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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
AMENDMENT NO. 1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1993
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Date of Report: January 6, 1995
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NETWORK SYSTEMS CORPORATION
(Exact name of registrant as specified in its charter)
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<S> <C> <C>
DELAWARE 0-9691 41-1231031
(State of incorporation) (Commission (I.R.S. Employer
File Number) Identification Number)
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<S> <C>
7600 BOONE AVENUE NORTH,
MINNEAPOLIS, MINNESOTA 55428
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: 612-424-4888
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ITEM 1. BUSINESS
GENERAL
Network Systems Corporation (the "Company") was incorporated under the laws
of Delaware in 1974. The Company's principal offices and facilities are located
at 7600 Boone Avenue North, Minneapolis, Minnesota 55428.
The Company designs, manufactures and sells computer networking products and
provides maintenance services for these products. These products and services
are sold worldwide, primarily through the Company's direct marketing force in
the United States and its subsidiaries in Canada and Europe. The Company has
also developed independent distribution channels, which include foreign and
domestic resellers and independent distributors in the Asia/Pacific and other
international areas.
In the past, the Company had significant liquid funds. These funds consisted
of cash and short-term investments and marketable securities. The Company's
primary intent was to utilize these funds in the computer networking business.
The Company did not intend that its investment activities would be a permanent
part of its business. The Company utilized a significant portion of its funds to
acquire Vitalink in 1991 and Bus-Tech and Bytex in 1993. The Company also used a
portion of these funds to repurchase its common stock over the past two years,
and has authorization from the Board of Directors to continue to repurchase
stock, at management's discretion. A further significant portion of these funds
was used to pay the Internal Revenue Service an accumulated earnings tax
assessment and interest on that assessment for the years 1983 through 1988. The
Company disputes the imposition of this tax, has filed for repayment of the
amount paid in the United States Federal District Court, and has been awarded
repayment for years 1983 through 1985. The Company's claim for 1986 through 1988
is still pending. This matter is discussed more fully in a section of this
report under the caption "Income Taxes" in the Notes to the Consolidated
Financial Statements.
The Company's cash reserves at the present time are adequate to meet its
normal operating needs. However, the Company has secured a bank line of credit
to assure access to additional cash if the need arises. The Company intends to
continue to retain any internally generated cash to rebuild its cash reserves.
The Company also intends to continue to pursue its strategy of acquiring other
computer networking companies to supplement its internal growth. Any
acquisitions will be financed from future generation of cash from operations
supplemented by alternative sources of investment capital of a debt or equity
nature depending upon market conditions at the time of any such acquisition.
Since it is the Company's intent to use a large portion of its liquid funds
in operating activities, investment policy is concentrated on the preservation
of capital rather than maximizing investment yield at a higher risk. The Company
has a written policy that dictates the type, dollar limits, and quality of
investments.
RESTRUCTURING
During the fourth quarter of 1993, Network Systems completed its acquisition
of Bytex and a strategic plan for reengineering Network Systems. In connection
with these events Network Systems recorded a pre-tax charge of $15,642,000 (the
"1993 Restructuring") which included a write-off of $7,060,000 of fair value
allocated to research and development costs relating to unfinished product
development in connection with the valuation of the Bytex acquisition . The
remaining $8,582,000 of charges were associated with moving the Bytex
manufacturing operation from Boston to Minneapolis and completing the move of
the remaining Vitalink operations from Fremont to Minneapolis, which was part of
a restructuring plan that was finalized and approved by Network Systems' Board
of Directors in December of 1993. The rapid decline in revenues from Vitalink
products in 1993 led to a decision in December 1993 to totally close the
Vitalink operations in Fremont, California. The restructuring of the Bytex
operations resulted from Network Systems' overall strategic assessment of
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how its operations needed to be organized and structured subsequent to the
abandonment of Vitalink and the purchase of both Bus-Tech and Bytex. The 1993
restructuring charge was for actions to be implemented primarily in the first
quarter of 1994.
The primary components of the $8,582,000 restructuring charge discussed
above included $4,127,000 of costs associated with severance and relocation of
employees; $1,927,000 for the write-off of non-productive or abandoned fixed
assets, leasehold improvements, and inventory; $1,490,000 of costs relating to
the complete abandonment of the Vitalink facility which is to be completed in
1994; and $550,000 of costs associated with modifying current automated
accounting and service support systems to accommodate Vitalink and Bytex
requirements. Network Systems believes that these restructuring measures,
although costly to implement, will nevertheless result in cost savings in the
long-run due to the reduction in duplicative costs inherent in operating
multiple manufacturing facilities with excess plant capacity.
During the fourth quarter of 1992, Network Systems recorded a restructuring
charge of $60,310,000 (the "1992 Restructuring") to cover the costs associated
with a major restructuring of Network Systems' Vitalink operations. The
restructuring resulted in a reorganization that reduced the level of Vitalink
operations based upon the recognition that the marketplace was turning to
competitive product offerings rather than the Vitalink products at a faster rate
than initially expected and therefore the Vitalink revenues would be much lower
than planned. The trend toward lower levels of revenues can be attributable to a
number of factors, including costly initial product delays. The majority of the
charge, or $48,401,000, was for the write-off of the unamortized goodwill and
intangible assets of Vitalink, that was necessitated by the fact that the
projected discounted cash flows of the Vitalink operation no longer reflected
recovery of the goodwill and intangible assets. As a reaction to the magnitude
of Network Systems' restructuring of its Vitalink operations, Network Systems
also decided the timing was right to act on weaknesses identified in the
Minneapolis headquarters and European operations. The remaining charge of
$11,909,000 was for various costs associated with the reorganization of Vitalink
and Network Systems' Minneapolis and European operations. These costs included
$5,268,000 for employee severance and $2,108,000 for non-productive or abandoned
fixed assets and inventory. The charges also included $3,095,000 for costs
associated with eliminating duplicative sales, general and administrative
functions for Vitalink, Minneapolis, and Europe and $1,438,000 for restructuring
charges related to the costs associated with integrating the Vitalink
manufacturing facilities in Minneapolis.
The 1992 Restructuring was substantially completed in the second quarter of
1993, although Vitalink's service function and certain development and support
functions remained in Fremont, California until a decision was made relative to
the 1993 restructuring to move these remaining operations to Minneapolis and
Boston. Network Systems believes that the short-term costs associated with these
restructuring actions were justified to realize the long-term benefits of a
lower cost structure which is necessary to compete in today's manufacturing
environment.
INDUSTRY SEGMENTS
The Company operates in one industry segment. Operations include the design,
manufacture, marketing, and maintenance of equipment and related software
intended for high-speed computer networking applications in the data
communications industry.
TECHNOLOGY AND PRODUCTS
All of the Company's products are similar in that they are designed to
provide the interconnection of computer resources through high-performance
networking. The Company continues to add to its family of networking products to
broaden the span of computer resources that can be connected to a network, and
to accommodate a number of official and de facto data communication standards.
Products that comprise a network solution range from simple cable connectors to
sophisticated hardware and software products. The Company sells its networking
products as separate units and as components of packaged networking solutions.
