments: GA, CAD and GIS. The Company believes that the textile and photography segments will be the next emerging market segments. Users in the GA segment include graphic artists, print shops, photo-labs, sign shops and service bureaus. Applications in the GA segment include back-lit and other signs, point-of-sale advertising, posters, pre-press proofing - --------------- (1) NovaJet and CADJET are registered trademarks of ENCAD. 2 (proofs or other quick output to demonstrate concepts for advertising or graphics layouts), and digital photo imaging. The Company is a leader in the GA segment. The Company's product lines are particularly well-suited to the GA segment since they are capable of producing a full range of outputs, from single line monochrome to full color, photorealistic images. GA users require output in three distinct segments of the GA and design process, all of which require performance balanced by low-cost, quickly-produced output. In the pre- press segment, GA users require proofs or other quick output to demonstrate concepts for advertising or graphics layouts. Pre-press output involves any output where form, shape or color is emphasized. In the quick print segment, GA users include print shops, service bureaus and corporate GA departments that produce signs or posters. Quick print output includes backlit and wall-mount signs and point-of-sale displays. In the digital photo segment, GA users include photo labs, service bureaus and corporate GA departments that produce high resolution digitized photographs. Digitized photo output is used when photographic images are manipulated, including architectural images and text overlay. The CAD segment includes architectural, engineering and construction design users. This is a diverse group that utilizes technical graphics applications to automate the design process and includes architects, mechanical engineers, electrical engineers and users involved in many aspects of building design and construction. Historically, output for the CAD segment consisted mostly of two- dimensional monochrome line drawings. With the introduction of wide-format inkjet printers, CAD users are now able to create full color and three- dimensional output. CAD and other design users often require spot color and speed in their output and look for productivity enhancement in producing the output. The Company's CADJET product line offers a CAD user spot color in addition to excellent line quality and the NovaJet product line offers a full range of color outputs. GIS users are a more specialized group that utilizes technical graphics applications similar to those used in the CAD segment, primarily for mapping. GIS users include civil engineers, mining engineers and geologists working for government agencies, utilities and natural resource companies. GIS involves a distinct use of CAD databases to manage, analyze and present data in a three- dimensional "mapping" format. Generally, GIS users require more color than CAD users since GIS involves the use of color fills and varied fonts for richer presentations. This segment, although smaller than the CAD and GA segments, represents opportunities for the Company's product lines since GIS applications require, in some instances, both three-dimensional renderings and color fills to differentiate acreage, objects and topographical features. PRINTING TECHNOLOGIES There are a number of printing technologies, including thermal inkjet, pen, electrostatic, light emitting diode ("LED") and thermal, that allow users to produce wide-format output. Each of these technologies has specific qualities that can be critical to any given application, including resolution, speed, accuracy, color fill capability, the ability to render a three-dimensional image, reliability and cost. A combination of characteristics has made thermal inkjet the fastest growing technology in the wide-format printer market. The characteristics of wide-format inkjet printers include relatively low cost, high speed and the ability to print high-quality color. Inkjet printers form images, lines and other characters by placing very small dots of ink as the print head moves horizontally, called a raster scan, while the media is scrolled vertically. Because inkjet print heads move above the paper and never actually make contact with the paper, there is less mechanical wear and tear than experienced by a pen plotter. Inkjet printers can print on almost any media. Pen plotters draw lines and make symbols and other characters by moving a pen on the surface of the media. This creates high quality output for working drawings, reports, presentations or archival copies. Pen plotters offer the advantages of low-cost color output and different levels of line quality using liquid ink, fiber tip or ball-point pens. Although cost effective, pen plotters are relatively slow and are generally limited to eight colors. Electrostatic printers generally are more expensive than inkjet or pen plotters and require special plotting paper. They offer certain advantages to users requiring enhanced color, color fills and high-speed characteristics. Thermal printer/plotters are similar to electrostatic printers and generally require special paper to take advantage of the thermal print head. Thermal printers cost considerably more than inkjet printers. LED printers are the most expensive "plain paper" technology, producing monochrome output at high speed, but the cost is much higher than inkjet. 3 Other technologies that can be adapted to wide-format use include photographic output, electrophotographic output and dot matrix printers. Each of these other technologies has disadvantages for the CAD, GIS and GA markets, including relatively poor resolution or high costs when compared to inkjet technology. ENCAD PRODUCTS ENCAD has designed a variety of wide-format hard copy peripherals, including color inkjet printers and pen plotters. The Company currently sells the second generation of the CADJET product line, the first of which was introduced in November 1994, and the fourth and fifth generation of the NovaJet product line, including the NovaJet family, first introduced in October 1991, NovaCut, NovaJet PROe Series and the Croma24. All of ENCAD's products support at least one, and typically several, emulation graphics languages and interfaces, including the industry standard, HP-GL-Registered Trademark-, HP- GL/2-Registered Trademark-, and HP-RTL-Registered Trademark-, to provide compatibility and utility for the end user.(1) In addition, ENCAD products allow users to print in a variety of sizes from standard small-format to wide- format. ENCAD's automatic media sensing feature also permits the accommodation of some special sizes. ENCAD products have an easy-to-operate keyboard and display, with layered menus to set printer parameters and stored pre-set configurations. CADJET 2 CADJET 2, first shipped in October 1995, is targeted at sophisticated low- end pen plotter and thermal printer users, primarily in the CAD and GIS markets. CADJET 2, which can produce drawings ranging in size from A (8-1/2" by 11") to E (36" by 48"), offers performance benefits over existing pen plotter technology and costs less than comparable thermal printers. The CADJET 2 has two inkjet print heads. A black cartridge produces fast monochrome drawings and 600 dpi can be used to produce higher quality images. A tri-chamber cyan-magenta-yellow cartridge can be used to produce color lines and/or spot color fills. Output can be generated on roll or cut-sheet media. NOVAJET FAMILY NovaJet 4 is targeted at sophisticated mid-range and high-end pen and thermal printer users, as well as electrostatic printer users. The NovaJet 4 was first shipped in February 1996. NovaJet 4, which can produce drawings ranging in size from A (8-1/2" by 11") to E (36" by 48"), offers performance benefits over existing pen plotter technology, costs less than comparable thermal and electrostatic printers and is up to 25 times faster than existing pen plotters. NovaJet 4 uses four ENCAD customized inkjet heads and snap-in refillable cartridges, one filled with black ink and the remaining three filled with color inks, and is capable of printing in either monochrome or color. It offers 256 color selections. NovaJet 4 uses standard paper, vellums and transparencies, as well as specialized inkjet media and can generate output on roll or cut-sheet media with vector or raster input options. The NovaJet PRO series, which includes the NovaJet Pro (36" width) and the NovaJet Pro 50 (50" width), is targeted at sophisticated mid-range and high-end printer users, as well as electrostatic printer users in the GA market. NovaJet PRO was first shipped in November 1995 and the NovaJet PRO 50 was first shipped in March 1996. The NovaJet PRO Series has been designed specifically for the professional graphic artist, and other short run production oriented professional users. The NovaJet PRO series was the first wide-format color inkjet printer to include a manufacturer designed and integrated continuous flow ink supply. The NovaJet PRO series products use four inkjet print heads, one for black ink and the remaining three for colored inks, and are capable of printing in either monochrome or color. They offer a full gamut of color, up to 16 million colors, and use standard paper, vellums and transparencies, as well as specialized inkjet media. NOVACUT The NovaCut family of printer/cutters was first shipped in February 1997. The NovaCut, available in both 24" width and 54" width models, functions as both a printer and a cutter, and thus costs less than a separate printer and cutter. The NovaCut features a friction-feed media moving technology that provides precision delivery of media and a "swivel" style cutting knife which assures high-precision cutting, combined with NovaJet color printing accurate enough for paneling. The NovaCut also features ENCAD's 500 ml continuous flow ink system that allows for - --------------- (1) HP-GL, HP-GL/2, and HP-RTL are registered trademarks of Hewlett-Packard Company ("Hewlett-Packard"). 4 unattended operation and offers NovaJet Pro color capability. The NovaCut is targeted to users in the graphics and signage markets. NOVAJET PROe SERIES The NovaJet PROe Series, first shipped in May 1997, is available in both 42" width and 60" width models. These models are ENCAD's most full-featured inkjet printers on the market and feature a 500 ml continuous flow ink system with dual plumbing for two ink sets, automatic feed/take-up system, and a built- in dryer. They also include an imaging management architecture designed to provide the user with higher quality imaging, improved ease of use, and increased productivity. The NovaJet PROe Series is designed specifically for users that require a faster, more productive, and even wider media solution to their growing print-for-pay needs. It is targeted to high-volume producers of large photorealistic prints, murals, point-of-sale displays and imposition proofs for direct-to-plate applications. CROMA24 The Croma24, first shipped in June 1997, is the industry's first cost- effective, color inkjet printer which produces 24" photo-realistic images. Expanding traditional 11" x 17" print widths by more than doubling the size, the ENCAD Croma24 surpasses the width limitations of current desktop printers and provides new alternatives for the creative professional or first-time wide- format user. It is targeted to CAD users, creative professionals, small service bureaus, photographers, sign shops, and small office/home office users. Offered at prices believed to be affordable to these users, the Croma24 has MAC, PC, and PostScript interfaces and advanced software drivers to enable the user to control color calibration, ink counting, paper selection, automatic cutting and dry time functions from the desktop. As with ENCAD's other printer models, a full range of scientifically matched supplies is available. ENCAD QUALITY IMAGING SUPPLIES-TM- ENCAD's line of supplies for its family of wide-format printers, launched in 1995, provides a comprehensive output system for ENCAD printer owners. Because they are designed to ensure the highest quality output possible from ENCAD printers, these supplies are branded ENCAD Quality Imaging Supplies (QIS). Sales of supplies accounted for 22%, 14% and 7% of net sales in 1997, 1996 and 1995, respectively. The ENCAD QIS product line consists of both outdoor and indoor solutions. The outdoor line of products includes fade-resistant pigmented inks and a broad line of water-resistant and durable banner and sign materials. Because outdoor solutions are new to the inkjet printing market, ENCAD provides a guarantee for most of its outdoor products. The outdoor line of products allows ENCAD to better compete in the sign-making market and also provides new applications for traditional ENCAD printer owners. The indoor line of products includes specially-formulated dye-based inks optimized for ENCAD printers and ENCAD's custom ink cartridges. In order to fulfill the broad needs of the GA marketplace, ENCAD provides two ink options - Graphic Arts Ink, for colors beyond the traditional color palette, and Graphic Standard Ink, for colors that mirror press-quality output. While the former tends to be used for posters and photo-realistic images, the latter is more appropriate for color proofing. ENCAD's broad range of QIS Media feature a proprietary inkjet coating that is optimized for use with QIS Inks. The coatings control ink absorption for images that are vibrantly colorful and high in print quality. The media line consists of 16 media options, from photo-based papers to adhesive-backed vinyl, two types of canvas and three types of film. All QIS Media are made with a recyclable, water-based coating. ACCESSORIES In support of its goal of providing a comprehensive output system and to ensure compatibility to its wide-format customers, ENCAD has developed and sells a wide variety of software and hardware accessories. Sales of accessories accounted for 3% of net sales in 1997 and 2% in 1996. The ENCAD print utility and Windows drivers provide the user with the power to control color output by providing five screening options, seven print quality modes, user-selectable color device tables, gamma correction and 5 the ability to set ink drying times. The ENCAD FastPort 3400X Micro Print Server allows a printer or plotter to be available to users of multiple network protocols simultaneously. In order to minimize the need for costly on-board printer memory and increase print speed, ENCAD provides software to run on the host computer which converts the vector output (HP-GL, HP-GL/2) of third party application programs into raster data. THIRD PARTY INTERFACES Third-party PostScript-Registered Trademark- hardware and software developers have created products that interface with the NovaJet products. These products allow NovaJet to output color near photo-realistic images in its enhanced mode. In addition, numerous software packages, such as AutoCAD- Registered Trademark-, Adobe Photoshop-Registered Trademark-, VersaCAD- Registered Trademark-, Adobe Print Shop-Registered Trademark-, Adobe Illustrator-Registered Trademark-, Quark XPress-Registered Trademark- and ARC/INFO-Registered Trademark-, are used with ENCAD products in Macintosh- Registered Trademark-, DOS-Registered Trademark- and Windows-Registered Trademark- platforms.(1) RECENT DEVELOPMENTS NOVAJET PRO 600e SERIES - The NovaJet PRO 600e Series, introduced in March 1998 and scheduled to ship during the second quarter of 1998, is available in both 42" and 60" models. These models include ENCAD's imaging management architecture, a 500 ml continuous flow ink system with dual plumbing for two ink sets, automatic feed/take-up system, built-in dryer, and the ability to switch between 300 dots per inch ("dpi") and 600 dpi resolution. The NovaJet PRO 600e Series are ENCAD's fastest printers, and are designed specifically for users who specialize in photo enlargements, signmaking and reproduction enlargements, and need the higher 600 dpi print resolution and overall productivity this Series provides. DIGITAL TEXTILE SYSTEM-TM- - The Digital Textile System, consisting of the 1500 TX-TM- Printer, TXPrint-TM- color-management and image-processing software, TX Inks and specially-coated ENCAD Textiles, was introduced in March 1998 and scheduled to ship during the second quarter of 1998. The system is targeted to users in the textile market. The digital textile printing market is growing at a rapid rate, as digital imaging technology offers customers compelling alternatives to traditional textile design and production methods. Initially, ENCAD plans to target the sampling, personalization, and small production run segment of the market. The 1500 TX Printer is 60" wide and is equipped with an integrated roll fabric feeder to guide the fabric through the printing mechanism, and a take-up device for collecting finished fabric samples. The printer also includes a 500 ml continuous flow ink system. The software, which includes color profiles for ENCAD Textiles, providing for easy color matching and switching between fabrics, is formatted for both PC and Macintosh and accurately matches ink and fabric for color quality and accuracy in printed fabric samples. The TX Inks are scientifically formulated to penetrate ENCAD Textiles' proprietary, patent- pending inkjet coating to dry quickly and produce vibrant, accurate, and repeatable colors. The ENCAD Textiles, specifically designed for use with the other components of the system, do not require pre- or post-treatment, are available in widths up to 60", are residue-free, and are paper-backed for easy transport through the printer. The Digital Textile System was designed specifically for textile designers who require a faster, more productive and more secure solution to their design and sampling needs. RESEARCH, PRODUCT DEVELOPMENT AND ENGINEERING ENCAD's ability to compete successfully in its target markets depends on, among other things, anticipating and reacting to market demands and developing appropriate products to satisfy customer requirements. ENCAD believes that the timely development and introduction of new products is essential. In its development of new products and enhancement of existing products, ENCAD focuses on simplicity of design, technological advancements in performance and image quality and continuing improvements in price/performance ratios. ENCAD is presently developing new products that incorporate its experience and expertise with the latest inkjet technologies. In addition, ENCAD markets hardware and software accessories that convert industry standard PostScript data to a raster data format which can then be directly printed at high speed without the need for the addition of costly memory to the printer. - --------------- (1) Windows is a registered trademark of the Microsoft Corporation. Macintosh is a registered trademark of Apple Computer, Inc. Illustrator, Print Shop, PostScript and Photoshop are registered trademarks of Adobe Systems, Inc. AutoCAD and VersaCAD are registered trademarks of AutoDesk. Other product names are trademarks or registered trademarks of their manufacturers. 6 In developing new products, ENCAD has assembled design teams consisting of engineers with expertise in hardware, firmware, software, chemistry, physics, color science, material science, fluid mechanics, electricity, mechanics, manufacturing and 3-D CAD design. The Company's design engineers have expertise and experience in digital servo/motion control, inkjet technology and emulation of HP-GL, HP-GL/2 and HP-RTL languages and interfaces. As part of its research and development efforts, ENCAD complements its existing resources by utilizing industry consultants and technology suppliers to assist in and influence design and cost decisions, ensure continued compatibility with software and hardware leaders, and advise the Company of the latest technological advances. ENCAD has also designed custom gate arrays to control aspects of its proprietary technology which permits a reduction in parts and an increase in reliability at lower cost than is achievable using standard components. Since its founding in 1981, ENCAD has introduced numerous product families, each of which incorporated advances in mechanical, electronic and software or firmware technologies. Within product families, model differences are based upon the size of the plotting area, as well as feature and performance characteristics. ENCAD intends to develop products that reach markets or market segments currently not served by the Company's products. Research and development expenses were $10,544,000, $8,794,000, and $5,578,000 in 1997, 1996, and 1995, respectively, which represent approximately 7%, 8%, and 9% of net sales in those respective periods. MANUFACTURING AND SUPPLIERS ENCAD's printer manufacturing operations consist of subassembly, final assembly and testing, quality assurance, packaging and shipping. ENCAD contracts with various outside vendors for printed circuit board fabrication and assembly, and for fabrication of metal and plastic parts, and then performs the final assembly of its printer products in its San Diego facility. Most materials for printer manufacturing operations are available locally in Southern California from multiple vendors, and the majority are produced in the United States. For its supplies business, ENCAD partners with large multi-national companies for the acquisition of inks and media. Inks are acquired from three sources and the various forms of media from multiple sources. Assembly of refill and accessory ink kits are outsourced prior to distribution. Certain components used in ENCAD's products are available only from single sources. Although ENCAD primarily buys components under purchase orders and does not have long-term agreements with most of its suppliers, it anticipates that its suppliers will be able to continue to satisfy its requirements. Although alternative suppliers are readily available for most of these components, for some components the process of qualifying replacement suppliers, replacing existing tooling, or ordering and receiving replacement components could take up to six additional months. Any difficulty in receiving components on time could have a material adverse effect on ENCAD's financial condition and results of operations. Any significant increase in component prices or decrease in component availability could also have a material adverse effect on ENCAD's financial condition and results of operations. Certain key components of ENCAD's products are supplied indirectly by its principal competitor, Hewlett-Packard Company ("Hewlett-Packard"), and the inkjet cartridge, used in some of the Company's older generation products, are purchased from Hewlett-Packard resellers. The Company believes that Hewlett-Packard supplies these components to many other companies. Because ENCAD places strong emphasis on product quality and customer satisfaction, it requires that quality is designed into products, components and the manufacturing processes. As a result, ENCAD has developed quality control programs with its suppliers in its product development and manufacturing operations. Suppliers are encouraged to participate in new product designs. Suppliers' manufacturing capabilities are statistically evaluated to allow for certification and direct shipment to the production floor. ENCAD uses a "Just- in-Time" program for delivery of some raw materials and subassemblies to manufacturing to minimize these types of inventories. The Company uses a material requirements planning system that is intended to aid in making "Just- in-Time" decisions. The Company maintains raw materials which include printer parts for manufacturing and service, ink and media. 