The products developed and sold as elements of a data network solution are based
on multiple platforms. The largest element of product is called the
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DataExchange (DXE). The DXE is modular platform with a large range of LAN, WAN
and channel interfaces. The second most significant platform is the BYTEX 7700,
a family of port switching hubs. The Bus-Tech acquisition introduced a single
board channel interface product set including the Ethernet LAN Controller (ELC),
the Token Ring Controller (TCA) and a variety of Novell NetWare gateways. Other
platforms include the Vitalink bridges, the 6600 single board router, and
gigabit switches. Various network management tools are offered to aid in the
installation and management of these complex networks. The Company also sells
hardware products produced by other manufacturers, but these sales represent
less than 5 percent of total revenues.
To provide complete solutions for customer networking problems, the Company
also licenses software that allows customers to effectively use the network for
file transfer, archival storage, back-up, disaster recovery, channel extension,
and other utility-type applications. Some of these software applications have
been developed by the Company, notably NETEX and channel extension software,
while others, such as USER-Access, were developed by third parties. Software is
licensed on a paid-up basis, or on a monthly royalty basis. In most cases,
customers pay a monthly support fee to keep their software current. Generally
software products are licensed in conjunction with the sale of hardware
products.
An important part of the Company's revenue is generated from services,
principally maintenance contracts on hardware. Other services include customer
training and the development of custom networking applications. The Company also
provides lease and installment financing to its customers through its wholly
owned subsidiary, Network Systems Credit Corp.
DXE TECHNOLOGY
The Company introduced the DXE hardware platform in 1993, and the DXE
product generated the bulk of the Company's product revenues in 1993. Each DXE
data communication system has a nucleus processor, a large high-speed memory
capability, a 400 or 800 million-bits-per-second backplane, and interfaces to
various computers, media, networking protocols, and peripherals. By inserting
various interface boards, most of which have their own high-performance
microprocessor and program memory, a wide variety of networking configurations
are made possible. For example, the Company provides boards that interface to
mainframe computers made by IBM, Amdahl, other IBM plug compatible
manufacturers, Unisys, Cray, computers using the IBM FIPS Channel, and
minicomputers. Interface boards for network technologies such as ethernet, FDDI,
Token Ring, and HYPERchannel are available as well as for media such as coaxial
cable, twisted pair cable, fiber optic cable, and long distance communication
links (T-1 and T-3 or their European equivalent, E-1 and E-3). Communication
protocols such as NETEX, TCP/IP, Appletalk, IPX, DECnet, and others are also
available.
With this modularity, DXE allows the construction of large complex networks
that use a combination of dissimilar computers, media, and protocols. In
addition, the modular architecture of DXE will allow new elements, such as
faster microprocessors, network management, and security to be introduced as
technology, market needs, and industry standards evolve. The Company uses its
DXE technology platform to provide applications for three types of customer
networking requirements: CPU connection, channel extension, and internetworking.
The DXE allows for six-card, thirteen-card, or dual six-card configurations for
flexibility and redundancy. Certain configurations allow for total fault
tolerance in a single box, and all DXE configurations come with dual power
supplies for greater redundancy. The DXE has been designed for improved
manufacturability, serviceability, and reliability.
BYTEX LOCAL AREA NETWORKING (LAN) TECHNOLOGY
The Bytex Series 7700-TM- Intelligent Switching Hub (Series 7700) is an
integrated system that allows network administrators to control and manage the
physical layer of their LANs from a central management console. The switching
hub combines the Company's expertise in fault-tolerance, switching, and
state-of-the-art software design in a system which enables hands-off remote LAN
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management. The Series 7700 supports both Ethernet and Token Ring connectivity.
The Series 7700 family includes the 144-port 7760-TM- for large applications,
the 36-port 7730-TM- for smaller sites, and the 24-port 7720-TM- for branch
offices.
The Bytex Network Management System enables network administrators to create
a virtual network. Through centralized software management network
administrators can create a network of temporary work groups without having to
rewire the network. Teams of LAN users from anywhere in the world can be
assembled and reassembled at any time from a central data center.
BYTEX WIDE AREA NETWORKING (WAN) TECHNOLOGY
Bytex's family of UNITY matrix switching systems provide increased network
availability by providing the ability for operators of critical networks to
switch around failed equipment and rapidly diagnose problems in the network. All
UNITY switches feature fault tolerance and facilitate the control of both local
and widely distributed networks. These systems can handle wide area
communications interfaces with speeds ranging from 75 bits per second to 2.048
megabits per second. These systems can be controlled by a variety of network
control options. These include sophisticated high-end workstations and
management systems, the PC based UNITY management system, dumb terminals, and
IBM's NetView, allowing customers to choose the control option for their
environment.
BUS-TECH INTERCONNECT CONTROLLER TECHNOLOGY
The Bus-Tech products consist of interface boards and interconnect
controllers. The interface boards are sold on an OEM basis. They enable storage,
print or communication devices to connect to the IBM FIPS channel. The
interconnect controllers provide Ethernet, Token Ring, or FDDI LAN connectivity
to an IBM or other mainframe through the FIPS channel. This connection and
associated firmware enables a Unix user on a LAN to communicate as a client or
peer with the Unix system running on the mainframe. This environment is commonly
called the TCP/IP market. The market has grown dramatically as the power of the
workstation has grown and applications have moved from the host to the desktop.
Another important element of the desktop PC world is Novell. The Bus-Tech
interconnect controllers, utilizing different firmware, provide connectivity
with this world and the IBM SNA host.
Bus-Tech's latest product is the Bus-Tech Enterprise/Branch Network
Controller. The Bus-Tech Enterprise/Branch Network Controller products are
high-powered, Novell endorsed platforms that provide NetWare users with a
single, integrated solution for managing access across the enterprise. They
offer the hardware connections needed to manage mainframe access from either the
central data center or the branch office. Integrating the functions of a
channel-attached NetWare for SAA, server, hub, and router at the central site
and a server, hub, and router at the branch locations, Bus-Tech's
Enterprise/Branch Network Controllers save network managers hardware costs and
allow for the centralized management of remote sites.
BRIDGE/ROUTER TECHNOLOGY
The Company's 6000 series multi-protocol bridge routers includes the 6600
single-board technology platform, and the 6800 and 6400, which are both based on
DXE technology. The 6600 model utilizes a RISC-based microprocessor and is
configured for specific internetworking applications such as interconnecting
ethernet networks to each other and to a T-I telecommunications line. Multiple
configurations of the 6600 are available including ethernet, T-1, FDDI, and
Token Ring. The advantage of the single-board platform is lower cost with equal
or greater performance than that provided by a modular design. For large,
complex networks, both modular and single-board designs may be employed to
achieve the most cost effective solution.
The Company recently introduced new products that extend its backbone
routing expertise to branch and regional sites. The fixed-port 6200 branch
office routers and the modular 6300 regional office routers offer affordable
pricing, fast menu-driven configuration, and a full range of LAN/WAN protocol
support. Both the 6200 and 6300 routers support SNMP/MIBII and are managed by a
common SNMP manager. Both routers support protocols such as TCP/IP, IPX/SPX,
DECnet,
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AppleTalk, and XNS as well as various bridging technologies. The routers provide
the ability to route from any LAN -- including Ethernet, Token Ring, and FDDI --
across a WAN using Frame Relay, ISDN, X.25, or dedicated point-to-point (PPP)
link. Speeds rage up to T1/E1.
The Company's bridge/routers, host controllers, and Bytex hubs include
Network Control Facility (NCF) software that enables building virtual networks.
A virtual network created with NCF allows complete control of all phases of
network traffic and provides a virtual network that allows for department
security and traffic optimization. Instead of enlarging the number of devices
used to physically separate network traffic, NCF virtual networks allow better
use of the existing network resources.
HIGH PERFORMANCE PARALLEL INTERFACE TECHNOLOGY
HIPPI is a standard channel design that transmits data from a large
mainframe, supercomputer, or superminicomputer at 800 million bits per second.
The Company has designed a crosspoint switch that connects to the HIPPI channel
and provides up to 32 ports for connectivity to supercomputers, workstations,
storage devices, and other peripheral devices. Each of these ports can transmit
data at the 800 million bits per second rate for a total capacity, in the case
of the 32 port model, of 25.6 gigabits per second. An interface for the
Company's DXE adapters connects to a port on the switch, thus permitting FDDI,
ethernet and HYPERchannel networks and high-speed telecommunication links to be
attached to the switch. Since switches can also be linked together with fiber
extenders, this technology can be used to provide a very high-performance
backbone network at a relatively low cost.
VITALINK TRANSLAN, TRANSRING, AND TRANSPATH TECHNOLOGY
The Trans technology uses bridge architecture to transparently interconnect
local area networks. TransLAN products are multifunction bridges which
interconnect ethernet LANs. TransRING products interconnect Token-Ring LANs, and
TransPATH products provide routing services between ethernet LANs. The Company
has introduced protocols that permit the model 6600 routers to communicate with
the Trans products thus allowing customers an upgrade path to the higher-
performance router technology for interconnecting LANs.
APPLICATIONS
The Company's product technologies are used to provide a broad range of
enterprise wide networking solutions from the branch office to the data center.
To provide focus on the user, these applications have been classified into three
groups: CPU Connection, Channel Extension, and Internetworking.
CPU CONNECTION includes a wide range of applications from the connection of
a minicomputer to an IBM mainframe for backup and file storage to complex
networks of mainframes manufactured by different vendors, supercomputers,
minicomputers, and workstations for cooperative computer processing, file
archival, and transaction processing. Many of these networks are geographically
dispersed and communicate with each other over high-speed public or private data
communication facilities. Customers for these networks generally have multiple
data centers with several large mainframes, but there are less complex
applications, such as the connection of an engineering system running on a
Unisys mainframe to a manufacturing system using an IBM computer, that can
justify the cost of a network.
CHANNEL EXTENSION provides the capability to drive peripheral devices such
as printers, tape drives, terminals, and in some cases, other computers, which
are located geographically distant from the computer center. This distance can
range from several kilometers to distances spanning the ocean. The Company's
channel extension products allow these distances to be spanned without
sacrificing response time for the peripheral user. Typical users of this
application are able to achieve significant cost savings by consolidating data
centers and by locating these centers in areas where real estate, taxes, and
personnel costs are lower. The Company also markets a product called Central
Archiving
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that allows for the automated backup of remote systems and LAN's to a central
location. Vital corporate information is thereby protected, and users are
relieved of a burdensome task that is often neglected.
INTERNETWORKING applications provide connectivity between LANs, networks
located in a local area such as a building or group of buildings, and between
WANs, networks located over a wider geographical area. These networks may also
be connected to a mainframe or a network of mainframe computers in the central
data center. Bridging and routing are two different ways to connect these
networks and recently the Company has introduced products which incorporate both
technologies. An organization's LANs may often be dissimilar in that different
communication protocols are used and different types of computers and other
devices may utilize the same LAN. Therefore the need for multi-protocol
capability is important. Hubs, which create and manage networks through
switching of individual desktop connections, are another important element in
this market.
SALES AND SERVICE
The Company primarily sells and services its products in the United States,
Canada, and Europe through its own direct sales and service staffs. In addition,
the Company utilizes a network of resellers and independent distributors,
particularly in the Asia/Pacific region and Italy and Spain.
Financial information relating to the amounts of revenue, operating loss or
profit, identifiable assets, and export sales attributable to the Company's
geographic areas of operation is provided under the caption "Geographic Area and
Major Customer Information" in the Notes to the Consolidated Financial
Statements of the Company, which are included in a separate section of this
report.
The Company warrants that its products will function in accordance with its
published specifications existing on the date of acquisition. The warranty
period is thirteen months after shipment for hardword products and 90 days after
shipment for software products. Costs to the Company regarding this warranty
policy have not been material.
The Company offers to maintain the equipment it markets in the United
States, Europe, and Canada. Pursuant to its maintenance contracts, the Company
is required for the period of the agreement (usually one year) to maintain the
equipment for a monthly fixed fee and to respond to customer maintenance calls
within an agreed time period during the service period. The service period is a
specified number of hours per day and days per week, as selected and paid for by
the customer.
CUSTOMERS
The Company's customers generally have large data processing systems, and
some may place large orders for the Company's products. However, no single
government agency or commercial customer accounted for more than 10 percent of
total revenues in any of the three years for the period ended December 31, 1993.
Contractual relationships between the Company and government agencies have been
on a normal purchase order and maintenance contract basis with no continuing
contractual relationships. No material portion of the Company's business is
subject to renegotiation of profits or termination of contracts or subcontracts
at the election of the Government.
BACKLOG
The Company's backlog represents orders deliverable over a short period of
time, normally over 30 to 90 days. The backlog of the Company's products at
December 31, 1993 was $4.3 million, as compared with $8.7 million at December
31, 1992. In the Company's experience, its backlog at any given time is not
indicative of prospective sales volume.
Neither the Company's business nor its backlog is of a seasonal nature.
Historically, however, the Company's quarterly revenues are the smallest in the
first quarter and the largest in the last quarter of the year.
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MANUFACTURING AND SUPPLIERS
The Company manufactures its products from components and prefabricated
parts such as integrated circuits, printed circuit boards, power supplies, and
metal parts manufactured by others. Certain of the items manufactured by others
are made to the Company's specifications. All inspection functions, final
assembly, and systems tests are performed within the Company's manufacturing
facilities. Most of the components for the Company's systems are available from
a number of different suppliers. The Company believes that alternative sources
could be developed if required for present single-supply sources. Although the
Company has not experienced any significant problem in obtaining its required
supplies, future shortages of components could result in production delays which
could adversely affect its business.
PATENT, TRADEMARK, AND COPYRIGHT
The Company owns various domestic and foreign patents, trademarks, and
copyrights. In general, the Company does not rely on patent or copyright
protection to safeguard its market position due to the rapid rate of
technological development that characterizes the computer and data
communications industries. It is the Company's belief that trademark protection
is not necessary for it to compete effectively.
However, the Company continues to pursue further patent, trademark, and
copyright protection domestically and throughout the world. In addition to
copyright protection for its software products, including microcode, and
documentation, the Company also relies upon the protection afforded by the
common law, trade secret laws, license agreement restrictions, and nondisclosure
agreements.
COMPETITION
Network Systems, the pioneer in high-speed multi-vendor networking, faces
competitors on all fronts. In CPU connection, large system vendors offer some
connections to systems from other vendors. Some networking companies also offer
a limited number of multi-vendor connections. In channel extension, a number of
companies offer point-to-point connections for driving remote devices. In the
internetworking arena, a number of companies offer a variety of bridges and
routers that connect local area networks with each other and with wide area
networks. And in the hub market other hub vendors have announced some form of
port switching.