7 MARKETING, SALES AND DISTRIBUTION ENCAD markets and sells its products worldwide primarily through specialty distributors, value-added resellers ("VARs"), dealers and Original Equipment Manufacturers ("OEMs"). DISTRIBUTORS, VARS AND DEALERS Neither the Company nor its three domestic distributors sell a material amount of products directly to end users, reflecting ENCAD's philosophy that its approximately 500 domestic dealers are a critical channel to deliver product to the end user. In addition to the Company's sales and marketing headquarters located in San Diego, California, ENCAD has field salespersons residing in Georgia, Texas, Michigan and California. These salespersons work closely with ENCAD's regional distributors and dealers. Internationally, ENCAD generally utilizes one major distributor in each market. ENCAD's approximately 90 international distributors sell to dealers, specialized systems integrators and VARs. ENCAD's international distributor network provides the Company with a presence in Canada, Mexico, Europe, the Pacific Rim, the Middle East, Central and South America, South Africa, China and India. ENCAD maintains Pacific Rim sales offices in Hong Kong, China and Australia, and has sales subsidiaries located in France, Germany and England. ENCAD's dependence on international sales subjects it to the risks associated with conducting business internationally, including currency fluctuations, to the extent they affect local office expenses and product pricing in local markets, general international market conditions, export and import controls, and other governmental regulations. Revenues, operating profits and identifiable assets of the Company's foreign operations are not material. Export sales accounted for the percentages of net sales as follows:
1997 1996 1995 ---- ---- ---- Europe, Middle East, Africa 32% 30% 30% Americas, excluding U.S. 8% 6% 6% Asia Pacific 19% 22% 27% --- --- --- Total 59% 58% 63%
ENCAD's agreements with its worldwide distributors generally grant each distributor the non-exclusive right to distribute the Company's products in its market. The Company's form of distribution agreement generally provides for payment net 30 days after shipment, by irrevocable letter of credit or by prepayment by wire transfer for international distributors and in the case of domestic distributors, net 30 days upon credit approval. Any outstanding amounts remain owing subsequent to termination of the agreements. The Company provides price protection to some of its distributors such that, if the Company reduces the price of its products, a distributor is entitled to a credit for the difference between the reduced price and the price it previously paid for products purchased within the preceding 30 days or, in some cases, 60 days, and which remain in inventory at the time of the price reduction. As a result, price reductions could have a material adverse effect on results of operations, depending on distributor inventory levels at the time of such price reductions. ENCAD supports the marketing and sales efforts of its worldwide distributors and dealers through participation at worldwide computer industry trade shows as well as specialized trade shows targeted at specific applications for the Company's products. The Company believes that it maintains good relationships with its worldwide distributors and dealers. Domestically, ENCAD has developed an authorized dealer network through an active dealer-support campaign consisting of advertising, lead referrals, product literature, promotional pricing, training and telephone support. Internationally, ENCAD assists its distributors in the larger markets through active advertising and trade show participation. ENCAD offers its worldwide distributors a cooperative advertising program that partially reimburses them for expenses spent in advertising and promoting ENCAD's products. Such reimbursements are determined based upon the distributor's sales levels. In 1997 and in 1995, no one customer accounted for more than 10% of net sales, and in 1996, one customer accounted for 15% of net sales. 8 ORIGINAL EQUIPMENT MANUFACTURERS To expand its distribution channels, the Company has entered into several OEM and private label arrangements that allow it to better address specific market segments or geographical areas. Sales from combined OEM and private label arrangements accounted for 26%, 25% and 19% of net sales in 1997, 1996 and 1995, respectively. The Company annually assesses the success of the individual arrangements and believes that, in the aggregate, they will continue to represent a substantial portion of its revenue. There can be no assurance that the Company will retain these existing arrangements or obtain additional ones. If the Company is not able to acquire additional OEM or private label customers, the loss of existing OEM and private label customers could adversely affect the Company's results of operations. CUSTOMER SUPPORT ENCAD considers ongoing support of its products to be an essential element of its business. The Company has established a customer service and support organization which provides technical support and printer repair to distributors, dealers and end-users of its printers and supplies. Customers have telephone access to technical specialists who respond to printer, software, supplies and applications questions. In addition, the Company has established an electronic bulletin board or Internet access on which the Company posts notes and software updates to provide on-line support and solutions for its customers. The Company provides a standard one-year warranty against defects in materials and workmanship in its products. The Company also offers third party, on-site warranty for certain products in the United States and certain European countries. An extended warranty for most products sold in the U.S. is also available at additional cost. The Company's OEM suppliers do their own warranty service. Any product sold domestically that needs to be repaired may be returned directly to the Company for repair. International distributors repair the Company's products with ENCAD supplying the parts to them directly. Since a large number of ENCAD's products are the sole color inkjet printers in a facility, the Company offers a head swap-out program for domestic purchases during the warranty period. For certain products, during the warranty period, the domestic end user can return the head to the Company for service and in exchange, the Company will provide a replacement head within 24 to 48 hours. Warranty expense has constituted less than 5% of net sales on an annual basis, and, to date, has not had a material adverse effect on the Company's operations. COMPETITION In addition to the direct competition from products using inkjet technology, ENCAD's products face competition from other technologies in the wide-format printer market, namely pen plotters, electrostatic printers, LED printers and thermal printers, which are offered by several companies. The competition to sell ink, media and software products to the customer is also intense. While the Company believes that it competes successfully against these other technologies and products, these alternative technologies and products may compete favorably for certain applications in which speed or cost are of key importance. There can be no assurance that the Company will be able to compete successfully in the future or that the competitive pressures previously described will not have a material adverse effect on the Company's business, profitability, financial condition and results of operations. The Company competes in the wide-format market mainly on the basis of performance and price. Price competition increased during 1997 and the Company expects that competition will accelerate in the future. Historically, the Company has reduced prices on older generation products upon introduction of the newer generation models. The Company's most recent price reduction took effect in March 1998. There can be no assurance that additional price reductions will not be required in the future. Price reductions will affect gross margins, and may adversely affect the Company's financial condition and results of operations. PROPRIETARY RIGHTS AND LICENSES ENCAD relies on a combination of trade secret, copyright, trademark and patent protection, as well as confidentiality and non-disclosure agreements, in order to protect its proprietary rights. The Company has pursued, and intends to continue to pursue patent protection for inventions it considers important. The Company believes its success will also continue to be dependent upon its reputation for unique technology, product innovation, affordability, marketing ability and responsiveness to customers' needs. The Company currently holds 13 patents related to inkjet technology and design. In 1997, ENCAD filed nine patent applications covering the Company's imaging technology. There can be no assurance that the Company will be successful in protecting its proprietary technology, or that 9 ENCAD's proprietary rights will preclude competitors from developing products or technology equivalent or superior to that of the Company. From time to time, certain competitors, including Hewlett-Packard, have asserted patent rights relevant to the Company's business. The Company expects that this will continue. The Company carefully evaluates each assertion relating to its products. If the Company is not successful in establishing that asserted rights have not been violated, the Company could be prohibited from marketing the products that incorporate such technology. The Company could also incur substantial costs to redesign its products or to defend any legal action taken against the Company. If the Company's products should be found to infringe upon the intellectual property rights of others, the Company could be enjoined from further infringement and be liable for any damages. The Company relies on a combination of trade secret, copyright, trademark and patent protection and non-disclosure agreements to protect its proprietary rights. There can be no assurance, however, that the measures adopted by the Company for the protection of its intellectual property will be adequate to protect its interests, or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technologies. EMPLOYEES As of February 28, 1998, the Company employed approximately 420 persons, including 102 in sales, marketing and related activities, 127 in manufacturing and operations, 80 in research, product development and engineering, 50 in technical support and service, and 61 in management, administration and finance. The Company's success is highly dependent on its ability to attract and retain qualified employees. Competition for employees is intense in its industry. None of the Company's employees is represented by a labor union or is the subject of a collective bargaining agreement. The Company has never experienced a work stoppage and believes that its employee relations are good. RISKS AND UNCERTAINTIES POTENTIAL FLUCTUATION IN QUARTERLY PERFORMANCE The Company's quarterly operating results can fluctuate significantly depending on factors such as the timing of product announcements and subsequent introductions of products by the Company and its competitors, availability and cost of components, timing of shipments of the Company's products, mix of product families shipped, market acceptance of new products, seasonality, currency fluctuations, changes in prices by the Company and its competitors, and price protection for selling price reductions offered to distributors and OEMs. In addition, the timing of expenditures for staffing and related support costs, advertising, trade show attendance, promotion, research and development expenditures, and, of course, changes in general economic conditions can impact quarterly performance. Any one of these factors could have a material adverse effect on the Company's results of operations. The Company may experience significant quarterly fluctuations in total revenues as well as operating expenses with respect to future new product introductions. In addition, the Company's component purchases, production and spending levels are based upon forecast demand for the Company's products. Accordingly, any inaccuracy in forecasting could adversely affect the Company's financial condition and results of operations. Demand for the Company's products could be adversely affected by a slowdown in the overall demand for computer systems, printer products or digitally printed images. The Company's failure to complete shipments during a quarter could have a material adverse effect on the Company's results of operations for that quarter. Quarterly results are not necessarily indicative of future performance for any particular period, and there can be no assurance that the Company can maintain the levels of revenue and profitability experienced over the past several years on a quarterly or annual basis. On March 16, 1998, the Company announced that lower than anticipated product sales, coupled with accelerated competitor-driven pressure on gross profits for its flagship products, could generate operating results ranging from break even to a loss for the first quarter of 1998 on sales significantly lower than the same quarter last year. Lower product sales for the first quarter of 1998 are expected to result from continued sales weakness in Asia and a severe slowdown in purchase decisions due to customer expectations of several new product announcements in the industry in March. First quarter 1998 net income is anticipated to be reduced due to lower sales and profits as the Company responds to attempts by competitors to capture market share. Due to the anticipated results for the first quarter, the likelihood of continued sales weakness in Asia, lower gross profit in its core business over the course of 1998, and increased marketing and selling expenses required to respond to competitive pressures, ENCAD also expects that net income for the year will fall well below comparable 1997 results, and that sales for full-year 1998 could be only slightly higher or equal to 1997 sales. 10 HIGHLY COMPETITIVE INDUSTRY The markets for the Company's products, both printers and supplies, is highly competitive and rapidly changing. Several new competitors have entered the market. The Company's principal competitor is Hewlett-Packard, which dominates the CAD segment of the wide-format inkjet markets and is the Company's principal competition in the GA segment. In addition to direct competition in inkjet printers and related supplies, the Company's products also face competition from other technologies in the wide-format market. Such technologies include pen, electrostatic and thermal methods. The competition to sell ink, media and software products to the customer is also intense. Some of the Company's current and prospective competitors, particularly Hewlett-Packard, have significantly greater financial, technical, manufacturing and marketing resources than the Company. The Company's ability to compete in the wide-format inkjet market depends on a number of factors within and outside its control, including the success and timing of product introductions by the Company and its competitors, selling prices, product performance, product distribution, marketing ability and customer support. A key element of the Company's strategy is to provide competitively priced, quality products. There can be no assurance that the Company's products will continue to be competitively priced. The Company has reduced prices on certain of its products in the past and will likely continue to do so in the future. Price reductions, if not offset by similar reductions in product costs, will affect gross margins and may adversely affect the Company's financial condition and results of operations. See "SHORT PRODUCT LIVES AND TECHNOLOGICAL CHANGE" and "BUSINESS - COMPETITION." SHORT PRODUCT LIVES AND TECHNOLOGICAL CHANGE The markets for wide-format printers and related supplies are characterized by rapidly evolving technology, frequent new product introductions and significant price competition. Consequently, short product life cycles and reductions in unit selling prices due to competitive pressures over the life of a product are common. The Company's future success will depend on its ability to continue to develop and manufacture competitive products and achieve cost reductions for its existing products. In addition, the Company monitors new technology developments and coordinates with suppliers, distributors and dealers to enhance existing products and lower costs. Advances in technology will require increased investment to maintain the Company's market position. The Company's financial condition and results of operations could be adversely affected if the Company is unable to develop and manufacture new, competitive products in a timely manner. DEVELOPING WIDE-FORMAT INKJET AND SUPPLIES MARKETS AND APPLICATIONS The markets for wide-format, color inkjet printers and related supplies are relatively new and are still developing. The Company believes that there has been growing market acceptance for inkjet printers and related supplies. There can be no assurance that the markets and applications for wide-format printers and related supplies will continue to grow. Other technologies are constantly evolving and improving. There can be no assurance that products based on these other technologies will not have a material adverse effect on the demand for the Company's products. FUTURE CAPITAL NEEDS Although the Company first achieved profitability on an annual basis in 1992, there can be no assurance that future profitability or revenue growth, if any, will continue on a quarterly or annual basis. Losses may occur on a quarterly or annual basis for a number of reasons outside the Company's control. See "Potential Fluctuation in Quarterly Performance." The growth of the Company's business will require the commitment of substantial capital resources. If funds are not available from operations, the Company will need additional funds. The Company may seek such additional funding through public and private financing, including debt or equity financing. Adequate funds for these purposes, whether through financial markets or from other sources, may not be available when needed or, if available, not on terms acceptable to the Company. Insufficient funds may require the Company to delay, reduce or eliminate some or all of its planned activities. DEPENDENCE ON KEY PERSONNEL The success of the Company is dependent, in part, on its ability to attract and retain qualified management and technical personnel. Competition for such personnel is intense, and the inability to attract additional key employees or the loss of one or more key employees could adversely affect the Company. The Company does not have employment 11 agreements with senior management, nor does it maintain life insurance on members of this group. There can be no assurance that the Company will retain its key personnel. The Company relies heavily on industry consultants and other specialists to assist and influence decisions, keep abreast of technological and industry advances, and assist in other Company processes. A delay in product introduction is possible to the extent key consultants become unavailable. COMPONENT AVAILABILITY AND COST; DEPENDENCE ON SINGLE SOURCES While most components are available locally from multiple vendors, certain components used in the Company's products are only available from single sources. Although the Company generally buys components under purchase orders and does not have long-term agreements with its suppliers, it expects that its suppliers will be able to continue to satisfy its requirements. The Company has developed strategic relationships with single suppliers of several of its components. Although alternate suppliers are readily available for many of these components, for some components the process of qualifying replacement suppliers, replacing tooling or ordering and receiving replacement components could take several months and cause substantial disruption to the Company's operations. The Company uses a material requirements planning system that is intended to aid in making "Just-in-Time" decisions; however, if a supplier is unable to meet the Company's needs or supplies parts which the Company finds unacceptable, the Company may not be able to meet production demands. Certain key components of the Company's products are supplied indirectly by its principal competitor, Hewlett-Packard. The Company believes that Hewlett- Packard supplies these components to many other customers. Any significant increase in component prices or decrease in component availability could have a material adverse effect on the Company's financial condition and results of operations. SEE "BUSINESS - MANUFACTURING AND SUPPLIERS." POSSIBILITY OF CHALLENGE TO COMPANY'S PRODUCTS OR INTELLECTUAL PROPERTY RIGHTS From time to time, certain competitors, including Hewlett-Packard, have asserted patent rights relevant to the Company's business. The Company expects that this will continue. The Company carefully evaluates each assertion relating to its products. If the Company is not successful in establishing that asserted rights have not been violated, the Company could be prohibited from marketing the products that incorporate such technology. The Company could also incur substantial costs to redesign its products or to defend any legal action taken against the Company. If the Company's products should be found to infringe upon the intellectual property rights of others, the Company could be enjoined from further infringement and be liable for any damages. The Company relies on a combination of trade secret, copyright, trademark and patent protection and non-disclosure agreements to protect its proprietary rights. There can be no assurance, however, that the measures adopted by the Company for the protection of its intellectual property will be adequate to protect its interests, or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technologies. DEPENDENCE ON EXPORT SALES In 1997, 1996, and 1995, sales outside the United States represented approximately 59%, 58% and 63% of the Company's net sales, respectively. The Company expects export sales to continue to represent a significant portion of its sales. All of the Company's products sold in the international markets are denominated in U.S. dollars. An increase in the value of the U.S. dollar relative to foreign currencies could make the Company's products less competitive in foreign markets. 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 critical technology, currency exchange fluctuations, political instability, trade restrictions, changes in tariffs, difficulties in staffing and managing international operations and collecting 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. As the Company continues to expand its international business, there can be no assurance that these factors will not have an adverse effect on the Company's sales and, consequently, on the Company's financial condition and results of operations. RELIANCE ON INDIRECT DISTRIBUTION The Company markets and sells its products domestically and internationally primarily through specialty distributors, dealers, VARs and OEMs. The Company's sales are principally made through distributors which may carry competing product lines. Such distributors could reduce or discontinue sales of the Company's products which could have a material adverse effect on the Company's financial condition and results of operations. There can be no 12 assurance that these independent distributors will devote the resources necessary to provide effective sales and marketing support of the Company's products. In addition, the Company is dependent upon the continued viability and financial stability of these distributors, many of which are small organizations with limited capital. These distributors, in turn, are substantially dependent on general economic conditions and other unique factors affecting the wide-format printer market. The Company believes that its future growth and success will continue to depend in large part upon its distribution channels. Although the Company believes that it provides adequate allowances for bad debts which may arise from sales to these customers, and, to date, has not experienced significant amounts of bad debts, there can be no assurance that actual bad debts will not exceed recorded allowances resulting in a material adverse effect on the Company's financial condition and results of operations. To expand its distribution channels, the Company has entered into select OEM and private label arrangements that allow it to address specific market segments or geographic areas. In order to prevent inventory write-downs, to the extent that OEM and private label customers do not purchase products as anticipated, the Company may need to convert such products to make them salable to other customers. MANAGEMENT OF GROWTH The Company has recently experienced significant growth as net sales have increased to $149.0 million in 1997 compared to $107.4 million in 1996 and $65.5 million in 1995. Such growth has placed, and, if continued, will continue to place, a significant strain on the Company's management, employees, systems and operations. The Company's future operating results will depend on its ability to continue to broaden the Company's senior management group, attract, hire and retain skilled employees, and implement new and enhance existing operational information and financial control systems. There can be no assurance that any new personnel hired by the Company will be successfully integrated into the business or that changes to the Company's systems will be effective. The Company's inability to manage growth effectively could have a material adverse effect on the Company's results of operations. VOLATILITY OF STOCK PRICE The market price of the Company's Common Stock has fluctuated significantly since the Company's initial public offering in December 1993. The Company believes that factors such as general stock market trends, announcements of developments related to the Company's business, fluctuations in the Company's operating results, general conditions in the computer peripheral market and the markets served by the Company or in the worldwide economy, a shortfall in revenue or earnings from securities analysts' expectations, announcements of technological innovations or new inkjet products or enhancements by the Company or its competitors, developments in patents or other intellectual property rights and developments in the Company's relationships with its customers and suppliers could cause a further significant fluctuation in the price of the Company's Common Stock. In addition, in recent years the stock market in general, and the market for shares of technology stocks in particular, have experienced extreme price fluctuations, which have often been unrelated to the operating performance of affected companies. There can be no assurance that the market price of the Company's Common Stock will not experience significant fluctuations that are unrelated to the Company's operating performance. ENTERPRISE-WIDE INFORMATION SYSTEM The Company is in the process of replacing its current management information system with a comprehensive enterprise-wide information system and is devoting significant resources to system and process design and system testing. The Company expects that this system will allow it to realize significant operational efficiencies and facilitate future growth. The Company's operations could be disrupted, however, if the transition to the new system is not effected smoothly or if the system does not perform as expected. YEAR 2000 COMPLIANCE The Company is aware of the issues associated with the programming code in existing computer systems as the year 2000 approaches. The "year 2000 problem" is pervasive and complex as virtually every computer operation will be affected in some way by the rollover of the two digit year value to 00. The issue is whether computer systems will properly recognize date sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Company's recent enterprise-wide information system implementation, the initial phase of which is expected to be completed in 1998, should mitigate most internal problems as the system vendors have represented that these systems are already year 2000 compliant. In 13 addition, the Company is in the process of communicating with others with whom it does significant business to determine their year 2000 compliance readiness and the extent to which the Company is vulnerable to any third party year 2000 issues. Management does not anticipate that the Company will incur significant operating expenses or be required to invest heavily in other computer systems improvements to be year 2000 compliant. The Company plans to devote the necessary resources to resolve significant year 2000 issues in a timely manner; however, if the Company, its customers, vendors or others with whom it does significant business are unable to resolve external processing issues in a timely manner, it could result in material adverse effect on certain of the Company's operations. ABSENCE OF DIVIDENDS No cash dividends have been paid on the Company's Common Stock to date and the Company does not anticipate paying cash dividends in the foreseeable future. EFFECT OF STOCKHOLDER RIGHTS PLAN In March 1998, the Company's Board of Directors adopted a preferred stockholder rights plan (the "Stockholder Rights Plan") which provides for a dividend distribution of one preferred share purchase right (a "Right") on each outstanding share of the Common Stock. On March 19, 1998, the Company's Board of Directors declared a dividend of one Right for each outstanding share of Common Stock, payable on April 2, 1998 to stockholders of record on that date. Each Right entitles stockholders to buy 1/1000th of a share of ENCAD Series A Junior Participating Preferred Stock at an exercise price of $80, subject to adjustment. The Rights will become exercisable on the close of business on the first day a person or group announces an acquisition of 15% or more of the Common Stock or on the tenth day after a person or a group commences or announces commencement of a tender offer, the consummation of which would result in ownership by the person or group of 15% or more of the Common Stock. The Company will be entitled to redeem the Rights at $0.01 per Right at any time on or before the close of business on the first date of a public announcement that a person has acquired beneficial ownership of 15% or more of the Common Stock. ENCAD's Certificate of Incorporation requires that any action required or permitted to be taken by the stockholders of ENCAD must be effected at a duly called annual meeting or special meeting of stockholders and may not be effected by any consent in writing. In addition, special meetings of stockholders of ENCAD may only be called by the Board of Directors, the Chairman of the Board or the President of ENCAD or by any person or persons holding shares representing at least 10% of the outstanding Common Stock. The Stockholder Rights Plan and other charter provisions may discourage certain types of transactions involving an actual or potential change in control of ENCAD, including transactions in which the stockholders might otherwise receive a premium for their shares over then current market prices, and may limit the ability of stockholders to approve transactions that they may deem to be in their best interests. In addition, the Board of Directors has the authority to fix the rights and preferences of and issue shares of preferred stock, which may have the effect of delaying or preventing a change in control of ENCAD without action by the stockholders. ITEM 2: PROPERTIES The Company's headquarters are located in San Diego, California, in facilities it purchased in February 1996 for $6 million. The property consists of two buildings of approximately 51,000 and 47,000 square feet and houses the principal administrative, research and manufacturing facility. The Company also leases a 44,000 square foot warehouse near its headquarters. The Company considers its facilities adequate for its current needs and believes that additional space can be obtained in the future if necessary. ITEM 3: LEGAL PROCEEDINGS From time to time, ENCAD may be involved in litigation relating to claims arising out of its operations in the usual course of business. In September 1995, the Company filed a lawsuit against Hewlett-Packard in the U.S. District Court for the Southern District of California, seeking to have the court declare that the Company's products do not infringe a Hewlett-Packard patent, as has been asserted by Hewlett-Packard, and that the patent is invalid. Hewlett-Packard filed a counterclaim alleging that the Company did infringe the patent. On July 29, 1997 Hewlett-Packard advised the Company that it had abandoned all claims of the patent asserted against the Company in the pending litigation due to a prior invention which invalidated the claims, and that it had requested that the Court dismiss the lawsuit. Hewlett- 14 Packard's claims against the Company were dismissed on August 7, 1997; however, the Company's claim for recovery of its attorneys' fees was not dismissed, and the Company continues to pursue recovery of its attorneys' fees. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the security holders during the quarter ended December 31, 1997. PART II ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS The Common Stock of ENCAD is traded on the Nasdaq National Market under the symbol "ENCD." Prior to the initial public offering on December 16, 1993, there was no established published trading market for ENCAD's Common Stock. The following table presents the quarterly high and low sales prices of the Common Stock as reported by Nasdaq. Such quotations represent inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions.
1997 1996 ----------------------------------- HIGH LOW HIGH LOW -------------------------------------------------------------------- First Quarter 41.25 27.00 12.50 7.63 Second Quarter 43.00 29.25 25.25 11.50 Third Quarter 46.25 30.50 43.75 16.75 Fourth Quarter 40.125 23.75 46.75 34.38 --------------------------------------------------------------------
The Company had 200 stockholders of record and approximately 10,000 beneficial stockholders as of February 28, 1998. DIVIDEND POLICY The Company has not paid dividends on its Common Stock and currently intends to continue this policy in order to retain earnings for use in its business. In addition, the Company's line of credit arrangement prohibits the payment of cash dividends without prior bank approval if amounts are outstanding under such lines of credit. 15 ITEM 6: SELECTED FINANCIAL DATA FIVE YEAR FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA, PERCENTAGES AND EMPLOYEES)
1997 1996 1995 1994 1993 - ----------------------------------------------------------------------------------------------------------------------------- RESULTS OF OPERATIONS Net sales . . . . . . . . . . . . . . . . . . . $149,041 $107,437 $65,548 $43,653 $23,229 Cost of sales . . . . . . . . . . . . . . . . . $ 78,259 $ 56,021 $36,471 $22,917 $12,123 Gross profit. . . . . . . . . . . . . . . . . . $ 70,782 $ 51,416 $29,077 $20,736 $11,106 Research and development. . . . . . . . . . . . $ 10,544 $ 8,794 $ 5,578 $ 3,265 $ 1,995 Operating income. . . . . . . . . . . . . . . . $ 26,493 $ 19,572 $11,619 $ 9,137 $ 4,118 Interest income (expense) . . . . . . . . . . . $ 35 $ 183 $ 307 $ 270 $ (66) Pretax income . . . . . . . . . . . . . . . . . $ 26,528 $ 19,755 $11,926 $ 9,407 $ 4,052 Taxes . . . . . . . . . . . . . . . . . . . . . $ 9,099 $ 6,902 $ 4,069 $ 3,392 $ 1,317 Extraordinary item. . . . . . . . . . . . . . . -- -- -- -- $ 463 Net income. . . . . . . . . . . . . . . . . . . $ 17,429 $ 12,853 $ 7,857 $ 6,015 $ 3,198 Earnings per share - basic. . . . . . . . . . . $ 1.53 $ 1.15 $ 0.72 $ 0.56 $ 0.42 Earnings per share - diluted. . . . . . . . . . $ 1.45 $ 1.08 $ 0.70 $ 0.55 $ 0.41 MARGINS Gross profit. . . . . . . . . . . . . . . . . . 47% 48% 44% 48% 48% Research and development. . . . . . . . . . . . 7% 8% 9% 7% 9% Operating income. . . . . . . . . . . . . . . . 18% 18% 18% 21% 18% Pretax income . . . . . . . . . . . . . . . . . 18% 18% 18% 22% 17% Net income. . . . . . . . . . . . . . . . . . . 12% 12% 12% 14% 14% YEAR END FINANCIAL POSITION Cash and cash equivalents . . . . . . . . . . . $ 1,265 $ 6,949 $ 3,067 $ 842 $ 7,388 Short-term investments. . . . . . . . . . . . . -- -- $ 6,072 $ 4,902 -- Accounts receivable - net . . . . . . . . . . . $ 36,800 $ 19,762 $13,029 $ 8,582 $ 4,177 Inventories . . . . . . . . . . . . . . . . . . $ 29,155 $ 13,630 $ 8,047 $ 4,628 $ 2,064 Property - net. . . . . . . . . . . . . . . . . $ 14,825 $ 10,881 $ 3,138 $ 2,224 $ 1,028 Total assets. . . . . . . . . . . . . . . . . . $ 90,295 $ 57,467 $36,128 $24,084 $15,998 Total current liabilities . . . . . . . . . . . $ 24,300 $ 14,246 $ 7,450 $ 4,136 $ 3,417 Stockholders' equity. . . . . . . . . . . . . . $ 64,722 $ 43,042 $28,678 $19,948 $12,556 Working capital . . . . . . . . . . . . . . . . $ 47,818 $ 30,326 $25,304 $17,619 $11,279 CAPITAL MANAGEMENT Depreciation expense. . . . . . . . . . . . . . $ 3,709 $ 2,726 $ 1,599 $ 732 $ 518 Capital expenditures. . . . . . . . . . . . . . $ 7,653 $ 10,469 $ 2,513 $ 1,928 $ 954 Operating return on average assets. . . . . . . 36% 42% 39% 46% 36% Return on average equity. . . . . . . . . . . . 32% 36% 32% 37% 40% Current ratio . . . . . . . . . . . . . . . . . 3.0 3.1 4.4 5.3 4.3 Inventory turnover. . . . . . . . . . . . . . . 3.7 5.2 5.8 6.8 5.3 Average days receivable . . . . . . . . . . . . 69 56 60 53 55 HUMAN RESOURCE MANAGEMENT Average number of employees . . . . . . . . . . 467 355 272 197 138 Average assets per employee . . . . . . . . . . 158 132 111 102 82 Sales per employee. . . . . . . . . . . . . . . 319 303 241 222 168 COMMON SHARES OUTSTANDING* Weighted average shares - basic . . . . . . . . 11,390 11,217 10,971 10,788 7,544 Weighted average shares - diluted . . . . . . . 12,044 11,871 11,192 10,974 7,786 Number of shares outstanding at year end. . . . 11,501 11,300 11,100 10,880 10,280
* Adjusted for the two-for-one stock split in the form of a 100% stock dividend on May 31, 1996. 16 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table sets forth, as a percentage of net sales, certain consolidated statements of income data for the periods indicated. Except for percentages, all other amounts are in thousands. CONSOLIDATED STATEMENTS OF INCOME
1997 1996 1995 ----------------------------------------------------------------------- NET SALES 100% 100% 100% COST OF SALES 53% 52% 56% ----------------------------------------------------------------------- GROSS PROFIT 47% 48% 44% MARKETING AND SELLING 17% 15% 12% RESEARCH AND DEVELOPMENT 7% 8% 9% GENERAL AND ADMINISTRATIVE 6% 6% 6% ----------------------------------------------------------------------- INCOME FROM OPERATIONS 18% 18% 18% INTEREST INCOME - NET 0% 0% 0% ----------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 18% 18% 18% PROVISION FOR INCOME TAXES 6% 6% 6% ----------------------------------------------------------------------- NET INCOME 12% 12% 12% ----------------------------------------------------------------------- -----------------------------------------------------------------------
RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1997 AND 1996 ENCAD's 1997 net sales increased 39% over 1996 net sales. This increase was primarily due to sales of the Company's NovaJet product lines, including sales of the NovaJet PROe Series which was shipped in May 1997. The supplies business unit continued to contribute to the Company's growth with the successful introduction of several new lines of ink and media ("supplies"). In 1997, supplies sales increased 124% over 1996, and accounted for approximately 22% of 1997 net sales versus 14% in 1996. The Company's numerous original equipment manufacturers ("OEM") arrangements contributed to the increase in net sales for 1997, accounting for 26% of net sales as compared to 25% for 1996. No one customer accounted for more than 10% of product sales in 1997, whereas in 1996, one customer accounted for 15% of product sales. International sales accounted for approximately 59% and 58% of the Company's net sales in 1997 and 1996, respectively. Cost of sales includes costs related to product shipments, including materials, labor, overhead and other direct or allocated costs involved in the manufacture, warehousing, delivery, support and maintenance of products. Cost of sales as a percentage of net sales stood at 53% and 52% in 1997 and 1996, respectively. This percentage remained relatively constant due primarily to the mix of sales of higher margin NovaJet product offsetting the lower margin products - CADJET, supplies (as a group) and accessories. The Company expects lower gross profit margin percentages in 1998 due to lower average unit selling prices for existing products and increased sales of supplies, which, in general, have lower gross margins than the printer products. The Company's future success will depend on its ability to continue to develop and manufacture competitive products and achieve cost reductions for its existing products. Marketing and selling expenses were 17% of net sales in 1997 compared to 15% in 1996 and grew by 51% over 1996. Most of the increase was related to costs associated with increased staffing in the Company's international offices and in the customer support organization, the advertising and promotion of existing and new products, and 17 increased trade show activity compared to the prior year. Marketing and selling expenses are expected to continue to increase over prior periods as the Company promotes its products and supports its marketing and selling activities. Research and development expenses were 7% of net sales in 1997 compared to 8% in 1996 and grew by 20% over 1996. The increase in spending was driven by increased project costs and staffing levels related to new product development, in particular in the area of supplies development. The Company expects to continue to invest significant resources in its strategic programs and enhancements to existing products. The Company expects that research and development expenses will continue to increase in absolute dollars as compared to prior periods. General and administrative expenses were 6% of net sales in 1997 and 1996 and grew by 34% over 1996. The increase in absolute dollars of $2,224 was due to higher staffing levels necessary to support an increased level of business, higher consulting expenses, and increased legal costs. The Company expects general and administrative expenses will continue to increase in absolute dollars over prior periods. Net interest income decreased to $35 in 1997 from $183 in 1996 due to less cash available for external investment and increased borrowings under the bank line of credit. The Company's effective income tax rate in 1997 was 34%, compared to 35% in 1996. The slight decrease in the effective rate was due to a decreased effective rate for state income taxes. 1997 net income was 12% of net sales for both 1997 and 1996 and increased 36% over 1996 for the reasons previously described. YEARS ENDED DECEMBER 31, 1996 AND 1995 ENCAD's 1996 net sales increased 64% over 1995 net sales. This increase was primarily due to increased unit sales of the Company's NovaJet product lines, including sales of the NovaJet Pro and NovaJet Pro 50 which were introduced in November 1995 and February 1996, respectively. Also contributing to the Company's growth was the successful introduction of two new lines of supplies. In 1996, supplies sales increased 208% over 1995, and accounted for approximately 14% of 1996 net sales versus 7% in 1995. The Company's multiple OEM arrangements contributed to the increase in net sales for 1996, accounting for 25% of product sales as compared to 19% for 1995. For the year ended December 31, 1996, one customer accounted for 15% of product sales whereas no one customer accounted for more than 10% of product sales in 1995. International sales accounted for approximately 59% and 63% of the Company's product sales in 1996 and 1995, respectively. Cost of sales includes costs related to product shipments, including materials, labor, overhead and other direct or allocated costs involved in the manufacture, delivery, support and maintenance of products. Cost of sales as a percentage of net sales decreased to 52% in 1996, from 56% in 1995, causing a comparable increase in gross margin percentages. The decrease in the cost of sales was due primarily to a favorable product mix including the higher margin NovaJet Pro products, offsetting the lower margin products - CADJET, supplies (as a group) and accessories. Marketing and selling expenses were 15% of net sales compared to 12% in 1995 and grew by 104% over 1995. Most of the increase was related to costs associated with increased staffing, the advertising of new products, increased emphasis on promoting the Company's supplies business and increased trade show activity compared to the same period in the prior year. Research and development spending grew by 58% from 1995 to 1996 and slightly decreased as a percentage of net sales. The increase in spending was driven by increased project costs and staffing levels related to new product development. General and administrative expenses were 6% of net sales in 1996 and 1995. The 72% increase in absolute dollars was due to higher staffing levels necessary to support an increased level of business. Net interest income decreased to $183 in 1996 from $307 in 1995 due to less cash available for external investment. 18 The Company's effective income tax rate in 1996 was 35%, compared to 34% in 1995. The higher rate was due to the Company moving to a higher tax bracket due to increased income. 1996 net income increased 64% over 1995 for the reasons previously described. LIQUIDITY AND CAPITAL RESOURCES The Company funds its operations primarily through cash flow provided from operations. As of December 31, 1997, the Company had cash and cash equivalents totaling $1,265, and working capital of $47,818. In comparison, the Company had cash and cash equivalents totaling $6,949, and working capital of $30,326 as of December 31, 1996. The decrease in cash and cash equivalents was due primarily to an increase in accounts receivable balances and inventories from year to year. The Company has received and anticipates it will continue to receive the majority of its cash from collections of accounts receivable from its distributors and OEMs. These groups have a history of timely payments; however, an increasing amount of international sales can increase accounts receivable balances due to traditionally slower payments by international customers. At December 31, 1997, net accounts receivable increased by $17,038 over 1996's year end balance of $19,762. The increase was directly related to increased sales in 1997 and also slower payments of amounts due, particularly for international customers, than the Company experienced in 1996. The Company invests its excess cash in money market accounts and has established guidelines relative to diversification and maturities to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. The Company has not experienced, to date, any losses on its short-term investments. During 1997, the Company invested cash in short-term investments which generated interest income of $175. Inventory levels increased by $15,525 at December 31, 1997 from $13,630 at the end of 1996. This increase was primarily attributable to a general increase in the level of the Company's business and also to increased inventories to support increased sales and to provide shorter lead times in filling customer orders. In the years ended December 31, 1997 and 1996, the Company had capital expenditures of $7,653 and $10,469, respectively. 1997 expenditures included the initial software purchase of the enterprise-wide information system. 1996 expenditures included $6,000 for the purchase of the Company's headquarter facilities. During 1998, the Company plans to increase its capital expenditures, especially for tooling relating to new products, computers and related systems and network assets, and costs related to the implementation of the enterprise-wide information system. At December 31, 1997, the Company had available a $20 million revolving line of credit. The line requires the Company to maintain certain financial ratios. $3,261 was outstanding under the line at December 31, 1997. The line expires on January 2, 2000. The Company's overall level of operating expense is expected to increase due to increased expense associated with increased sales and also with the development and marketing of new products. Management believes that its existing cash, cash equivalents, cash generated from operations, and funds available under the bank line of credit will be sufficient to satisfy its currently anticipated working capital needs. Actual cash requirements may vary from planned amounts, depending on the timing of the launch and extent of acceptance of new products. There can be no assurances that future cash requirements to fund operations will not require the Company to seek additional capital, or that such additional capital will be available when required on terms acceptable to the Company. To date, inflation has not had a significant effect on the Company's operating results. The Company is aware of the issues associated with the programming code in existing computer systems as the year 2000 approaches. The "year 2000 problem" is pervasive and complex as virtually every computer operation will be affected in some way by the rollover of the two digit year value to 00. The issue is whether computer systems will properly recognize date sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Company's recent enterprise-wide information system implementation, the initial phase of which is expected to be completed in 1998, should mitigate 19 most internal problems as the system vendors have represented that these systems are already year 2000 compliant. In addition, the Company is in the process of communicating with others with whom it does significant business to determine their year 2000 compliance readiness and the extent to which the Company is vulnerable to any third party year 2000 issues. Management does not anticipate that the Company will incur significant operating expenses or be required to invest heavily in other computer systems improvements to be year 2000 compliant. The Company plans to devote the necessary resources to resolve significant year 2000 issues in a timely manner; however, if the Company, its customers, vendors or others with whom it does significant business are unable to resolve external processing issues in a timely manner, it could result in material adverse effect on certain of the Company's operations. RECENT ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share" ("SFAS No. 128"). Effective for financial statements issued after December 15, 1997, SFAS No. 128 requires dual presentation of "Basic" and "Diluted" EPS by entities with complex capital structures, replacing "Primary" and "Fully Diluted" EPS under APB Opinion No. 15. Basic EPS excludes dilution from common stock equivalents and is computed by dividing income available to common stockholders by the weighted- average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from common stock equivalents, similar to fully diluted EPS, but uses only the average stock price during the period as part of the computation. As a result, the Company has changed the method used to compute earnings per share and has restated all prior periods as required by SFAS No. 128. In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in financial statements. Comprehensive income is defined as "the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners." SFAS No. 130 is effective for fiscal years beginning after December 15, 1997, and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company believes that the adoption of SFAS No. 130 will not have a material effect on the financial statements or disclosures of the Company. In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 establishes annual and interim reporting standards for an enterprise's business segments and related disclosures about its products, services, geographic areas, and major customers. This statement supersedes SFAS No. 14, Financial Reporting for Segments of a Business Enterprise. SFAS No. 131 is effective for periods beginning after December 15, 1997, and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company believes that the adoption of SFAS No. 131 will not have a material effect on the financial statements or disclosures of the Company. ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK None. ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is included in Part IV, Item 14(a)(1) and (2). ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 20 PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY The information required by this item is incorporated by reference from the Proxy Statement in the sections entitled "Election of Directors", "Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance." ITEM 11: EXECUTIVE COMPENSATION The information required by this item is incorporated by reference from the Proxy Statement in the section entitled "Compensation of Executive Officers." ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference from the Proxy Statement in the section entitled "Security Ownership of Certain Beneficial Owners and Management." ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference from the Proxy Statement in the section entitled "Certain Relationships and Related Transactions." PART IV ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF, OR INCORPORATED BY REFERENCE INTO, THIS ANNUAL REPORT ON FORM 10-K: (1) FINANCIAL STATEMENTS. The following Consolidated Financial Statements of ENCAD, Inc. and Independent Auditors' Report are included in a separate section of this Report beginning on page F-1:
Page Description Number ----------- ------ Independent Auditors' Report. . . . . . . . . . . . . . . . . . . . . .F-2 Consolidated Balance Sheets as of December 31, 1997 and 1996. . . . . .F-3 Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . . . .F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . .F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . . . .F-6 Notes to Consolidated Financial Statements. . . . . . . . . . . . . . .F-7
(2) FINANCIAL STATEMENT SCHEDULES Financial statement schedules have been omitted because they are either not required, not applicable or the information is otherwise included. 21 (3) Exhibits:
Exhibit Number Description 2.1 Agreement and Plan of Merger between ENCAD Delaware and ENCAD California dated January 5, 1998 (filed as Exhibit 2.1). (6) 3.1 Certificate of Incorporation of the Company (filed as Exhibit 3.1). (6) 3.2 Bylaws of the Company (filed as Exhibit 3.2). (6) 4.1 Rights Agreement, dated as of March 19, 1998, between the Company and Harris Trust Company of California, which includes the Form of Certificate of Designation for the Series A Preferred Stock as Exhibit A, the Form of Rights Certificate as Exhibit B and the Summary of Rights to Purchase Shares as Exhibit C. (7) 10.1 Form of Distributor Agreement (Domestic) (filed as Exhibit 10.14). (1) 10.2 Form of International Distributor Agreement (filed as Exhibit 10.15). (1) 10.3 Form of OEM Agreement (filed as Exhibit 10.16). (1) + 10.4 The Company's Incentive Stock Option Plan (filed as Exhibit 10.29). (1) + 10.5 The Company's 1986 Non-Qualified Stock Option Plan, as amended (filed as Exhibit 10.30). (1) + 10.6 Form of Incentive Stock Option Agreement (filed as Exhibit 10.31). (1) + 10.7 Form of Non-Qualified Stock Option Agreement (filed as Exhibit 10.32). (1) + 10.8 The Company's 1993 Stock Option/Stock Issuance Plan, as amended (filed as Exhibit 99.1). (2) + 10.9 Form of Notice of Grant of Stock Option and Stock Option Agreement (filed as Exhibit 10.34). (1) + 10.10 Form of Stock Issuance Agreement (filed as Exhibit 10.35). (1) + 10.11 1993 Employee Stock Purchase Plan, as amended (filed as Exhibit 99.1). (4) + 10.12 Form of Stock Purchase Agreement (filed as Exhibit 10.37). (1) 10.13 Form of Non-Disclosure Agreement (filed as Exhibit 10.38). (1) 10.14 Form of Employee Proprietary Information Agreement (filed as Exhibit 10.39). (1) + 10.15 Form of Indemnification Agreements between the Company and each of its directors. + 10.16 Form of Indemnification Agreements between the Company and each of its officers. 10.17 Agreement to Sell Real Estate dated January 31, 1996 between the Registrant and The Chase Manhattan Bank, N.A., Real Estate Finance. (3) + 10.18 Form of Severance Letter Agreements between the Company and each of its officers. (5) + 10.19 Form of Senior Executive 1997 Annual Performance Bonus between the Company and each of its officers. (5) + 10.20 Select Compensation, Non-Qualified Deferred Compensation Plan and related documents. (5) 10.21 1997 Supplemental Stock Option Plan (filed as Exhibit 99.2). (2) 10.22 Form of Notice of Grant of Stock Option (filed as Exhibit 99.3). (2) 10.23 Form of Stock Option Agreement (filed as Exhibit 99.4). (2) + 10.24 Form of Non-Statutory Stock Option Agreement (filed as Exhibit 99.5). (2) 21.1 Subsidiaries. 23.1 Independent Auditors' Consent, Deloitte & Touche LLP. 22 24.1 Power of Attorney. (See page 24) 27.1 Financial Data Schedule for fiscal year end 1997. 27.2 Financial Data Schedule for fiscal year end 1996 and quarters one, two and three of 1996. 27.3 Financial Data Schedule for quarters one, two and three of 1997.
--------------- (1) Filed as exhibit to the Registrant's Registration Statement on Form S-1 (No. 33-70220) or amendments thereto and incorporated herein by reference. (2) Filed as exhibit to the Registrant's Registration Statement on Form S-8 (No. 333-44923) and incorporated herein by reference. (3) Filed as exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference. (4) Filed as exhibit to the Registrant's Registration Statement on Form S-8 (No. 333-45327) and incorporated herein by reference. (5) Filed as an exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, as amended, and incorporated herein by reference. (6) Filed as an exhibit to Registrant's Current Report on Form 8-K dated January 5, 1998 and incorporated herein by reference. (7) Filed as an exhibit to Registrant's Current Report on Form 8-K dated March 20, 1998 and incorporated herein by reference. + Management compensatory plan. (b) REPORTS ON FORM 8-K None (c) EXHIBITS The exhibits required by this Item are listed under Item 14(a)(3). (d) FINANCIAL STATEMENT SCHEDULES The consolidated financial statement schedules required by this Item are listed under Item 14(a)(2). 23 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. ENCAD, INC. By /s/ David A. Purcell Date: March 30, 1998 ------------------------------- ------------------ David A. Purcell Chief Executive Officer By /s/ Todd W. Schmidt Date: March 30, 1998 ------------------------------- ------------------ Todd W. Schmidt Chief Financial Officer POWER OF ATTORNEY Know all men by these presents, that each person whose signature appears below constitutes and appoints David A. Purcell or Thomas L. Green, his attorney-in- fact, with power of substitution in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that the attorney-in-fact or his substitute or substitutes may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated. SIGNATURE TITLE DATE /s/ David A. Purcell Chairman of the Board and March 30, 1998 - ------------------------- Chief Executive Officer (David A. Purcell) (Principal Executive Officer) /s/ Richard A. Plante President and - ------------------------- Chief Operating Officer March 30, 1998 (Richard A. Plante) /s/ Robert V. Adams Director March 30, 1998 - ------------------------- (Robert V. Adams) /s/ Craig S. Andrews Director March 30, 1998 - ------------------------- (Craig S. Andrews) /s/ Ronald J. Hall Director March 30, 1998 - ------------------------- (Ronald J. Hall) /s/ Howard L. Jenkins Director March 30, 1998 - ------------------------- (Howard L. Jenkins) /s/ Charles E. Volpe Director March 30, 1998 - ------------------------- (Charles E. Volpe) 24 ENCAD, INC. INDEX TO CONSOLIDATED FINANCIAL STATMENTS
Page ---- Independent Auditors Report. . . . . . . . . . . . . . . . . . . . . . . . .F-2 Consolidated Balance Sheets. . . . . . . . . . . . . . . . . . . . . . . . .F-3 Consolidated Statements of Income. . . . . . . . . . . . . . . . . . . . . .F-4 Consolidated Statements of Stockholders' Equity. . . . . . . . . . . . . . .F-5 Consolidated Statements of Cash Flows. . . . . . . . . . . . . . . . . . . .F-6 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . .F-7
F-1 ENCAD, INC. INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of ENCAD, Inc. We have audited the accompanying consolidated balance sheets of ENCAD, Inc. and its subsidiaries (collectively, the "Company") as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1997 and 1996 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP San Diego, California January 30, 1998 (March 19, 1998 as to the last paragraph of Note 8) F-2 ENCAD, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, --------------------------- 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,265 $ 6,949 Accounts receivable - net 36,800 19,762 Inventories 29,155 13,630 Deferred income taxes 3,118 3,858 Prepaid expenses 1,780 373 - ----------------------------------------------------------------------------------------------------------------------------- Total current assets 72,118 44,572 Property - net 14,825 10,881 Other assets 3,352 2,014 - ----------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $90,295 $57,467 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $12,369 $ 8,244 Accrued expenses and other liabilities 8,670 6,002 Borrowings under line of credit 3,261 -- - ----------------------------------------------------------------------------------------------------------------------------- Total current liabilities 24,300 14,246 OTHER LIABILITIES 1,273 179 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock - $.001 par value and no par value in 1997 and 1996 respectively, 5,000 shares authorized, no shares issued and outstanding -- -- Common stock - $.001 par value and no par value; 60,000 and 15,000 shares authorized; 11,501 and 11,300 shares issued and outstanding in 1997 and 1996, respectively 12 13,338 Additional paid-in capital 17,577 -- Retained earnings 47,133 29,704 - ----------------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 64,722 43,042 - ----------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $90,295 $57,467 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. F-3 ENCAD, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- Net sales $149,041 $107,437 $65,548 Cost of sales 78,259 56,021 36,471 - ----------------------------------------------------------------------------------------------------------------------------- Gross profit 70,782 51,416 29,077 Marketing and selling 25,023 16,552 8,111 Research and development 10,544 8,794 5,578 General and administrative 8,722 6,498 3,769 - ----------------------------------------------------------------------------------------------------------------------------- Operating costs and expenses 44,289 31,844 17,458 - ----------------------------------------------------------------------------------------------------------------------------- Income from operations 26,493 19,572 11,619 Interest income - net 35 183 307 - ----------------------------------------------------------------------------------------------------------------------------- Income before income taxes 26,528 19,755 11,926 Provision for income taxes 9,099 6,902 4,069 - ----------------------------------------------------------------------------------------------------------------------------- Net income $ 17,429 $ 12,853 $ 7,857 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- Earnings per share - basic $ 1.53 $ 1.15 $ 0.72 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- Earnings per share - diluted $ 1.45 $ 1.08 $ 0.70 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding - basic 11,390 11,217 10,971 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- Weighted average common and common equivalent shares outstanding - diluted 12,044 11,871 11,192 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. F-4 ENCAD, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