The Company's technology provides an enterprise backbone, which offers a
broad range of high-performance networking solutions. In the Company's opinion,
the range of networking solutions it offers, the technical level of its
products, the availability of these products, its financial stability, and the
level of service and support it offers are all factors positively influencing
its ability to compete in the data communications networking market.
In 1993 the Company was recommended for registration to the ISO 9001
standard, the most stringent of the quality system standards of the
International Organization for Standardization. Many companies elect to register
to the less stringent ISO 9002 standard. By choosing to register to the ISO 9001
standard the Company's engineering and service functions were included in its
registration.
The Company views its foreign markets as an important element of its growth
strategy. Potential trade barriers and protectionism in Europe and Japan could
be an adverse factor to the Company's growth in these areas in the future,
although the Company is not aware of any such developments at this time.
RESEARCH AND DEVELOPMENT
The Company is committed to a high level of research and development
activity. The Company incurred expenditures for research and development of
$27.8 million, $25.0 million, and $21.4 million in 1993, 1992, and 1991,
respectively, representing 13, 11, and 11 percent of total revenues in each such
period. In 1986, the Company adopted Statement of Financial Accounting Standards
No. 86 requiring the capitalization of software development costs incurred
subsequent to establishment of
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the technological feasibility of producing the finished software product. In
1993, 1992, and 1991, $2.5 million, $3.0 million, and $3.7 million,
respectively, of such costs were capitalized. If these costs were included,
research and development incurred in 1993, 1992, and 1991 would be $30.3
million, $28.0 million, and $25.1 million, respectively, or 14, 13, and 13
percent of total revenues in each such period.
The Company contracts with third party software and hardware developers for
the development of certain adaptations of its products. None of these
arrangements are of a material nature.
WORKING CAPITAL
As is typical in the data communications industry, significant amounts of
working capital are required to finance inventory and receivables. In addition
to these requirements, the Company may be required to pay an accumulated
earnings tax of approximately $9.4 million and interest estimated to exceed $3.0
million for the years 1989 and 1990. If the Company is required to make this
payment, it will aggressively pursue a refund in the federal district court.
(See the Note to the Consolidated Financial Statements captioned "Income
Taxes".) Other than for these anticipated payments, the Company believes its
overall working capital requirements are normal for the industry. During 1993,
the Company financed all working capital requirements from internally generated
funds.
ENVIRONMENTAL MATTERS
The Company's compliance with federal, state, and local environmental laws
has had no material effect upon its capital expenditures, earnings, or
competitive position.
EMPLOYEES
As of December 31, 1993, the Company had 1,599 employees.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth items from Network Systems Corporation's
consolidated statement of operations as percentages of total revenues.
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YEARS ENDED DECEMBER 31,
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1993 1992 1991
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Revenues:
Product........................................................................ 69.7% 69.6% 71.8%
Services....................................................................... 30.3 30.4 28.2
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Total revenues............................................................... 100.0 100.0 100.0
Cost of revenues:
Product........................................................................ 31.0 27.1 28.9
Services....................................................................... 19.6 19.8 19.5
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Total cost of revenues....................................................... 50.6 46.9 48.4
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Gross profit..................................................................... 49.4 53.1 51.6
Operating expenses:
Research and development....................................................... 12.9 11.4 10.8
Selling, general, and administrative........................................... 31.8 31.6 31.3
Amortization of intangibles.................................................... .2 1.5 1.0
Acquisition, restructuring, and acquired research
and development............................................................... 7.2 27.5 2.0
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Total operating expenses..................................................... 52.1 72.0 45.1
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Income (loss) from operations.................................................... (2.7) (18.9) 6.5
Interest income, net of interest and other expense............................... 3.4 3.4 5.3
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Income (loss) before income taxes................................................ .7 (15.5) 11.8
Provision for (benefit from) income taxes........................................ (.3) 2.6 4.1
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Net income (loss)................................................................ 1.0% (18.1)% 7.7%
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RESULTS OF OPERATIONS
REVENUES: Revenues from product sales decreased 1.5 percent in 1993 from
1992, while revenue from services decreased 1.9 percent, resulting in an overall
decrease of 1.6 percent. When 1992 is compared with 1991, revenues from product
sales increased 7.0 percent and services increased 18.5 percent for an overall
increase in total revenues of 10.3 percent. In 1993 Vitalink Communications
Corporation ("Vitalink") revenues continued a decline that started in 1992.
Declining Vitalink revenues account for a 11.5 percent decrease in product
revenue, a 1.6 percent decrease in service revenue, and a 8.5 percent decrease
in total revenues in 1993. This compares with increases of 3.7 percent for
product revenue, 9.1 percent for service revenue, and 5.2 percent for total
revenues contributed by Vitalink when 1992 is compared to 1991. In 1991 Vitalink
revenues were included only for the seven months after its June 1991
acquisition. The addition of revenues from the acquisitions of Bus-Tech, Inc.
("Bus-Tech") in May 1993 and Bytex Corporation ("Bytex") in November 1993
largely offset the decline in Vitalink revenue, accounting for a 9.9 percent
increase in product revenue, a 2.1 percent increase in service revenues, and a
7.5 percent increase in total revenues for 1993.
As a percentage of total revenues, sales to customers in the United States
("Domestic") and customers outside the United States ("International") are:
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1993 1992 1991
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Domestic..................................... 59.1% 58.2% 55.6%
International................................ 40.9 41.8 44.4
-------- -------- --------
Total revenues............................. 100.0% 100.0% 100.0%
-------- -------- --------
-------- -------- --------
</TABLE>
9
<PAGE>
In 1993 domestic revenues were flat while international revenues declined.
Poor economic conditions in Europe were reflected in the decrease in
international revenues provided by European sales. However, the Company's
Asia/Pacific distributor revenues increased substantially offsetting the effect
of Europe's decline.
Product revenues are generated from sales of the Company's networking
hardware, licensing of associated software, and other related income.
Summarizing the Company's revenue by market applications helps to explain the
Company's networking business. Market applications for CPU Connection
represented 22.9, 23.3, and 27.4 percent; Channel Extension 25.7, 20.7, and 21.5
percent; and Internetworking 21.1, 25.6, and 22.9 percent of total revenues for
1993, 1992, and 1991, respectively. Service revenues accounted for the remaining
30.3, 30.4, and 28.2 percent of total revenues for 1993, 1992, and 1991.
The Company is reengineering its organization and its processes and
procedures to become more responsive to market changes and to provide solutions
to customer networking requirements. The Company is focusing its development,
acquisitions, and strategic partnerships on its core competencies adding new
products across all of its market applications. With the addition of Bytex and
certain strategic partnerships the largest growth is expected in the Company's
Internetworking applications. Service revenue is expected to grow with the
addition of the Bytex installed base. However, partially offsetting this growth,
will be a decline in Vitalink service revenues and other service revenues as
newer and lower maintenance DX series products continue to replace the Company's
older A series products.