COMMON STOCK ADDITIONAL ------------------------ PAID-IN RETAINED SHARES AMOUNT CAPITAL EARNINGS TOTAL - ----------------------------------------------------------------------------------------------------------------------------- BALANCE, JANUARY 1, 1995 10,880 $ 10,954 $ -- $ 8,994 $ 19,948 Common stock issued under stock option and purchase plans, including related tax benefits 120 573 -- 573 Exercise of warrants 100 300 -- 300 Net income 7,857 7,857 - ----------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1995 11,100 11,827 -- 16,851 28,678 Common stock issued under stock option and purchase plans, including related tax benefits 200 1,511 -- 1,511 Net income 12,853 12,853 - ----------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1996 11,300 13,338 -- 29,704 43,042 Conversion to $.001 par value stock (13,326) 13,326 -- -- Common stock issued under stock option and purchase plans, including related tax benefits 201 -- 4,251 -- 4,251 Net income 17,429 17,429 - ----------------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1997 11,501 $ 12 $17,577 $47,133 $64,722 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. F-5 ENCAD, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 17,429 $ 12,853 $ 7,857 Adjustments to reconcile net income to cash (used in) provided by operating activities: Depreciation and amortization 3,709 2,726 1,599 Tax benefit from exercise of stock options 2,568 539 173 Changes in assets and liabilities: Accounts receivable (17,038) (6,733) (4,447) Inventories (15,525) (5,583) (3,419) Deferred income taxes 154 (2,284) (501) Prepaid expenses and other assets (2,159) (1,186) 632 Accounts payable 4,125 3,672 2,231 Accrued expenses and other liabilities 3,762 3,303 1,083 - ----------------------------------------------------------------------------------------------------------------------------- Cash (used in) provided by operating activities (2,975) 7,307 5,208 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property (7,653) (10,469) (2,513) Net cash from (purchases of) short-term investments -- 6,072 (1,170) - ----------------------------------------------------------------------------------------------------------------------------- Cash used in investing activities (7,653) (4,397) (3,683) CASH FLOWS FROM FINANCING ACTIVITIES: Exercise of Common Stock options and sale of stock under employee stock purchase plan 1,683 972 418 Net proceeds from issuance of Common Stock -- -- 282 Net borrowings under line of credit 3,261 -- -- - ----------------------------------------------------------------------------------------------------------------------------- Cash provided by financing activities 4,944 972 700 - ----------------------------------------------------------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (5,684) 3,882 2,225 Cash and cash equivalents at beginning of year 6,949 3,067 842 - ----------------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 1,265 $ 6,949 $ 3,067 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for income taxes $ 4,234 $ 7,927 $ 5,005 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. F-6 ENCAD, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY ENCAD, Inc. and its subsidiaries (collectively, the "Company") operate in one industry segment, principally the design, development, manufacture and sale of wide-format color inkjet printers and related supplies for the graphic arts and computer-aided design markets. The Company markets and sells its products domestically and internationally primarily through specialty distributors, dealers, value-added resellers and original equipment manufacturers. Export sales accounted for 59%, 58% and 63% of 1997, 1996 and 1995 net sales, respectively. Receivables from export sales at December 31, 1997 and 1996 were approximately $23,200,000 and $11,500,000, respectively. In 1997, and in 1995, no one customer accounted for more than 10% of sales. In 1996, one customer accounted for 15% of sales. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company. All significant intercompany balances have been eliminated in consolidation. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments purchased with an original maturity date of three months or less to be cash equivalents. SHORT-TERM INVESTMENTS Short-term interest bearing investments are those with maturities of less than one year but greater than three months when purchased. These investments are readily convertible to cash and are stated at cost, which approximates fair value. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out method) or market. PROPERTY Property is stated at cost. Depreciation and amortization are computed using the straight-line method over the following estimated useful lives of the property: buildings and related improvements - 40 years; computer equipment and related software, machinery, equipment, furniture and fixtures -two to five years. REVENUE RECOGNITION Revenue from product sales is recognized at the time of shipment. Price protection adjustments for customers are accrued when the anticipated price reduction is known. WARRANTY The Company warrants its products against defects, generally for one year. Management evaluates the Company's warranty experience and adjusts its warranty reserve accordingly. PRODUCT RETURNS In the event the Company terminates any of its distribution agreements, the terminated distributor may return products for a refund. The Company has not experienced any significant terminations or product returns to date. RESEARCH AND DEVELOPMENT Research and development costs are expensed in the period incurred. INCOME TAXES The Company adopted the Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." This statement requires that deferred income taxes be reported in the Company's financial statements utilizing the asset and liability method. Under this method, deferred income taxes are determined based on enacted tax rates applied to the differences between the financial statement and tax bases of assets and liabilities. FOREIGN CURRENCY TRANSLATION Assets and liabilities of the Company's foreign operations are translated into U.S. dollars at the exchange rate in effect at the balance sheet date, and revenue and expenses are translated at the average exchange rate for the year. Translation gains or losses of the Company's foreign subsidiaries historically have not been material. All of the Company's worldwide sales are conducted in U.S. dollars. Gains and losses on transactions in denominations other than the functional currency of the Company's foreign operations, while not F-7 material in amount, are included in the results of operations. The Company has not entered into foreign exchange transactions to hedge certain balance sheet exposures and intercompany balances against movements in foreign exchange rates as these balances have historically not been material. CONCENTRATION OF CREDIT RISK The Company sells its products primarily to customers in the United States, Europe and Asia. The Company maintains a reserve for potential credit losses and such losses, to date, have been minimal. To date, the Company has not recorded any losses on it's cash accounts. ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. ACCOUNTING FOR STOCK-BASED COMPENSATION In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). SFAS No. 123 requires expanded disclosures of stock-based compensation arrangements with employees and encourages (but does not require) compensation cost to be measured based on the fair value of the equity instrument awarded. Companies are permitted, however, to continue to apply Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," which recognizes compensation cost based on the intrinsic value of the equity instrument awarded. The Company will continue to apply APB Opinion No. 25 to its stock-based compensation awards to employees and has disclosed the required pro forma effect on the net income and earnings per share. See Note 6. EARNINGS PER SHARE In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share" ("SFAS No. 128"), effective for financial statements issued after December 15, 1997. SFAS No. 128 requires dual presentation of "Basic" and "Diluted" EPS by entities with complex capital structures, replacing "Primary" and "Fully Diluted" EPS under APB Opinion No. 15. Basic EPS excludes dilution from common stock equivalents and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from common stock equivalents, similar to fully diluted EPS, but uses only the average stock price during the period as part of the computation. On December 31, 1997, the Company adopted SFAS No. 128, and as a result, the Company has changed the method used to compute earnings per share and has restated all prior periods. The following table is a reconciliation of the basic and diluted earnings per share computations for the years ended December 31, 1997, 1996 and 1995 (in thousands):
1997 1996 1995 ---------------------------------------------------------------------- Net Income $17,429 $12,853 $ 7,857 ---------------------------------------------------------------------- Earnings per share - basic $ 1.53 $ 1.15 $ .72 ---------------------------------------------------------------------- ---------------------------------------------------------------------- Basic weighted average common shares outstanding 11,390 11,217 10,971 Effect of dilutive securities: Stock options 654 654 221 ---------------------------------------------------------------------- Diluted weighted average common and common equivalent shares outstanding 12,044 11,871 11,192 ---------------------------------------------------------------------- Earnings per share - diluted $ 1.45 $ 1.08 $ .70 ---------------------------------------------------------------------- ----------------------------------------------------------------------
RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in financial statements. Comprehensive income is defined as "the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from F-8 investments by owners and distributions to owners." SFAS No. 130 is effective for fiscal years beginning after December 15, 1997, and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company believes that the adoption of SFAS No. 130 will not have a material effect on the financial statements or disclosures of the Company. In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 establishes annual and interim reporting standards for an enterprise's business segments and related disclosures about its products, services, geographic areas, and major customers. This statement supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise". SFAS No. 131 is effective for periods beginning after December 15, 1997, and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company believes that the adoption of SFAS No. 131 will not have a material effect on the financial statements or disclosures of the Company. STOCKHOLDERS' EQUITY Effective May 31, 1996, for stockholders of record on May 17, 1996, the Company effected a two-for-one stock split in the form of a 100% stock dividend resulting in the issuance of 5,599,007 shares of Common Stock. The effects of the stock dividend have been retroactively restated in these financial statements. In July 1997, the Company's stockholders approved an Agreement and Plan of Merger whereby the Company merged with and into a newly incorporated Delaware corporation ("ENCAD, Inc.") which is the surviving corporation. In conjunction with the merger, each share of the Company's Common Stock, no par value, and options or rights to acquire shares of Common Stock were exchanged for one share of ENCAD, Inc. Delaware Common Stock, par value $.001, options or rights to acquire Common Stock. See Note 8 - Subsequent Events. The change in par value did not affect any of the existing rights of the stockholders and has been recorded as an adjustment to additional paid-in capital as of December 31, 1997. In July 1997, the Company's stockholders approved an increase in the number of shares of Common Stock authorized for issuance by the Delaware company from 15,000,000 to 60,000,000 shares, concurrently with the Company's reincorporation in Delaware. RECLASSIFICATIONS Certain items in the 1996 and 1995 financial statements have been reclassified to conform to the 1997 presentation. F-9 2. BALANCE SHEET DETAILS (in thousands)
DECEMBER 31, ----------------- 1997 1996 ---------------------------------------------------------------------- ACCOUNTS RECEIVABLE: Trade receivables $37,400 $20,404 Allowance for doubtful accounts (600) (642) ---------------------------------------------------------------------- Total $36,800 $19,762 ---------------------------------------------------------------------- ---------------------------------------------------------------------- INVENTORIES: Raw materials $11,043 $ 7,247 Work-in-process 629 253 Finished goods 17,483 6,130 ---------------------------------------------------------------------- Total $29,155 $13,630 ---------------------------------------------------------------------- ---------------------------------------------------------------------- PROPERTY: Computer equipment and related software $ 7,526 $ 4,022 Machinery and equipment 6,130 3,267 Buildings and improvements 5,967 5,601 Furniture and fixtures 2,383 1,787 Land 1,250 1,250 ---------------------------------------------------------------------- 23,256 15,927 Accumulated depreciation and amortization (8,431) (5,046) ---------------------------------------------------------------------- Total $14,825 $10,881 ---------------------------------------------------------------------- ---------------------------------------------------------------------- ACCRUED EXPENSES AND OTHER LIABILITIES: Compensation and vacation pay $ 3,352 $ 3,018 Income taxes payable 2,722 690 Warranty 1,390 1,538 Co-op programs 996 736 Other 210 20 ---------------------------------------------------------------------- Total $ 8,670 $ 6,002 ---------------------------------------------------------------------- ----------------------------------------------------------------------
3. REVOLVING LINE OF CREDIT At December 31, 1997, the Company had available a $20 million revolving line of credit (the "Line") which provides for interest at the bank's prime rate (8.50% at December 31, 1997) or at the Company's option, a rate based on the London Interbank Overnight Rate (5.81% at December 31, 1997 plus 1.25 to 1.75% based upon certain ratios) on outstanding balances. The Company pays a commitment fee on the unused portion of the Line. The Line requires the Company to maintain: (i) a minimum amount of tangible net worth, (ii) a current ratio of 1.85 to 1.0, (iii) a total liabilities to tangible net worth ratio less than 1.1 to 1.0 and (iv) a minimum level of cash flow. $3,261,000 was outstanding under the Line at December 31, 1997. The Line expires on January 2, 2000. 4. OPERATING LEASE COMMITMENTS (in thousands) The Company leases certain facilities and equipment under operating leases which expire over the next five years. Most of these operating leases provide the Company with the option after the initial lease term to renew its lease at the then fair rental value of periods of one month to four years. Generally, management expects that leases will be renewed in the normal course of business. F-10 Minimum payments for operating leases having initial or remaining noncancelable terms of one year are as follows:
YEAR ---------------------------------------- 1998 $ 837 1999 721 2000 610 2001 321 2002 157 ---------------------------------------- Total $2,646 ----------------------------------------
Total rent expense under operating leases was approximately $416, $298, and $604 for the years ended December 31, 1997, 1996 and 1995, respectively. 5. INCOME TAXES (in thousands except for percentages) The tax effects of items comprising the Company's net deferred income tax asset are as follows:
DECEMBER 31, ----------------- 1997 1996 ---------------------------------------------------------------------- Non deductible reserves and accruals $ 2,598 $ 2,817 Differences between book and tax basis in inventory and property 1,256 856 Accrued co-op advertising 300 323 State taxes 189 287 Other 41 255 ---------------------------------------------------------------------- Net deferred tax asset $ 4,384 $ 4,538 ---------------------------------------------------------------------- ----------------------------------------------------------------------
The Net Deferred Tax Asset is classified between current and long term assets as follows: Deferred income taxes $ 3,118 $ 3,858 Other assets 1,266 680 ---------------------------------------------------------------------- Net deferred tax asset $ 4,384 $ 4,538 ---------------------------------------------------------------------- ----------------------------------------------------------------------
The components of income before income tax expense and income tax expense attributable to foreign operations are not material. The components of the provision for income taxes are as follows:
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ---------------------------------------------------------------------- CURRENT EXPENSE: Federal $ 7,626 $ 7,375 $ 3,541 State 1,521 1,810 1,030 DEFERRED EXPENSE: Federal (22) (1,865) (396) State (26) (418) (106) ---------------------------------------------------------------------- Total $ 9,099 $ 6,902 $ 4,069 ---------------------------------------------------------------------- ----------------------------------------------------------------------
F-11 The effective rate of the provision for income taxes differs from the federal statutory rate because of the effect of the following items:
YEAR ENDED DECEMBER 31, ------------------------ 1997 1996 1995 ---------------------------------------------------------------------- Statutory rate 35.0% 35.0% 34.0% State income taxes, net of Federal benefit 4.5 6.2 6.2 Benefit of foreign sales corporation, net of tax (4.1) (4.0) (4.2) Research and development tax credit (0.9) (0.8) (1.0) Other (0.2) (1.4) (0.8) ---------------------------------------------------------------------- Effective rate 34.3% 35.0% 34.2% ---------------------------------------------------------------------- ----------------------------------------------------------------------
6. EMPLOYEE BENEFIT PLANS (in thousands except for percentages and average and per share data) The number of shares authorized under the following plans and the number of shares outstanding under those plans will be appropriately adjusted in the event of certain changes in the Company's capital structure, such as stock dividends or splits, or other recapitalizations. 1993 EMPLOYEE STOCK PURCHASE PLAN Under this plan, for which 520 shares of Common Stock have been reserved for issuance, eligible employees may elect up to 10% of their base cash compensation to be deducted each pay period for the purchase of the Company's Common Stock. On the last business day of each calendar quarter, shares of Common Stock are purchased with the employees' payroll deductions, at a price per share of 85% of the lesser of the closing market price of the Common Stock on the purchase date, or the closing market price on the first day of the period. Participants may not purchase more than 2 shares of Common Stock and not more than $25 worth of Common Stock in any one calendar year. The plan will terminate on January 1, 2003. In 1997, 1996 and 1995, 45, 60, and 62 shares, respectively, were issued, at average prices ranging from $7.44 to $35.06, $5.26 to $14.45, and $2.13 to $7.65, respectively. 1993 STOCK OPTION/STOCK ISSUANCE PLAN Under this plan, for which 1,779 shares of Common Stock have been reserved for issuance, employees, officers, directors and consultants may be granted incentive or non-qualified stock options. All outstanding options under any of the Company's previous stock option plans were incorporated into this plan but will continue to be governed by the terms and conditions under which those options were granted. To date, only non-qualified stock options have been granted under this plan at prices not less than fair market value on the date of grant. The options granted under this plan as of December 31, 1997 are exercisable quarterly over four years and expire in ten years. 1997 SUPPLEMENTAL STOCK OPTION PLAN On October 13, 1997, the Company's Board of Directors adopted the 1997 Supplemental Stock Option Plan. Under this plan, for which 140 shares of Common Stock have been reserved for issuance, employees other than executive officers, consultants and independent advisors, may be granted non-qualified stock options. The options granted under this plan as of December 31, 1997 are exercisable quarterly over four years and expire in ten years. F-12 A summary of option activity under all plans is as follows:
OPTIONS OUTSTANDING --------------------------------------------- AVAILABLE FOR SHARES WEIGHTED AGGREGATE GRANT AVERAGE EXERCISE PRICE PRICES - ----------------------------------------------------------------------------------------------------------------------------- BALANCES, JANUARY 1, 1995 232 496 $3.25 $1,611 Authorized 500 -- -- -- Options granted (543) 543 8.89 4,827 Options exercised -- (57) 2.58 (146) Options canceled 271 (271) 9.22 (2,502) - ----------------------------------------------------------------------------------------------------------------------------- BALANCES, DECEMBER 31, 1995 460 711 5.33 3,790 Options granted (460) 460 11.29 5,197 Options exercised -- (140) 3.90 (544) Options canceled 89 (89) 10.17 (569) - ----------------------------------------------------------------------------------------------------------------------------- BALANCES, DECEMBER 31, 1996 89 942 8.36 7,874 Authorized 380 -- -- -- Options granted (371) 371 30.42 11,297 Options exercised -- (156) 5.05 (786) Options canceled 42 (42) 19.25 (811) - ----------------------------------------------------------------------------------------------------------------------------- BALANCES, DECEMBER 31, 1997 140 1,115 $15.75 $17,574 - ----------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------- Exercisable at December 31, 1995 202 $2.40 Exercisable at December 31, 1996 268 $5.12 EXERCISABLE AT DECEMBER 31, 1997 378 $8.84 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding at December 31, 1997:
WEIGHTED AVERAGE WEIGHTED WEIGHTED RANGE OF EXERCISE PRICES NUMBER REMAINING CONTRACTUAL AVERAGE EXERCISE NUMBER AVERAGE OUTSTANDING LIFE PRICE EXERCISABLE EXERCISE PRICE - ----------------------------------------------------------------------------------------------------------------------------- $ 1.17 - $ 4.44 116 5.47 $ 3.35 109 $ 3.29 7.19 - 8.00 351 7.62 7.57 149 7.51 8.44 - 21.75 271 8.18 11.01 98 10.66 27.50 - 27.50 246 10.00 27.50 -- -- 28.75 - 39.88 131 9.20 36.27 22 36.55 - ----------------------------------------------------------------------------------------------------------------------------- $ 1.17 - $39.88 1,115 8.24 $15.75 378 $ 8.84 - ----------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------
The Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock-based compensation plans. Had compensation expense for the Company's stock option plans and stock purchase plan been determined based upon the fair value at the grant date for awards under those plans consistent with the methodology prescribed under SFAS No. 123, the Company's net income, earnings per share - basic and earnings per share-diluted for 1997, 1996 and 1995 would have been reduced by approximately $1,217 or $0.11 and $0.10 per share, $909 or $0.08 and $0.08 per share and $279 or $0.03 and $0.02 per share, respectively. The weighted-average fair value of the options granted during 1997, 1996 and 1995 is estimated as $4,999, $2,054 and $1,581, respectively, on the date of grant using the Black-Scholes option-pricing model with the following weighted- average assumptions used for grants in 1997, 1996 and 1995, respectively: no dividend yield; expected F-13 volatility of 65%, 65% and 65%; risk-free interest rate of 6.1%, 6.0% and 6.0% and expected life of 3.40, 2.68 and 2.80 years. 7. QUARTERLY FINANCIAL INFORMATION (unaudited; in thousands, except per share data) Summarized quarterly financial information for each of the three years ended December 31, 1997, 1996, and 1995 is as follows :
Quarter 1 Quarter 2 Quarter 3 Quarter 4 Year ------------------------------------------------------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, 1997 Net sales $31,511 $37,725 $38,509 $41,296 $149,041 Gross profit 15,406 17,665 18,100 19,611 70,782 Income from operations 5,642 6,398 6,811 7,642 26,493 Net income 3,694 4,223 4,443 5,069 17,429 Earnings per share - basic 0.33 0.37 0.39 0.44 1.53 Earnings per share - diluted 0.31 0.35 0.37 0.42 1.45 ------------------------------------------------------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, 1996 Net sales 19,618 24,752 30,047 33,020 107,437 Gross profit 9,217 11,990 14,142 16,067 51,416 Income from operations 3,157 4,357 5,594 6,464 19,572 Net income 2,099 2,805 3,732 4,217 12,853 Earnings per share - basic 0.19 0.25 0.33 0.37 1.15 Earnings per share - diluted 0.18 0.24 0.31 0.35 1.08 ------------------------------------------------------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, 1995 Net sales 14,666 17,524 15,606 17,752 65,548 Gross profit 6,810 7,876 6,777 7,614 29,077 Income from operations 3,169 3,266 2,522 2,662 11,619 Net income 1,991 2,238 1,786 1,842 7,857 Earnings per share - basic 0.18 0.20 0.16 0.17 0.72 Earnings per share - diluted 0.18 0.20 0.16 0.16 0.70 ------------------------------------------------------------------------------------------------------------------------
8. SUBSEQUENT EVENTS REINCORPORATION In July 1997, the Company's stockholders approved an Agreement and Plan of Merger whereby the Company merged with and into a newly incorporated Delaware corporation ("ENCAD, Inc.") which is the surviving corporation. In conjunction with the merger, each share of the Company's Common Stock and options or rights to acquire shares of Common Stock were exchanged for one share of ENCAD, Inc. Delaware Common Stock, options or rights to acquire Common Stock. The reincorporation became effective in January 1998. STOCKHOLDER RIGHTS AGREEMENT In March 1998, the Company's Board of Directors adopted a preferred stockholder rights plan which provides for a dividend distribution of one preferred share purchase right (a "Right") on each outstanding share of the Common Stock. On March 19, 1998, the Company's Board of Directors declared a dividend of one Right for each outstanding share of Common Stock, payable on April 2, 1998 to stockholders of record on that date. Each Right entitles stockholders to buy 1/1000th of a share of ENCAD Series A Junior Participating Preferred Stock at an exercise price of $80, subject to adjustment. The Rights will become exercisable on the close of business on the first day a person or group announces an acquisition of 15% or more of the Common Stock or on the tenth day after a person or a group commences or announces commencement of a tender offer, the consummation of which would result in ownership by the person or group of 15% or more of the Common Stock. The Company will be entitled to redeem the Rights at $0.01 per Right at any time on or before the close of business on the first date of a public announcement that a person has acquired beneficial ownership of 15% or more of the Common Stock. F-14 EX-10.15 2 EXHIBIT 10.15 EXHIBIT 10.15 FORM OF INDEMNIFICATION AGREEMENT BETWEEN THE COMPANY AND ITS DIRECTORS INDEMNIFICATION AGREEMENT THIS AGREEMENT is made and entered into this ____ day of ___________, 1998 between ENCAD, Inc., a Delaware corporation ("Corporation"), whose address is 6059 Cornerstone Court West, San Diego, California 92121 and ________________ ("Director"). RECITALS: A. WHEREAS, Director, a member of the Board of Directors of Corporation, performs a valuable service in such capacity for Corporation; and B. WHEREAS, the stockholders of Corporation have adopted Bylaws (the "Bylaws") providing for the indemnification of the officers, directors, agents and employees of Corporation to the maximum extent authorized by Section 145 of the Delaware General Corporation Law, as amended (the "Law"); and C. WHEREAS, the Bylaws and the Law, as amended and in effect from time to time or any successor or other statutes of Delaware having similar import and effect, currently purports to be the controlling law governing Corporation with respect to certain aspects of corporate law, including indemnification of directors and officers; and D. WHEREAS, in accordance with the authorization provided by the Law, Corporation may from time to time purchase and maintain a policy or policies of Directors and Officers Liability Insurance ("D & O Insurance"), covering certain liabilities which may be incurred by its directors and officers in the performance of services as directors and officers of Corporation; and E. WHEREAS, as a result of developments affecting the terms, scope and availability of D & O Insurance there exists general uncertainty as to the extent and overall desirability of protection afforded members of the Board of Directors by such D & O Insurance, if any, and by statutory and bylaw indemnification provisions; and F. WHEREAS, in order to induce Director to continue to serve as a member of the Board of Directors of Corporation, Corporation has determined and agreed to enter into this contract with Director. NOW, THEREFORE, in consideration of Director's continued service as a director after the date hereof, the parties hereto agree as follows: 1. CERTAIN DEFINITIONS. The following terms used in this Agreement shall have the meanings set forth below. Other terms are defined where appropriate in this Agreement. (a) "Disinterested Director" shall mean a director of Corporation who is not or was not a party to the Proceeding in respect of which indemnification is being sought by Director. (b) "Expenses" shall include all direct and indirect costs (including, without limitation, attorneys' fees, retainers, court costs, transcripts, fees of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, all other disbursements or out-of-pocket expenses and reasonable compensation for time spent by Director for which he or she is otherwise not compensated by Corporation) actually and reasonably incurred in connection with a Proceeding or establishing or enforcing a right to indemnification under this Agreement, applicable law or otherwise; provided, however, that "Expenses" shall not include any Liabilities. (c) "Final Adverse Determination" shall mean that a determination that Director is not entitled to indemnification shall have been made pursuant to Section 5 hereof and either (i) a final adjudication in a Delaware court or decision of an arbitrator pursuant to Section 13(a) hereof shall have denied Director's right to indemnification hereunder, or (ii) Director shall have failed to file a complaint in a Delaware court or seek an arbitrator's award pursuant to Section 13(a) for a period of one hundred twenty (120) days after the determination made pursuant to Section 5 hereof. (d) "Independent Legal Counsel" shall mean a law firm or member of a law firm selected by Corporation and approved by Director (which approval shall not be unreasonably withheld) and that neither is presently nor in the past five years has been retained to represent: (i) Corporation, in any material matter, or (ii) any other party to the Proceeding giving rise to a claim for indemnification hereunder. Notwithstanding the foregoing, the term "Independent Legal Counsel" shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either Corporation or Director in an action to determine Director's right to indemnification under this Agreement. (e) "Liabilities" shall mean liabilities of any type whatsoever including, but not limited to, any judgments, fines, ERISA excise taxes and penalties, penalties and amounts paid in settlement (including all interest assessments and other charges paid or payable in connection with or in respect of such judgments, fines, penalties or amounts paid in settlement) of any proceeding. (f) "Proceeding" shall mean any threatened, pending or completed action, claim, suit, arbitration, alternative dispute resolution mechanism, investigation, administrative hearing or any other proceeding whether civil, criminal, administrative or investigative, including any appeal therefrom. (g) "Change of Control" shall mean the occurrence of any of the following events after the date of this Agreement: (i) A change in the composition of the Board of Directors of Corporation (the "Board"), as a result of which fewer than two-thirds (2/3) of the incumbent directors are directors who either (1) had been directors of Corporation twenty-four (24) months prior to such change or (2) were elected, or nominated for election, to the Board with the -2- affirmative votes of at least a majority of the directors who had been directors of Corporation 24 months prior to such change and who were still in office at the time of the election or nomination; or (ii) Any "person" (as such term is used in section 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended) through the acquisition or aggregation of securities is or becomes the beneficial owner, directly or indirectly, of securities of Corporation representing twenty percent (20%) or more of the combined voting power of Corporation's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Capital Stock"), except that any change in ownership of Corporation's securities by any person resulting solely from a reduction in the aggregate number of outstanding shares of Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of Corporation. 2. INDEMNITY OF DIRECTOR. Corporation hereby agrees to hold harmless and indemnify Director to the fullest extent authorized or permitted by the provisions of the Law, as may be amended from time to time. 3. ADDITIONAL INDEMNITY. Subject only to the exclusions set forth in Section 4 hereof, Corporation hereby further agrees to hold harmless and indemnify Director: (a) against any and all expenses (including attorneys' fees), witness fees, judgments, fines and amounts paid in settlement actually and reasonably incurred by Director in connection with any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (including an action by or in the right of Corporation) to which Director is, was or at any time becomes a party, or is threatened to be made a party, by reason of the fact that Director is, was or at any time becomes a director, officer, employee or agent of Corporation, or is or was serving or at any time serves at the request of Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise; and (b) otherwise to the fullest extent as may be provided to Director by Corporation under the non-exclusivity provisions of the Bylaws of Corporation and the Law. 4. LIMITATIONS ON ADDITIONAL INDEMNITY. No indemnity pursuant to Section 3 hereof shall be paid by Corporation: (a) except to the extent the aggregate of losses to be indemnified thereunder exceeds the sum of such losses for which the Director is indemnified pursuant to Section 2 hereof or reimbursed pursuant to any D & O Insurance purchased and maintained by Corporation; (b) in respect of remuneration paid to Director if it shall be determined by a final judgment or other final adjudication that such remuneration was in violation of law; (c) on account of any action, suit or proceeding in which judgment is rendered -3- against Director for an accounting of profits made from the purchase or sale by Director of securities of Corporation pursuant to the provisions of Section 16(b) of the Securities Exchange Act of 1934 and amendments thereto or similar provisions of any federal, state or local statutory law; (d) on account of Director's conduct which is finally adjudged to have been knowingly fraudulent or deliberately dishonest, or to constitute willful misconduct if such conduct has been established by a judgment or other final adjudication adverse to Director (an "Adverse Judgment"); (e) provided there has been no Change of Control, on account of or arising in response to any action, suit or proceeding (other than an action, suit or proceeding referred to in Section 14(b) hereof) initiated by Director or any of Director's affiliates against Corporation or any officer, director or stockholder of Corporation unless such action, suit or proceeding was authorized in the specific case by action of the Board of Directors of Corporation; (f) if a final decision by a Court having jurisdiction in the matter shall determine that such indemnification is not lawful; or (g) on account of any action, suit or proceeding to the extent that Director is a plaintiff, a counter-complainant or a cross-complainant therein (other than an action, suit or proceeding permitted by Section 4(e) hereof). 5. PROCEDURE FOR DETERMINATION OF ENTITLEMENT TO INDEMNIFICATION. (a) Whenever Director believes that he or she is entitled to indemnification pursuant to this Agreement, Director shall submit a written request for indemnification to Corporation. Any request for indemnification shall include sufficient documentation or information reasonably available to Director to support his or her claim for indemnification. Director shall submit his or her claim for indemnification within a reasonable time not to exceed five years after any judgment, order, settlement, dismissal, arbitration award, conviction, acceptance of a plea of nolo contendere or its equivalent, final termination or other disposition or partial disposition of any Proceeding, whichever is the later date for which Director requests indemnification. The President or the Secretary or other appropriate officer shall, promptly upon receipt of Director's request for indemnification, advise the Board of Directors in writing that Director has made such a request. Determination of Director's entitlement to indemnification shall be made not later than ninety (90) days after Corporation's receipt of his or her written request for such indemnification. (b) The Director shall be entitled to select the forum in which Director's request for indemnification will be heard, which selection shall be included in the written request for indemnification required in Section 5(a). This forum shall be any one of the following: (i) The stockholders of Corporation; (ii) A quorum of the Board of Directors consisting of Disinterested -4- Directors; (iii) Independent Legal Counsel, who shall make the determination in a written opinion; or (iv) A panel of three arbitrators, one selected by Corporation, another by Director and the third by the first two arbitrators selected. If for any reason three arbitrators are not selected within thirty (30) days after the appointment of the first arbitrator, then selection of additional arbitrators shall be made by the American Arbitration Association. If any arbitrator resigns or is unable to serve in such capacity for any reason, the American Arbitration Association shall select his or her replacement. The arbitration shall be conducted pursuant to the commercial arbitration rules of the American Arbitration Association now in effect. If Director fails to make such designation, his or her claim shall be determined by the forum selected by Corporation. 6. PRESUMPTION AND EFFECT OF CERTAIN PROCEEDINGS. Upon making a request for indemnification, Director shall be presumed to be entitled to indemnification under this Agreement and Corporation shall have the burden of proof to overcome that presumption in reaching any contrary determination. The termination of any Proceeding by judgment, order, settlement, arbitration award or conviction, or upon a plea of nolo contendere or its equivalent shall not affect this presumption or, except as may be provided in Section 4 hereof, establish a presumption with regard to any factual matter relevant to determining Director's rights to indemnification hereunder. If the person or persons so empowered to make a determination pursuant to Section 5(b) hereof shall have failed to make the requested determination within thirty (30) days after any judgment, order, settlement, dismissal, arbitration award, conviction, acceptance of a plea of nolo contendere or its equivalent, or other disposition or partial disposition of any Proceeding or any other event which could enable Corporation to determine Director's entitlement to indemnification, the requisite determination that Director is entitled to indemnification shall be deemed to have been made. 7. CONTRIBUTION. If the indemnification provided in Sections 2 and 3 is unavailable and may not be paid to Director for any reason other than those set forth in Section 4, then in respect of any threatened, pending or completed action, suit or proceeding in which Corporation is or is alleged to be jointly liable with Director (or would be if joined in such action, suit or proceeding), Corporation shall contribute to the amount of expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred and paid or payable by Director in such proportion as is appropriate to reflect (i) the relative benefits received by Corporation on the one hand and Director on the other hand from the transaction from which such action, suit or proceeding arose, and (ii) the relative fault of Corporation on the one hand and of Director on the other hand in connection with the events which resulted in such expenses, judgments, fines or settlement amounts, as well as any other relevant equitable considerations. The relative fault of Corporation on the one hand and of Director on the other shall be determined by reference to, among other things, the parties' relative intent, knowledge, access to information and opportunity to correct or prevent the circumstances resulting in such expenses, judgments, fines or settlement amounts. Corporation agrees that it would not be just and -5- equitable if contribution pursuant to this Section 7 were determined by pro rata allocation or any other method of allocation which does not take account of the foregoing equitable considerations. 8. INSURANCE AND FUNDING. Corporation hereby represents and warrants that it shall purchase and maintain insurance to protect itself and/or Director against any Expenses and Liabilities in connection with any Proceeding to the fullest extent permitted by the Law. In the event of a Change of Control, Corporation shall establish a letter of credit, as provided in Section 9, to ensure the payment of such amounts as may be necessary to effect indemnification or advancement of Expenses as provided in this Agreement. 9. LETTER OF CREDIT. (a) In order to secure the obligations of Corporation to indemnify and advance Expenses to Director pursuant to this Agreement, Corporation shall obtain at the time of any Change of Control, upon request of any director, an irrevocable standby letter of credit naming the directors of the Corporation in office at the time of a Change of Control as joint beneficiaries (the "Letter of Credit"). The Letter of Credit shall be in an appropriate amount not less than two million dollars ($2,000,000), shall be issued by a commercial bank headquartered in the United States having assets in excess of $10 billion and capital according to its most recent published reports equal to or greater than the then applicable minimum capital standards promulgated by such bank's primary federal regulator and shall contain terms and conditions reasonably acceptable to all directors. The Letter of Credit shall provide that Director may from time to time draw certain amounts thereunder, upon written certification by Director to the issuer of the Letter of Credit that (i) Director has made written request upon Corporation for an amount not less than the amount he or she is drawing under the Letter of Credit and that Corporation has failed or refused to provide him with such amount in full within thirty (30) days after receipt of the request, and (ii) Director believes that he or she is entitled under the terms of this Agreement to the amount which he or she is drawing upon under the Letter of Credit. The issuance of the Letter of Credit shall not, in any way, diminish Corporation's obligation to indemnify Director against Expenses and Liabilities to the full extent required by this Agreement. (b) Once Corporation has obtained the Letter of Credit, Corporation shall maintain and renew the Letter of Credit or substitute letter of credit meeting the criteria of Section 9(a) during the term of this Agreement so that the Letter of Credit shall have an initial term of five years, be renewed for successive five-year terms, and always have at least one year of its term remaining. 