GROSS PROFIT
Gross profit as a percentage of total revenues was 49.4 percent in 1993,
compared to 53.1 percent in 1992, and 51.6 percent in 1991. The lower product
gross profit in 1993 is the result of a higher percentage of product revenues
coming from the Company's indirect distribution channels, in particular in
Asia/Pacific, and certain large orders in the United States that carried lower
margins. The lower product gross profit in 1993 is in contrast to 1992 when the
benefits of improved manufacturing efficiency, increased product quality, and
control of costs began to impact gross profits positively. In 1991, lower gross
profits were largely due to charges resulting from a decision to discontinue
several third-party arrangements for certain hardware and software products. For
1994, with manufacturing efficiencies in place, the return to a more traditional
product distribution mix, and with the addition of and improvement in Bytex's
historical product margins, the Company anticipates product gross profits will
improve. Gross profit contributed by services has changed little over the three
year period. For 1994, as higher margin Vitalink service revenues decline, gross
profit contributed by services is expected to decline slightly from the 1993
level. For 1994 the expected improvement in product gross margin should result
in an improvement in the overall gross margin.
RESEARCH AND DEVELOPMENT
The Company incurred expenditures for research and development of $27.8
million, $25.0 million, and $21.4 million in 1993, 1992, and 1991, respectively.
In addition, the Company capitalized software development costs of $2.5 million
in 1993, $3.0 million in 1992, and $3.7 million in 1991. Including capitalized
software development, the Company has devoted from 12 to 14 percent of its
revenue to research and development type activities. The Company intends to
continue making this significant investment in product development to keep pace
with technological advances in the networking field.
SELLING, GENERAL, AND ADMINISTRATIVE
Selling, general, and administrative expenses as a percentage of total
revenues are 31.8 percent in 1993, 31.6 percent in 1992, and 31.3 percent in
1991. The continuing effort to upgrade information systems and maintenance of
tight control over expenditures have allowed the Company to keep selling,
general, and administrative expenses relatively constant as a percentage of
total revenues. The Company plans continued tight control of expenditures and
does not anticipate a significant change in the level of selling, general, and
administrative expense in 1994.
10
<PAGE>
ACQUISITION, RESTRUCTURING, AND ACQUIRED RESEARCH AND DEVELOPMENT
During the fourth quarter of 1993, Network Systems completed its acquisition
of Bytex and a strategic plan for reengineering Network Systems. In connection
with these events Network Systems recorded a pre-tax charge of $15,642,000 which
included a write-off of $7,060,000 of fair value allocated to research and
development costs relating to unfinished product development in connection with
the valuation of the Bytex acquisition . The remaining $8,582,000 of charges
were associated with moving the Bytex manufacturing operation from Boston to
Minneapolis and completing the move of the remaining Vitalink operations from
Fremont to Minneapolis and Boston which was part of a restructuring plan that
was finalized and approved by Network Systems' Board of Directors in December of
1993. The rapid decline in revenues from Vitalink products in 1993 led to a
decision in December 1993 to totally close the Vitalink operations in Fremont,
California. The restructuring of the Bytex operations resulted from Network
Systems' overall strategic assessment of how its operations needed to be
organized and structured subsequent to the abandonment of Vitalink and the
purchase of both Bus-Tech and Bytex. The 1993 Restructuring charge was for
actions to be implemented primarily in the first quarter of 1994.
The primary components of the $8,582,000 restructuring charge discussed
above included $4,127,000 of costs associated with severance and relocation of
employees; $1,927,000 for the write-off of non-productive or abandoned fixed
assets, leasehold improvements, and inventory; $1,490,000 of costs relating to
the complete abandonment of the Vitalink facility which is to be completed in
1994; and $550,000 of costs associated with modifying current automated
accounting and service support systems to accommodate Vitalink and Bytex
requirements. Network Systems believes that these restructuring measures,
although costly to implement, should result in cost savings in the long-run due
to the reduction in duplicative costs inherent in operating multiple
manufacturing facilities when excess plant capacity exists.
Network Systems acquired Vitalink in June 1991 because of the strategic fit
of the companies. Vitalink was the market leader in remote Ethernet bridges, and
accounted for around 25% of such units shipped worldwide in 1990. Vitalink's
bridge products, however, were coming to the end of their life cycle. Vitalink
was trying to develop a router product, but had determined that it would be
unable to produce a quality router product in time to hold onto its bridge
customers.
Prior to the Vitalink acquisition, Network Systems had begun developing a
router product (the "6600"). Network Systems' primary reason for the acquisition
was to gain access to Vitalink's established customer base and sell Network
Systems' 6600 product through Vitalink's distribution channels. It was Network
Systems' expectation that the decreasing sales of Vitalink's bridge product
would coincide with the release of Network Systems' 6600 routers and the ramp up
in sales of such routers.
In early 1992, the 6600 product was released on a limited basis, with the
expectation that it would be generally available in the second half of 1992.
During the first quarter of 1992, delays in the development of certain 6600
critical features reduced shipments of the 6600, resulting in Vitalink revenues
that were below expectations. Although Vitalink revenues improved in the second
and third quarters of 1992, Network Systems was becoming concerned regarding the
cost structure that was in place for the Vitalink operations and the ability of
Vitalink revenues to support such a cost structure, particularly in light of the
delays in fully releasing the 6600 product.
During the third quarter of 1992, management of Network Systems investigated
the situation and, in the course of such investigation, analyzed a number of
factors, including product competiveness, the costs associated with the Vitalink
operations and projected Vitalink revenues for the fourth quarter of 1992 and
for 1993. Although by that time the 6600 product was being actively marketed,
market conditions for the product had deteriorated due to the long delay in
fully releasing the product, and it appeared that the router did not meet the
requirements on features and price needed in order for Vitalink to compete
effectively in its markets. The principal competitors in this area had entered
the market earlier and had grown so quickly that it was going to be difficult
for another router vendor
11
<PAGE>
to enter the market and get sufficient volume to meet the low prices offered by
such competitors. As a result, in November 1992, management recommended that
Network Systems restructure the Vitalink operations to consolidate
manufacturing, support and other duplicate functions in order to reduce costs,
and the Board approved this restructuring. The resulting restructuring charge
was composed primarily of a write-down of a large portion of the goodwill and
other intangible assets related to the acquisition of Vitalink. Following the
announcement of this restructuring, Vitalink sales, which had begun to fall off
in the fourth quarter, deteriorated further and numerous management and sales
personnel departed. As a result, the Board decided to write off the remainder of
the goodwill and intangible assets associated with the acquisition of Vitalink
that remained on the Network Systems books at December 31.
As a result, during the fourth quarter of 1992, Network Systems recorded a
restructuring charge of $60,310,000 to cover the costs associated with the
Vitalink restructuring. The majority of the charge, or $48,401,000, was for the
write-off of the unamortized goodwill and intangible assets of Vitalink which
was necessitated by the fact that the projected discounted cash flows of the
Vitalink operation no longer reflected recovery of the goodwill and intangible
assets. The total unamortized intangible assets written off of $48,401,000
included $32,075,000 of goodwill, $13,875,000 of customer relationships,
$1,582,000 of work force in place and $869,000 of other intangible assets. As a
reaction to the magnitude of Network Systems' restructuring of its Vitalink
operations Network Systems also decided the timing was right to act on
weaknesses identified in the Minneapolis headquarters and European operations.
The remaining charge of $11,909,000 was for various costs associated with the
reorganization of Vitalink and Network Systems' Minneapolis and European
operations. These costs included $5,268,000 for employee severance and
$2,108,000 for non-productive or abandoned fixed assets and inventory. The
restructuring charges also included $3,095,000 for costs associated with
eliminating duplicative sales, general and administrative functions for
Vitalink, Minneapolis, and Europe -- the primary components of which are
$1,092,000 for the accrual of costs relating to the abandonment of the
manufacturing facilities at Vitalink and the abandonment of duplicate United
States field offices; $614,000 for recruiting fees relating to the replacement
of personnel unwilling to relocate; $298,000 for employee relocation costs;
$260,000 of automated systems integration costs; and the residual relating
primarily to moving costs. The remaining $1,438,000 of restructuring charges
related to the costs associated with integrating the Vitalink manufacturing
facilities in Minneapolis.