10. CONTINUATION OF OBLIGATIONS. All agreements and obligations of Corporation contained herein shall continue during the period Director is a director, officer, employee or agent of Corporation (or is or was serving at the request of Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise) and shall continue thereafter so long as Director shall be subject to any possible claim or threatened, pending or completed action, suit or proceeding, whether civil, criminal or investigative, by reason of the fact that Director was serving Corporation or such other entity in any capacity referred to herein. -6- 11. NOTIFICATION AND DEFENSE OF CLAIM. Promptly after receipt by Director of notice of the commencement of any action, suit or proceeding, Director will, if a claim in respect thereof is to be made against Corporation under this Agreement, notify Corporation of the commencement thereof; but the omission so to notify Corporation will not relieve it from any liability which it may have to Director otherwise than under this Agreement. With respect to any such action, suit or proceeding as to which Director notifies Corporation of the commencement thereof: (a) Corporation will be entitled to participate therein at its own expense; (b) Except as otherwise provided below, to the extent that it may wish, Corporation jointly with any other indemnifying party similarly notified will be entitled to assume the defense thereof, with counsel reasonably satisfactory to Director. After notice from Corporation to Director of its election to assume the defense thereof, Corporation will not be liable to Director under this Agreement for any legal or other expenses subsequently incurred by Director in connection with the defense thereof other than reasonable costs of investigation or as otherwise provided below. Director shall have the right to employ his or her own counsel in such action, suit or proceeding but the fees and expenses of such counsel incurred after notice from Corporation of its assumption of the defense thereof shall be at the expense of Director unless (i) the employment of counsel by Director has been authorized by Corporation, (ii) Director shall have reasonably concluded that there may be a conflict of interest between Corporation and Director in the conduct of the defense of such action or (iii) Corporation shall not in fact have employed counsel to assume the defense of such action, in each of which cases the fees and expenses of Director's separate counsel shall be at the expense of Corporation. Corporation shall not be entitled to assume the defense of any action, suit or proceeding brought by or on behalf of Corporation or as to which Director shall have made the conclusion provided for in (ii) above; and (c) Provided there has been no Change of Control, Corporation shall not be liable to indemnify Director under this Agreement for any amounts paid in settlement of any action or claim effected without its written consent, which consent shall not be unreasonably withheld. Corporation shall be permitted to settle any action except that it shall not settle any action or claim in any manner which would impose any penalty, out-of-pocket liability, or limitation on Director without Director's written consent. 12. ADVANCEMENT AND REPAYMENT OF EXPENSES. (a) In the event that Director employs his or her own counsel pursuant to Section 11(b)(i) through (iii) above, Corporation shall advance to Director, prior to any final disposition of any threatened or pending action, suit or proceeding, whether civil, criminal, administrative or investigative, any and all reasonable expenses (including legal fees and expenses) incurred in investigating or defending any such action, suit or proceeding within ten (10) days after receiving copies of invoices presented to Director for such expenses. (b) Director agrees that Director will reimburse Corporation for all reasonable expenses paid by Corporation in defending any civil or criminal action, suit or proceeding against Director in the event and only to the extent it shall be ultimately determined by a final judicial -7- decision (from which there is no right of appeal) that Director is not entitled, under the provisions of the Law, the Bylaws, this Agreement or otherwise, to be indemnified by Corporation for such expenses. 13. REMEDIES OF DIRECTOR. (a) In the event that (i) a determination pursuant to Section 5 hereof is made that Director is not entitled to indemnification, (ii) advances of Expenses are not made pursuant to this Agreement, (iii) payment has not been timely made following a determination of entitlement to indemnification pursuant to this Agreement, or (iv) Director otherwise seeks enforcement of this Agreement, Director shall be entitled to a final adjudication in an appropriate court of his or her rights. Alternatively, Director at his or her option may seek an award in arbitration to be conducted by a single arbitrator pursuant to the commercial arbitration rules of the American Arbitration Association now in effect, whose decision is to be made within ninety (90) days following the filing of the demand for arbitration. The Corporation shall not oppose Director's right to seek any such adjudication or arbitration award. (b) In the event that a determination that Director is not entitled to indemnification, in whole or in part, has been made pursuant to Section 5 hereof, the decision in the judicial proceeding or arbitration provided in paragraph (a) of this Section 13 shall be made de novo and Director shall not be prejudiced by reason of a determination that he or she is not entitled to indemnification. (c) If a determination that Director is entitled to indemnification has been made pursuant to Section 5 hereof or otherwise pursuant to the terms of this Agreement, Corporation shall be bound by such determination in the absence of (i) a misrepresentation of a material fact by Director or (ii) a specific finding (which has become final) by an appropriate court that all or any part of such indemnification is expressly prohibited by law. (d) In any court proceeding pursuant to this Section 13, Corporation shall be precluded from asserting that the procedures and presumptions of this Agreement are not valid, binding and enforceable. The Corporation shall stipulate in any such court or before any such arbitrator that Corporation is bound by all the provisions of this Agreement and is precluded from making any assertion to the contrary. (e) Expenses reasonably incurred by Director in connection with his or her request for indemnification under this Agreement, meeting enforcement of this Agreement or to recover damages for breach of this Agreement shall be borne by Corporation. (f) Corporation and Director agree herein that a monetary remedy for breach of this Agreement, at some later date, will be inadequate, impracticable and difficult of proof, and further agree that such breach would cause Director irreparable harm. Accordingly, Corporation and Director agree that Director shall be entitled to temporary and permanent injunctive relief to enforce this Agreement without the necessity of proving actual damages or irreparable harm. The Corporation and Director further agree that Director shall be entitled to such injunctive relief, including temporary restraining orders, preliminary injunctions and -8- permanent injunctions, without the necessity of posting bond or other undertaking in connection therewith. Any such requirement of bond or undertaking is hereby waived by Corporation, and Corporation acknowledges that in the absence of such a waiver, a bond or undertaking may be required by the court. 14. ENFORCEMENT. (a) Corporation expressly confirms and agrees that it has entered into this Agreement and assumed the obligations imposed on Corporation hereby in order to induce Director to continue as a director of Corporation, and acknowledges that Director is relying upon this Agreement in continuing in such capacity. (b) In the event Director is required to bring any action to enforce rights or to collect moneys due under this Agreement and is successful in such action, the Corporation shall reimburse Director for all Director's reasonable fees and expenses in bringing and pursuing such action. 15. SEPARABILITY. Each of the provisions of this Agreement is a separate and distinct agreement and independent of the others, so that if any or all of the provisions hereof shall be held to be invalid or unenforceable to any extent for any reason, such invalidity or unenforceability shall not affect the validity or enforceability of the other provisions hereof, or the obligation of the Corporation to indemnify the Director to the full extent provided by the Bylaws or the Law, and the affected provision shall be construed and enforced so as to effectuate the parties' intent to the maximum extent possible. 16. GOVERNING LAW. This Agreement shall be governed by and interpreted and enforced in accordance with the internal laws of the State of Delaware. 17. CONSENT TO JURISDICTION. The Corporation and Director each irrevocably consent to jurisdiction of the courts of the State of California for all purposes in connection with any action or proceeding which arises out of or relates to this Agreement and agree that any action instituted under this Agreement shall be brought only in the state courts of the State of California. 18. BINDING EFFECT. This Agreement shall be binding upon Director and upon Corporation, its successors and assigns, and shall inure to the benefit of Director, his or her heirs, executors, administrators, personal representatives and assigns and to the benefit of Corporation, its successors and assigns. 19. ENTIRE AGREEMENT. This Agreement represents the entire agreement between the parties hereto and there are no other agreements, contracts or understandings between the parties hereto with respect to the subject matter of this Agreement, except as specifically referred to herein. This Agreement supersedes any and all agreements regarding indemnification heretofore entered into by the parties. 20. AMENDMENT AND TERMINATION. No amendment, modification, waiver, termination or cancellation of this Agreement shall be effective for any purpose unless set forth in writing -9- signed by both parties hereto. 21. SUBROGATION. In the event of payment under this agreement, Corporation shall be subrogated to the extent of such payment to all of the rights of recovery of Director, who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable Corporation effectively to bring suit to enforce such rights. 22. NON-EXCLUSIVITY OF RIGHTS. The rights conferred on Director by this Agreement shall not be exclusive of any other right which Director may have or hereafter acquire under any statute, provision of Corporation's Certificate of Incorporation or Bylaws, agreement, vote of stockholders or directors, or otherwise, both as to action in his official capacity and as to action in another capacity while holding office. 23. SURVIVAL OF RIGHTS. The rights conferred on Director by this Agreement shall continue after Director has ceased to be a director, officer, employee or other agent of Corporation or such other entity. 24. NOTICES. All notices, requests, demands and other communications hereunder shall be in writing and shall be addressed to Director or to Corporation, as the case may be, at the address shown on page 1 of this Agreement, or to such other address as may have been furnished by either party to the other, and shall be deemed to have been duly given if (i) delivered by hand and receipted for by the party to whom said notice or other communication shall have been directed, or (ii) mailed by certified or registered mail with postage prepaid, on the third business day after the date on which it is so mailed. IN WITNESS WHEREOF, the parties hereto have executed this Agreement on and as of the day and year first above written. DIRECTOR: ENCAD, INC. By: - ----------------------- -------------------------- (Signature) - ----------------------- -------------------------- Print Name Print Name and Title - ----------------------- Address - ----------------------- -10- EX-10.16 3 EXHIBIT 10.16 EXHIBIT 10.16 FORM OF INDEMNIFICATION AGREEMENT BETWEEN THE COMPANY AND ITS OFFICERS INDEMNIFICATION AGREEMENT THIS AGREEMENT is made and entered into this ____ day of ___________, 1998 between ENCAD, Inc., a Delaware corporation ("Corporation"), whose address is 6059 Cornerstone Court West, San Diego, California 92121 and __________________ ("Officer"). RECITALS: A. WHEREAS, Officer, an officer (but not currently a member of the Board of Directors) of Corporation, performs a valuable service in such capacity for Corporation; and B. WHEREAS, the stockholders of Corporation have adopted Bylaws (the "Bylaws") providing for the indemnification of the officers, directors, agents and employees of Corporation to the maximum extent authorized by Section 145 of the Delaware General Corporation Law, as amended (the "Law"); and C. WHEREAS, the Bylaws and the Law, as amended and in effect from time to time or any successor or other statutes of Delaware having similar import and effect, currently purports to be the controlling law governing Corporation with respect to certain aspects of corporate law, including indemnification of directors and officers; and D. WHEREAS, in accordance with the authorization provided by the Law, Corporation may from time to time purchase and maintain a policy or policies of Directors and Officers Liability Insurance ("D & O Insurance"), covering certain liabilities which may be incurred by its directors and officers in the performance of services as directors and officers of Corporation; and E. WHEREAS, as a result of developments affecting the terms, scope and availability of D & O Insurance there exists general uncertainty as to the extent and overall desirability of protection afforded officers by such D & O Insurance, if any, and by statutory and bylaw indemnification provisions; and F. WHEREAS, in order to induce Officer to continue to serve as an officer of Corporation, Corporation has determined and agreed to enter into this contract with Officer. NOW, THEREFORE, in consideration of Officer's continued service as an officer after the date hereof, the parties hereto agree as follows: 1. CERTAIN DEFINITIONS. The following terms used in this Agreement shall have the meanings set forth below. Other terms are defined where appropriate in this Agreement. (a) "Disinterested Director" shall mean a director of Corporation who is not or was not a party to the Proceeding in respect of which indemnification is being sought by Officer. (b) "Expenses" shall include all direct and indirect costs (including, without limitation, attorneys' fees, retainers, court costs, transcripts, fees of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, all other disbursements or out-of-pocket expenses and reasonable compensation for time spent by Officer for which he or she is otherwise not compensated by Corporation) actually and reasonably incurred in connection with a Proceeding or establishing or enforcing a right to indemnification under this Agreement, applicable law or otherwise; provided, however, that "Expenses" shall not include any Liabilities. (c) "Final Adverse Determination" shall mean that a determination that Officer is not entitled to indemnification shall have been made pursuant to Section 5 hereof and either (i) a final adjudication in a Delaware court or decision of an arbitrator pursuant to Section 13(a) hereof shall have denied Officer's right to indemnification hereunder, or (ii) Officer shall have failed to file a complaint in a Delaware court or seek an arbitrator's award pursuant to Section 13(a) for a period of one hundred twenty (120) days after the determination made pursuant to Section 5 hereof. (d) "Independent Legal Counsel" shall mean a law firm or member of a law firm selected by Corporation and approved by Officer (which approval shall not be unreasonably withheld) and that neither is presently nor in the past five years has been retained to represent: (i) Corporation, in any material matter, or (ii) any other party to the Proceeding giving rise to a claim for indemnification hereunder. Notwithstanding the foregoing, the term "Independent Legal Counsel" shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either Corporation or Officer in an action to determine Officer's right to indemnification under this Agreement. (e) "Liabilities" shall mean liabilities of any type whatsoever including, but not limited to, any judgments, fines, ERISA excise taxes and penalties, and penalties and amounts paid in settlement (including all interest assessments and other charges paid or payable in connection with or in respect of such judgments, fines, penalties or amounts paid in settlement) of any proceeding. (f) "Proceeding" shall mean any threatened, pending or completed action, claim, suit, arbitration, alternative dispute resolution mechanism, investigation, administrative hearing or any other proceeding whether civil, criminal, administrative or investigative, including any appeal therefrom. (g) "Change of Control" shall mean the occurrence of any of the following events after the date of this Agreement: (i) A change in the composition of the Board of Directors of Corporation (the "Board"), as a result of which fewer than two-thirds (2/3) of the incumbent directors are directors who either (1) had been directors of Corporation twenty-four (24) months prior to such change or (2) were elected, or nominated for election, to the Board with the affirmative votes of at least a majority of the directors who had been directors of Corporation 24 months prior to such change and who were still in office at the time of the election or nomination; or (ii) Any "person" (as such term is used in section 13(d) and 14(d) of -2- the Securities Exchange Act of 1934, as amended) through the acquisition or aggregation of securities is or becomes the beneficial owner, directly or indirectly, of securities of Corporation representing twenty percent (20%) or more of the combined voting power of Corporation's then outstanding securities ordinarily (and apart from rights accruing under special circumstances) having the right to vote at elections of directors (the "Capital Stock"), except that any change in ownership of Corporation's securities by any person resulting solely from a reduction in the aggregate number of outstanding shares of Capital Stock, and any decrease thereafter in such person's ownership of securities, shall be disregarded until such person increases in any manner, directly or indirectly, such person's beneficial ownership of any securities of Corporation. 2. INDEMNITY OF OFFICER. Corporation hereby agrees to hold harmless and indemnify Officer to the fullest extent authorized or permitted by the provisions of the Law, as may be amended from time to time. 3. ADDITIONAL INDEMNITY. Subject only to the exclusions set forth in Section 4 hereof, Corporation hereby further agrees to hold harmless and indemnify Officer: (a) against any and all legal expenses (including attorneys' fees), witness fees, judgments, fines and amounts paid in settlement actually and reasonably incurred by Officer in connection with any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (including an action by or in the right of Corporation) to which Officer is, was or at any time becomes a party, or is threatened to be made a party, by reason of the fact that Officer is, was or at any time becomes a director, officer, employee or agent of Corporation, or is or was serving or at any time serves at the request of Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise; and (b) otherwise to the fullest extent as may be provided to Officer by Corporation under the non-exclusivity provisions of the Bylaws of Corporation and the Law. 4. LIMITATIONS ON ADDITIONAL INDEMNITY. No indemnity pursuant to Section 3 hereof shall be paid by Corporation: (a) except to the extent the aggregate of losses to be indemnified thereunder exceeds the sum of such losses for which Officer is indemnified pursuant to Section 2 hereof or reimbursed pursuant to any D & O Insurance purchased and maintained by Corporation; (b) in respect of remuneration paid to Officer if it shall be determined by a final judgment or other final adjudication that such remuneration was in violation of law; (c) on account of any action, suit or proceeding in which judgment is rendered against Officer for an accounting of profits made from the purchase or sale by Officer of securities of Corporation pursuant to the provisions of Section 16(b) of the Securities Exchange Act of 1934 and amendments thereto or similar provisions of any federal, state or local statutory law; -3- (d) on account of Officer's conduct which is finally adjudged to have been knowingly fraudulent or deliberately dishonest, or to constitute willful misconduct if such conduct has been established by a judgment or other final adjudication adverse to Officer (an "Adverse Judgment"); (e) provided there has been no Change of Control, on account of or arising in response to any action, suit or proceeding (other than an action, suit or proceeding referred to in Section 14(b) hereof) initiated by Officer or any of Officer's affiliates against Corporation or any officer, director or stockholder of Corporation unless such action, suit or proceeding was authorized in the specific case by action of the Board of Directors of Corporation; (f) if a final decision by a Court having jurisdiction in the matter shall determine that such indemnification is not lawful; or (g) on account of any action, suit or proceeding to the extent that Officer is a plaintiff, a counter-complainant or a cross-complainant therein (other than an action, suit or proceeding permitted by Section 4(e) hereof). 5. PROCEDURE FOR DETERMINATION OF ENTITLEMENT TO INDEMNIFICATION. (a) Whenever Officer believes that he or she is entitled to indemnification pursuant to this Agreement, Officer shall submit a written request for indemnification to Corporation. Any request for indemnification shall include sufficient documentation or information reasonably available to Officer to support his or her claim for indemnification. Officer shall submit his or her claim for indemnification within a reasonable time not to exceed five years after any judgment, order, settlement, dismissal, arbitration award, conviction, acceptance of a plea of nolo contendere or its equivalent, final termination or other disposition or partial disposition of any Proceeding, whichever is the later date for which Officer requests indemnification. The President or the Secretary or other appropriate officer shall, promptly upon receipt of Officer's request for indemnification, advise the Board of Directors in writing that Officer has made such a request. Determination of Officer's entitlement to indemnification shall be made not later than ninety (90) days after Corporation's receipt of his or her written request for such indemnification. (b) The Officer shall be entitled to select the forum in which Officer's request for indemnification will be heard, which selection shall be included in the written request for indemnification required in Section 5(a). This forum shall be any one of the following: (i) The stockholders of Corporation; (ii) A quorum of the Board of Directors consisting of Disinterested Directors; (iii) Independent Legal Counsel, who shall make the determination in a written opinion; or -4- (iv) A panel of three arbitrators, one selected by Corporation, another by Officer and the third by the first two arbitrators selected. If for any reason three arbitrators are not selected within thirty (30) days after the appointment of the first arbitrator, then selection of additional arbitrators shall be made by the American Arbitration Association. If any arbitrator resigns or is unable to serve in such capacity for any reason, the American Arbitration Association shall select his or her replacement. The arbitration shall be conducted pursuant to the commercial arbitration rules of the American Arbitration Association now in effect. If Officer fails to make such designation, his or her claim shall be determined by the forum selected by Corporation. 6. PRESUMPTION AND EFFECT OF CERTAIN PROCEEDINGS. Upon making a request for indemnification, Officer shall be presumed to be entitled to indemnification under this Agreement and Corporation shall have the burden of proof to overcome that presumption in reaching any contrary determination. The termination of any Proceeding by judgment, order, settlement, arbitration award or conviction, or upon a plea of nolo contendere or its equivalent shall not affect this presumption or, except as may be provided in Section 4 hereof, establish a presumption with regard to any factual matter relevant to determining Officer's rights to indemnification hereunder. If the person or persons so empowered to make a determination pursuant to Section 5(b) hereof shall have failed to make the requested determination within thirty (30) days after any judgment, order, settlement, dismissal, arbitration award, conviction, acceptance of a plea of nolo contendere or its equivalent, or other disposition or partial disposition of any Proceeding or any other event which could enable Corporation to determine Officer's entitlement to indemnification, the requisite determination that Officer is entitled to indemnification shall be deemed to have been made. 7. CONTRIBUTION. If the indemnification provided in Sections 2 and 3 is unavailable and may not be paid to Officer for any reason other than those set forth in Section 4, then in respect of any threatened, pending or completed action, suit or proceeding in which Corporation is or is alleged to be jointly liable with Officer (or would be if joined in such action, suit or proceeding), Corporation shall contribute to the amount of expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred and paid or payable by Officer in such proportion as is appropriate to reflect (i) the relative benefits received by Corporation on the one hand and Officer on the other hand from the transaction from which such action, suit or proceeding arose, and (ii) the relative fault of Corporation on the one hand and of Officer on the other hand in connection with the events which resulted in such expenses, judgments, fines or settlement amounts, as well as any other relevant equitable considerations. The relative fault of Corporation on the one hand and of Officer on the other shall be determined by reference to, among other things, the parties' relative intent, knowledge, access to information and opportunity to correct or prevent the circumstances resulting in such expenses, judgments, fines or settlement amounts. Corporation agrees that it would not be just and equitable if contribution pursuant to this Section 7 were determined by pro rata allocation or any other method of allocation which does not take account of the foregoing equitable considerations. 8. INSURANCE AND FUNDING. Corporation hereby represents and warrants that it shall purchase and maintain insurance to protect itself and/or Officer against any Expenses and -5- Liabilities in connection with any Proceeding to the fullest extent permitted by the Law. In the event of a Change of Control, Corporation shall establish a letter of credit, as provided in Section 9, to ensure the payment of such amounts as may be necessary to effect indemnification or advancement of Expenses as provided in this Agreement. 9. LETTER OF CREDIT. (a) In order to secure the obligations of Corporation to indemnify and advance Expenses to Officer pursuant to this Agreement, Corporation shall obtain at the time of any Change of Control, upon request of any officer, an irrevocable standby letter of credit naming the officers of the Corporation in office at the time of a Change of Control as joint beneficiaries (the "Letter of Credit"). The Letter of Credit shall be in an appropriate amount not less than one million dollars ($1,000,000), shall be issued by a commercial bank headquartered in the United States having assets in excess of $10 billion and capital according to its most recent published reports equal to or greater than the then applicable minimum capital standards promulgated by such bank's primary federal regulator and shall contain terms and conditions reasonably acceptable to all directors. The Letter of Credit shall provide that Officer may from time to time draw certain amounts thereunder, upon written certification by Officer to the issuer of the Letter of Credit that (i) Officer has made written request upon Corporation for an amount not less than the amount he or she is drawing under the Letter of Credit and that Corporation has failed or refused to provide him with such amount in full within thirty (30) days after receipt of the request, and (ii) Officer believes that he or she is entitled under the terms of this Agreement to the amount which he or she is drawing upon under the Letter of Credit. The issuance of the Letter of Credit shall not, in any way, diminish Corporation's obligation to indemnify Officer against Expenses and Liabilities to the full extent required by this Agreement. (b) Once Corporation has obtained the Letter of Credit, Corporation shall maintain and renew the Letter of Credit or substitute letter of credit meeting the criteria of Section 9(a) during the term of this Agreement so that the Letter of Credit shall have an initial term of five years, be renewed for successive five-year terms, and always have at least one year of its term remaining. 10. CONTINUATION OF OBLIGATIONS. All agreements and obligations of Corporation contained herein shall continue during the period Officer is a director, officer, employee or agent of Corporation (or is or was serving at the request of Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan or other enterprise) and shall continue thereafter so long as Officer shall be subject to any possible claim or threatened, pending or completed action, suit or proceeding, whether civil, criminal or investigative, by reason of the fact that Officer was serving Corporation or such other entity in any capacity referred to herein. 11. NOTIFICATION AND DEFENSE OF CLAIM. Promptly after receipt by Officer of notice of the commencement of any action, suit or proceeding, Officer will, if a claim in respect thereof is to be made against Corporation under this Agreement, notify Corporation of the commencement thereof; but the omission so to notify Corporation will not relieve it from any liability which it may have to Officer otherwise than under this Agreement. With respect to any such action, suit -6- or proceeding as to which Officer notifies Corporation of the commencement thereof: (a) Corporation will be entitled to participate therein at its own expense; (b) Except as otherwise provided below, to the extent that it may wish, Corporation jointly with any other indemnifying party similarly notified will be entitled to assume the defense thereof, with counsel reasonably satisfactory to Officer. After notice from Corporation to Officer of its election to assume the defense thereof, Corporation will not be liable to Officer under this Agreement for any legal or other expenses subsequently incurred by Officer in connection with the defense thereof other than reasonable costs of investigation or as otherwise provided below. Officer shall have the right to employ his or her own counsel in such action, suit or proceeding but the fees and expenses of such counsel incurred after notice from Corporation of its assumption of the defense thereof shall be at the expense of Officer unless (i) the employment of counsel by Officer has been authorized by Corporation, (ii) Officer shall have reasonably concluded that there may be a conflict of interest between Corporation and Officer in the conduct of the defense of such action or (iii) Corporation shall not in fact have employed counsel to assume the defense of such action, in each of which cases the fees and expenses of Officer's separate counsel shall be at the expense of Corporation. Corporation shall not be entitled to assume the defense of any action, suit or proceeding brought by or on behalf of Corporation or as to which Officer shall have made the conclusion provided for in (ii) above; and (c) Provided there has been no Change of Control, Corporation shall not be liable to indemnify Officer under this Agreement for any amounts paid in settlement of any action or claim effected without its written consent, which consent shall not be unreasonably withheld. Corporation shall be permitted to settle any action except that it shall not settle any action or claim in any manner which would impose any penalty, out-of-pocket liability, or limitation on Officer without Officer's written consent. 12. ADVANCEMENT AND REPAYMENT OF EXPENSES. (a) In the event that Officer employs his or her own counsel pursuant to Section 11(b)(i) through (iii) above, Corporation shall advance to Officer, prior to any final disposition of any threatened or pending action, suit or proceeding, whether civil, criminal, administrative or investigative, any and all reasonable expenses (including legal fees and expenses) incurred in investigating or defending any such action, suit or proceeding within ten (10) days after receiving copies of invoices presented to Officer for such expenses. (b) Officer agrees that Officer will reimburse Corporation for all reasonable expenses paid by Corporation in defending any civil or criminal action, suit or proceeding against Officer in the event and only to the extent it shall be ultimately determined by a final judicial decision (from which there is no right of appeal) that Officer is not entitled, under the provisions of the Law, the Bylaws, this Agreement or otherwise, to be indemnified by Corporation for such expenses. 13. REMEDIES OF OFFICER. -7- (a) In the event that (i) a determination pursuant to Section 5 hereof is made that Officer is not entitled to indemnification, (ii) advances of Expenses are not made pursuant to this Agreement, (iii) payment has not been timely made following a determination of entitlement to indemnification pursuant to this Agreement, or (iv) Officer otherwise seeks enforcement of this Agreement, Officer shall be entitled to a final adjudication in an appropriate court of his or her rights. Alternatively, Officer at his or her option may seek an award in arbitration to be conducted by a single arbitrator pursuant to the commercial arbitration rules of the American Arbitration Association now in effect, whose decision is to be made within ninety (90) days following the filing of the demand for arbitration. The Corporation shall not oppose Officer's right to seek any such adjudication or arbitration award. (b) In the event that a determination that Officer is not entitled to indemnification, in whole or in part, has been made pursuant to Section 5 hereof, the decision in the judicial proceeding or arbitration provided in paragraph (a) of this Section 13 shall be made de novo and Officer shall not be prejudiced by reason of a determination that he or she is not entitled to indemnification. (c) If a determination that Officer is entitled to indemnification has been made pursuant to Section 5 hereof or otherwise pursuant to the terms of this Agreement, Corporation shall be bound by such determination in the absence of (i) a misrepresentation of a material fact by Officer or (ii) a specific finding (which has become final) by an appropriate court that all or any part of such indemnification is expressly prohibited by law. (d) In any court proceeding pursuant to this Section 13, Corporation shall be precluded from asserting that the procedures and presumptions of this Agreement are not valid, binding and enforceable. The Corporation shall stipulate in any such court or before any such arbitrator that Corporation is bound by all the provisions of this Agreement and is precluded from making any assertion to the contrary. (e) Expenses reasonably incurred by Officer in connection with his or her request for indemnification under this Agreement, meeting enforcement of this Agreement or to recover damages for breach of this Agreement shall be borne by Corporation. (f) Corporation and Officer agree herein that a monetary remedy for breach of this Agreement, at some later date, will be inadequate, impracticable and difficult of proof, and further agree that such breach would cause Officer irreparable harm. Accordingly, Corporation and Officer agree that Officer shall be entitled to temporary and permanent injunctive relief to enforce this Agreement without the necessity of proving actual damages or irreparable harm. The Corporation and Officer further agree that Officer shall be entitled to such injunctive relief, including temporary restraining orders, preliminary injunctions and permanent injunctions, without the necessity of posting bond or other undertaking in connection therewith. Any such requirement of bond or undertaking is hereby waived by Corporation, and Corporation acknowledges that in the absence of such a waiver, a bond or undertaking may be required by the court. 14. ENFORCEMENT. -8- (a) Corporation expressly confirms and agrees that it has entered into this Agreement and assumed the obligations imposed on Corporation hereby in order to induce Officer to continue as an officer of Corporation, and acknowledges that Officer is relying upon this Agreement in continuing in such capacity. (b) In the event Officer is required to bring any action to enforce rights or to collect moneys due under this Agreement and is successful in such action, the Corporation shall reimburse Officer for all of Officer's reasonable fees and expenses in bringing and pursuing such action. 15. SEPARABILITY. Each of the provisions of this Agreement is a separate and distinct agreement and independent of the others, so that if any or all of the provisions hereof shall be held to be invalid or unenforceable to any extent for any reason, such invalidity or unenforceability shall not affect the validity or enforceability of the other provisions hereof, or the obligation of the Corporation to indemnify the Officer to the full extent provided by the Bylaws or the Law, and the affected provision shall be construed and enforced so as to effectuate the parties' intent to the maximum extent possible. 16. GOVERNING LAW. This Agreement shall be governed by and interpreted and enforced in accordance with the internal laws of the State of Delaware. 17. CONSENT TO JURISDICTION. The Corporation and Officer each irrevocably consent to jurisdiction of the courts of the State of California for all purposes in connection with any action or proceeding which arises out of or relates to this Agreement and agree that any action instituted under this Agreement shall be brought only in the state courts of the State of California. 18. BINDING EFFECT. This Agreement shall be binding upon Officer and upon Corporation, its successors and assigns, and shall inure to the benefit of Officer, his or her heirs, executors, administrators, personal representatives and assigns and to the benefit of Corporation, its successors and assigns. 19. ENTIRE AGREEMENT. This Agreement represents the entire agreement between the parties hereto and there are no other agreements, contracts or understandings between the parties hereto with respect to the subject matter of this Agreement, except as specifically referred to herein. This Agreement supersedes any and all agreements regarding indemnification heretofore entered into by the parties. 20. AMENDMENT AND TERMINATION. No amendment, modification, waiver, termination or cancellation of this Agreement shall be effective for any purpose unless set forth in writing signed by both parties hereto. 21. SUBROGATION. In the event of payment under this agreement, Corporation shall be subrogated to the extent of such payment to all of the rights of recovery of Officer, who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable Corporation effectively to bring suit to enforce such rights. -9- 22. NON-EXCLUSIVITY OF RIGHTS. The rights conferred on Officer by this Agreement shall not be exclusive of any other right which Officer may have or hereafter acquire under any statute, provision of Corporation's Certificate of Incorporation or Bylaws, agreement, vote of stockholders or directors, or otherwise, both as to action in his official capacity and as to action in another capacity while holding office. 23. SURVIVAL OF RIGHTS. The rights conferred on Officer by this Agreement shall continue after Officer has ceased to be a director, officer, employee or other agent of Corporation or such other entity. 24. NOTICES. All notices, requests, demands and other communications hereunder shall be in writing and shall be addressed to Officer or to Corporation, as the case may be, at the address shown on page 1 of this Agreement, or to such other address as may have been furnished by either party to the other, and shall be deemed to have been duly given if (i) delivered by hand and receipted for by the party to whom said notice or other communication shall have been directed, or (ii) mailed by certified or registered mail with postage prepaid, on the third business day after the date on which it is so mailed. IN WITNESS WHEREOF, the parties hereto have executed this Agreement on and as of the day and year first above written. Officer: ENCAD, INC. By: - ------------------- ------------------------ (Signature) (Signature) - ------------------- ------------------------ Print Name Print Name and Title - ------------------- Address - ------------------- -10- EX-21.1 4 EXHIBIT 21.1 EXHIBIT 21.1 SUBSIDIARIES ENCAD INTERNATIONAL INCORPORATED (FOREIGN SALES CORPORATION IN U.S. VIRGIN ISLANDS) ENCAD EUROPE, S.A. (SALES OFFICE) ENCAD Ltd. (SALES OFFICE) ENCAD GmbH (SALES OFFICE) EX-23.1 5 EXHIBIT 23.1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT To the Board of Directors and Stockholders of ENCAD, Inc. We consent to the incorporation by reference in Registration Statements No. 333-24965, No. 333-44923 and No. 333-45327 of ENCAD, Inc. on Form S-8 of our report dated January 30, 1998 (March 19, 1998 as to the last paragraph of Note 8), incorporated by reference in this Annual report on Form 10-K of ENCAD, Inc. for the year ended December 31, 1997. DELOITTE & TOUCHE LLP San Diego, California March 26, 1998 EX-27.1 6 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ENCAD, INC. DECEMBER 31, 1997 FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1,265 0 36,800 0 29,155 72,118 23,256 8,431 90,295 24,300 0 0 0 12 17,577 90,295 149,041 149,041 78,259 78,259 44,289 0 0 26,528 9,099 17,429 0 0 0 17,429 1.53 1.45
EX-27.2 7 EXHIBIT 27.2
5 1,000 3-MOS 6-MOS 9-MOS YEAR DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 MAR-30-1996 JUN-30-1996 SEP-30-1996 DEC-31-1996 1,536 2,064 3,265 6,949 800 0 0 0 15,519 16,072 17,041 19,762 0 0 0 0 9,363 13,396 15,660 13,630 29,963 34,871 40,582 44,572 12,906 13,467 14,612 15,927 3,160 3,680 4,454 5,046 39,877 44,721 51,274 57,467 8,756 10,581 13,076 14,246 0 0 0 0 0 0 0 0 0 0 0 0 12,171 12,388 12,714 13,338 0 0 0 0 39,877 44,721 51,274 57,467 19,618 44,370 74,417 107,437 19,618 44,370 74,417 107,437 10,401 23,163 39,068 56,021 10,401 23,163 39,068 56,021 6,060 13,693 22,241 31,844 0 0 0 0 0 0 0 0 3,227 7,608 13,235 19,755 1,128 2,704 4,599 6,902 2,099 4,904 8,636 12,853 0 0 0 0 0 0 0 0 0 0 0 0 2,099 4,904 8,636 12,853 .19 .44 .77 1.15 .18 .42 .73 1.08
EX-27.3 8 EXHIBIT 27.3
5 1,000 3-MOS 6-MOS 9-MOS DEC-31-1997 DEC-31-1997 DEC-31-1997 MAR-31-1997 JUN-30-1997 SEP-30-1997 5,695 3,357 1,252 0 0 0 23,404 30,809 35,035 0 0 0 13,890 16,936 20,388 48,561 57,114 62,676 17,919 19,861 21,858 5,620 6,427 7,339 62,388 71,474 78,420 14,417 18,320 19,423 0 0 0 0 0 0 0 0 0 13,854 14,679 15,879 0 0 0 62,388 71,474 78,420 31,341 68,839 107,221 31,511 69,236 107,745 16,105 36,165 56,574 16,105 36,165 56,574 9,764 21,031 32,320 0 0 0 0 0 0 5,706 12,182 18,954 2,012 4,265 6,594 3,694 7,917 12,360 0 0 0 0 0 0 0 0 0 3,694 7,917 12,360 .33 .70 1.09 .31 .66 1.03
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