The 1992 Restructuring was substantially completed in the second quarter of
1993, although Vitalink's service function and certain development and support
functions remained in Fremont, California until a decision was made relative to
the 1993 Restructuring to move these remaining operations to Minneapolis.
Network Systems believes that the short-term costs associated with these
restructuring actions were justified to realize the long-term benefits of a
lower cost structure which is necessary to compete in today's manufacturing
environment.
Network Systems' total restructuring reserves were $9,624,000 and
$10,196,000 at December 31, 1993 and 1992, respectively, and included accruals
requiring cash payments of $7,359,000 and $8,182,000, respectively. The 1993
Restructuring reserve includes a change in estimate to increase the 1992
Restructuring reserve by $1,051,000 primarily for fixed assets that were
subsequently identified as being impaired. Substantially all of the cash outlays
relating to the 1992 Restructuring were paid in 1993, and Network Systems
expects that payments relating to the remaining accrual at December 31, 1993
will occur primarily in 1994.
Of the $15,642,000 charge for the 1993 Restructuring, $8,582,000 was
acquisition and restructuring costs associated with closing Network Systems'
Vitalink facility and restructuring certain operations in its Minneapolis
headquarters. Closing the Vitalink facility resulted in the elimination of
approximately 50 positions with annual salaries of approximately $2,326,000. The
charge for the 1993 Restructuring also included rent and property taxes due for
the remaining term of the Vitalink facility
12
<PAGE>
leased, which would have totaled approximately $1,600,000. Along with the lease,
Network Systems expensed the remaining value of leasehold improvements and other
fixed assets that had no future value to Network Systems totaling approximately
$1,500,000.
The most significant portion of the charge for the 1992 Restructuring was
for the write-off of the remaining goodwill and intangible assets associated
with the Vitalink acquisition totaling $48,401,000. The charge for the 1992
Restructuring also included a reduction in Network Systems' workforce that
eliminated over 100 positions during 1993. The positions eliminated reduced 1993
payroll expenditures by approximately $5,150,000. The annual salary of the
workforce reduction totaled approximately $6,288,000. The reduction of rent and
fixed asset depreciation for Vitalink's lease facility and fixed assets that
were abandoned as part of the 1992 Restructuring would have resulted in charges
of approximately $411,000 in 1993 and an additional $1,020,000 in years after
1993. Partially offsetting the reduction of 1993 expenditures were approximately
$1,370,000 of additional payroll expenditures for personnel added at other
locations when the Vitalink personnel would not relocate. The annual salary of
such personnel added in 1993 totaled approximately $2,055,000.
INTEREST INCOME
Net interest income was $7.3 million, $7.4 million, and $10.5 million in
1993, 1992, and 1991, respectively. In 1993 the impact of lower interest rates
and the reduction of average invested cash balances was offset by capital gains
recorded on disposal of investments. The cash generated by the disposal of
investments was used for the acquisition of Bus-Tech in May 1993 and Bytex in
November 1993. In addition the 1992 repayment of loans on corporate owned life
insurance policies reduced interest expense in 1993. In 1992 the decrease in
interest income was primarily due to the decline in interest rates. While the
Company has a strong balance sheet, its liquid funds at the end of 1993 are
substantially lower than previous years. Because Company funds available for
investment will be significantly lower in 1994, net interest income will also be
significantly lower in 1994.
INCOME TAXES
The Company's provision for (benefit from) income taxes has been recorded at
the effective rates of (48.4), 16.4, and 35.0 percent for 1993, 1992, and 1991,
respectively. For 1993, although the Company recorded income before income taxes
and the United States federal statutory income tax rate increased by one
percent, the Company recorded a benefit from income taxes. The 1993 income tax
benefit is the result of income tax benefits for nontaxable investment income,
favorable tax rates on export sales, and utilization of foreign tax credits
exceeding the income tax on income before income taxes including adjustments
that increased taxable income. In 1992, although the Company reported a loss
before income taxes, the Company recorded a provision for income taxes. The 1992
income tax provision resulted from the write-off of nondeductible goodwill and
other intangible assets. For details of the items affecting the income tax rate
for the three years see the footnote to the Consolidated Financial Statements
captioned "Income Taxes". For 1994 the Company anticipates its effective tax
rate will be slightly higher than the United States federal statutory rate.
FACTORS THAT MAY AFFECT FUTURE RESULTS
There are a number of factors that could affect the Company's future
operating results, including general economic conditions; market acceptance of
the Company's new products; the Company's ability to provide solutions for
customer networking requirements; and numerous competitive factors.
Since 1992 the Company has introduced many new products, announced its
strategy for future networking solutions such as ATM, acquired technology
companies and formed strategic partnerships with other technology companies to
enable the Company to provide its customers with networking solutions in the
future. The success of the Company's current and future products is dependent on
a number of factors, including market acceptance and the Company's ability to
provide the products in quantities sufficient to meet the expected demand.
The Company could be adversely affected if it is not able to manage growth
in selling, general, and administrative expenses.
13
<PAGE>
With a large portion of Network Systems' revenues coming from international
sales, Network Systems' results of operations can be significantly affected by
international factors, such as changes in foreign currency exchange rates.
Income from operations can be favorably or unfavorably impacted by the effects
of foreign currency exchange rate fluctuations on balances owing to Network
Systems by its foreign subsidiaries for product shipped for resale in Europe and
Canada. Network Systems minimizes this risk to the extent possible by entering
into foreign exchange forward contracts to hedge against the effects of movement
in foreign currency exchange rates on foreign currency denominated receivables
due from its affiliates. These hedging activities have served to mitigate the
effects of foreign currency fluctuations on income, resulting in an overall loss
on foreign currency transactions in 1993, 1992, and 1991 of $240,000,
$1,225,000, and $724,000, respectively. Network Systems' net investment in its
foreign subsidiaries is also subject to foreign currency risk, although these
risks do not affect operating income. Furthermore, these foreign currency risks
are not hedged as the net cash flows are retained by the foreign subsidiaries
and are not subject to actual transactional gains or losses.
Network Systems is a party to litigation which arises in the normal course
of business. Management regularly analyzes current information and, as
necessary, provides accruals for probable liabilities on the eventual
disposition of these matters. Management believes that the effect on Network
Systems' financial condition, if any, for the disposition of these matters will
not be material. However, depending on the amount and timing of an unfavorable
resolution of these contingencies it is possible that Network Systems' future
results of operations or cash flows could be materially affected in a particular
period.
Because of these and other factors that could affect the Company's operating
results, past financial performance should not be considered as a reliable
indicator of future performance, and investors should not use historical trends
to anticipate future periods' results, especially in light of the dynamic
industry in which the Company operates.
LIQUIDITY AND CAPITAL RESOURCES
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1993 1992 1991
---------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and short-term investments and marketable securities.................. $ 33,813 $ 127,894 $ 121,027
Working capital............................................................ $ 99,830 $ 102,694 $ 128,028
Cash provided by (used in) operations, net................................. $ (11,600) $ 29,694 $ 3,241
Cash provided by (used in) investing activities, net....................... $ 7,322 $ (46,009) $ (14,016)
Cash provided by (used in) financing activities, net....................... $ (7,510) $ (4,175) $ 5,680
</TABLE>
The $94.1 million reduction of the Company's 1993 year end balance of cash
and short-term investments and marketable securities to $33.8 million is largely
the result of utilizing $64.4 million of cash for the Bus-Tech and Bytex
acquisitions and $27.3 million for payment of the Internal Revenue Service
("IRS") accumulated earnings tax assessment and related interest for the 1986
through 1988 tax years. These uses of cash move the liquid assets to other
assets. The two acquisitions are expected to produce cash from their operations.
The Company anticipates it will receive a refund of the cash utilized for
payment of the tax assessment and interest along with an investment return equal
to the IRS refund rate. However, because the tax assessment issue is in the
early stages of litigation the Company can not predict a date by which the
refund is anticipated. The increase in accounts receivable, inventories, prepaid
expenses, property, plant, and equipment, goodwill and other intangibles,
accounts payable, and accrued liabilities from December 31, 1992 to December 31,
1993 are all primarily attributable to the Bus-Tech and Bytex acquisitions. The
increase in other non-current assets from $38,976,000 at December 31, 1992 to
$68,631,000 at December 31, 1993 relates primarily to the $27,300,000 payment
made to the IRS for the tax and interest assessment for the 1986 through
14
<PAGE>
1988 tax years previously discussed. Net deferred tax assets increased from
$9,030,000 at December 31, 1992 to $15,470,000, due primarily to net operating
loss and tax credit carryforwards. The Company has a strong working capital
position and its financial condition remains strong through December 31, 1993.
While the Company generated net income in 1993, noncash adjustments to net
income resulted in the net use of cash for operations. The major single
exceptional item in the adjustments to net income is the use of cash for payment
of the $27.3 million IRS tax assessment and related interest for the 1986
through 1988 tax years. In 1991 the Company paid $11.0 million for a similar IRS
tax assessment for the 1983 through 1985 tax years. In January 1994 the United
States Court of Appeals granted a dismissal of an IRS appeal in which the
Federal District Court ruled in favor of the Company and ordered the IRS to
refund the taxes the Company paid in 1991 plus interest. The Company anticipates
the refund and interest will be received and reflected as an addition to cash
generated from its operations in 1994. In addition during 1994 the Company will
be implementing several new management information systems. After the initial
1994 investment, improved management information systems and changes in
processes and procedures should result in improved cash flow.
Net cash provided by investing activities for 1993 is the result of the
Company liquidating its marketable securities to generate cash for the Bus-Tech
and Bytex acquisitions. The offsetting use of cash is reflected in cash provided
by investing activities for the acquisitions, in cash used in operations for
payment of the IRS tax assessment, and in cash used in financing activities for
the repurchase of the Company's common stock.
The net cash used for financing activities in 1993 reflects the use of $11.0
million for the repurchase of the Company's common stock. Partially offsetting
this use of cash are proceeds from issuing the Company's common stock to
employees totaling $3.5 million.
The Company's principal sources of liquidity are its cash and short-term
investments and marketable securities of $33.8 million at December 31, 1993,
revolving credit agreements with five banks that make approximately $3.0 million
of credit available to the Company's foreign subsidiaries, loan value available
from $20.7 million of cash values in company-owned life insurance policies, and
a one year $10.0 million bank line of credit negotiated in March 1994. The
Company believes that this liquidity, together with cash flows from operations,
will meet its 1994 operating requirements, fund the $8.5 million of
restructuring accruals, and provide cash for additional business opportunities
that may become available in 1994.
15
<PAGE>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Network Systems Corporation
We have audited the accompanying consolidated balance sheets of Network
Systems Corporation as of December 31, 1993 and 1992, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1993. Our audits also
include the financial statement schedules listed in the index at Item 14(a).
These financial statements and schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedules 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, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Network Systems
Corporation at December 31, 1993 and 1992, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1993, in conformity with generally accepted accounting principles.
Also in our opinion, the related financial statement schedules, when considered
in relation to the basic financial statements taken as a whole, present fairly
in all material respects the information set forth therein.
ERNST & YOUNG
Minneapolis, Minnesota
January 28, 1994
F-1
<PAGE>
NETWORK SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1993 1992
----------- -----------
<S> <C> <C>
Current assets:
Cash and short-term investments....................................................... $ 25,911 $ 38,075
Marketable securities................................................................. 7,902 20,108
Accounts receivable, less allowance of $744 for doubtful accounts in 1993 (1992 --
$275)................................................................................ 64,495 56,519
Notes receivable from officers........................................................ -- 522
Other receivables..................................................................... 5,531 3,233
Inventories........................................................................... 26,599 17,445
Prepaid expenses...................................................................... 7,199 2,959
Deferred income taxes................................................................. 18,830 9,030
----------- -----------
Total current assets.............................................................. 156,467 147,891
Property, plant, and equipment........................................................ 95,838 89,053
Less accumulated depreciation......................................................... 51,989 52,206
----------- -----------
Net property, plant, and equipment................................................ 43,849 36,847
Other assets:
Marketable securities................................................................. -- 69,711
Goodwill and other intangible assets, net of accumulated amortization of $2,305....... 36,534 --
Other................................................................................. 68,631 38,976
----------- -----------
Total other assets................................................................ 105,165 108,687
----------- -----------
$ 305,481 $ 293,425
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................................................... $ 9,317 $ 4,856
Accrued liabilities................................................................... 41,131 35,887
Income taxes payable.................................................................. 4,689 2,454
Deferred revenue...................................................................... 1,500 2,000
----------- -----------
Total current liabilities......................................................... 56,637 45,197
Deferred revenue........................................................................ -- 1,500
Long-term debt.......................................................................... 1,000 1,000
Deferred compensation................................................................... 11,852 10,328
Deferred income taxes................................................................... 3,360 --
Other long-term liabilities............................................................. 9,251 5,451
Stockholders' equity:
Preferred stock, $.02 par value -- none issued
Common stock, $.02 par value; 60,000,000 shares authorized, 29,721,074 shares issued
and outstanding (1992 -- 30,388,868 shares).......................................... 595 608
Additional paid-in capital............................................................ 110,271 117,408
Retained earnings..................................................................... 115,111 112,904
Cumulative translation adjustment..................................................... (2,596) (971)
----------- -----------
Total stockholders' equity........................................................ 223,381 229,949
----------- -----------
$ 305,481 $ 293,425
----------- -----------
----------- -----------
</TABLE>
See accompanying notes.
F-2
<PAGE>
NETWORK SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1993 1992 1991
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Product.................................................................. $ 150,280 $ 152,606 $ 142,602
Services................................................................. 65,278 66,512 56,126
----------- ----------- -----------
Total revenues....................................................... 215,558 219,118 198,728
Cost of revenues:
Product.................................................................. 66,770 59,368 57,428
Services................................................................. 42,320 43,361 38,877
----------- ----------- -----------
Total cost of revenues............................................... 109,090 102,729 96,305
----------- ----------- -----------
Gross profit............................................................... 106,468 116,389 102,423
Operating expenses:
Research and development................................................. 27,762 24,997 21,417
Selling, general, and administrative..................................... 68,499 69,338 62,214
Amortization of intangibles.............................................. 417 3,257 1,960
Acquisition, restructuring, and acquired
research and development costs.......................................... 15,642 60,310 3,974
----------- ----------- -----------
Total operating expenses............................................. 112,320 157,902 89,565
----------- ----------- -----------
Income (loss) from operations.............................................. (5,852) (41,513) 12,858
Interest income, net of interest and other expense......................... 7,339 7,429 10,546
----------- ----------- -----------
Income (loss) before income taxes.......................................... 1,487 (34,084) 23,404
Provision for (benefit from) income taxes.................................. (720) 5,590 8,190
----------- ----------- -----------
Net income (loss).......................................................... $ 2,207 $ (39,674) $ 15,214
----------- ----------- -----------
----------- ----------- -----------
Earnings per common and common equivalent share............................ $ .07 $ (1.31) $ .50
----------- ----------- -----------
----------- ----------- -----------
Common and common equivalent shares used in the calculation of earnings per
share..................................................................... 30,118 30,313 30,686
</TABLE>
See accompanying notes.
F-3
<PAGE>
NETWORK SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL CUMULATIVE
COMMON PAID-IN RETAINED TRANSLATION
STOCK CAPITAL EARNINGS ADJUSTMENT TOTAL
------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1990......................... $ 588 $ 103,817 $ 137,364 $ 4,700 $ 246,469
Issuance of common stock upon exercise of stock
options, 715,092 shares........................... 14 5,331 -- -- 5,345
Issuance of common stock through employee stock
purchase plan, 21,874 shares...................... 1 204 -- -- 205
Nonqualified discount options considered earned
compensation...................................... -- 163 -- -- 163
Discount options issued for the conversion of
Vitalink options.................................. -- 4,410 -- -- 4,410
Tax benefit of employee stock plans................ -- 2,571 -- -- 2,571
Change in cumulative translation adjustment........ -- -- -- (234) (234)
Net income......................................... -- -- 15,214 -- 15,214
------- ----------- ----------- ----------- -----------
Balance at December 31, 1991......................... 603 116,496 152,578 4,466 274,143
Issuance of common stock upon exercise of stock
options, 1,244,225 shares......................... 25 9,152 -- -- 9,177
Issuance of common stock through employee stock
purchase plan, 23,403 shares...................... 1 245 -- -- 246
Nonqualified discount options considered earned
compensation...................................... -- 41 -- -- 41
Repurchase and retirement of 1,033,500 shares of
common stock...................................... (21) (11,759) -- -- (11,780)
Tax benefit of employee stock plans................ -- 3,233 -- -- 3,233
Change in cumulative translation adjustment........ -- -- -- (5,437) (5,437)
Net loss........................................... -- -- (39,674) -- (39,674)
------- ----------- ----------- ----------- -----------
Balance at December 31, 1992......................... 608 117,408 112,904 (971) 229,949
Issuance of common stock upon exercise of stock
options, 446,508 shares........................... 9 3,190 -- -- 3,199
Issuance of common stock through employee stock
purchase plan, 30,698 shares...................... 1 266 -- -- 267
Repurchase and retirement of 1,145,000 shares of
common stock...................................... (23) (10,953) -- -- (10,976)
Tax benefit of employee stock plans................ -- 360 -- -- 360
Change in cumulative translation adjustment........ -- -- -- (1,625) (1,625)
Net income......................................... -- -- 2,207 -- 2,207
------- ----------- ----------- ----------- -----------
Balance at December 31, 1993......................... $ 595 $ 110,271 $ 115,111 $ (2,596) $ 223,381
------- ----------- ----------- ----------- -----------
------- ----------- ----------- ----------- -----------
</TABLE>
See accompanying notes.
F-4
<PAGE>
NETWORK SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1993 1992 1991
----------- ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)........................................................ $ 2,207 $ (39,674) $ 15,214
Adjustments to reconcile net income (loss) to cash provided by operating
activities:
Depreciation and amortization.......................................... 13,943 13,785 10,970
Amortization of software development................................... 3,256 3,528 3,432
Amortization of intangible assets...................................... 2,305 3,257 1,960
Intangible assets in acquisition and restructuring charges............. 7,060 48,401 --
Provision for losses on notes receivable............................... -- -- 1,000
Deferred income taxes.................................................. (3,323) (4,646) (2,620)
Income tax benefit from stock option plans............................. 360 3,233 2,571
(Increase) decrease in accounts receivable............................. 1,087 5,937 (3,027)
(Increase) decrease in inventories..................................... (436) 7,438 (6,348)
(Increase) in income tax deposits...................................... (27,333) (907) (11,564)
(Increase) decrease in all other assets, net........................... (7,793) (11,945) 5,157
Increase (decrease) in accounts payable................................ 2,732 (2,264) 936
Increase (decrease) in all other liabilities, net...................... (5,665) 3,551 (14,440)
----------- ------------ ------------
Net cash provided by (used in) operating activities................ (11,600) 29,694 3,241
INVESTING ACTIVITIES:
Purchases of marketable securities....................................... (81,560) (244,609) (264,027)
Maturities of marketable securities...................................... 40,301 26,200 86,021
Sales of marketable securities........................................... 130,116 187,998 218,893
Cost of companies acquired, net of cash acquired......................... (64,365) -- (36,686)
Purchases of property, plant, and equipment.............................. (15,192) (14,097) (13,827)
Additions to software development........................................ (2,500) (3,000) (3,660)
Additions to notes receivable............................................ -- -- (840)
Payments received on notes receivable.................................... 522 1,499 110
----------- ------------ ------------
Net cash provided by (used in) investing activities................ 7,322 (46,009) (14,016)
FINANCING ACTIVITIES:
Proceeds from short-term bank loan....................................... -- -- 45,000
Repayment of debt........................................................ -- (1,859) (45,033)
Proceeds from issuing common stock to employees.......................... 3,466 9,464 5,713
Repurchase of common stock............................................... (10,976) (11,780) --
----------- ------------ ------------
Net cash provided by (used in) financing activities................ (7,510) (4,175) 5,680
Effects of exchange rate changes......................................... (376) (743) (36)
----------- ------------ ------------
Decrease in cash and short-term investments.............................. (12,164) (21,233) (5,131)
Cash and short-term investments at beginning of year..................... 38,075 59,308 64,439
----------- ------------ ------------
Cash and short-term investments at end of year........................... $ 25,911 $ 38,075 $ 59,308
----------- ------------ ------------
----------- ------------ ------------
Supplemental cash flows information:
Interest paid.......................................................... $ 183 $ 1,285 $ 1,338
Income taxes paid, net................................................. $ 1,967 $ 7,370 $ 9,040
</TABLE>
See accompanying notes.
F-5
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1993, 1992, AND 1991
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION POLICY
The consolidated financial statements include the accounts of the Company
and its subsidiaries, all of which are wholly owned.
SEGMENT INFORMATION
The Company is engaged in a single business consisting of the design,
manufacture, marketing, and maintenance of data communications equipment and
related software.
TRANSLATION OF FOREIGN CURRENCIES
The financial statements of foreign subsidiaries have been translated into
U.S. dollars in accordance with the provisions of Statement of Financial
Accounting Standards No. 52. Under this Statement, assets and liabilities of
foreign subsidiaries are translated into U.S. dollars at the year-end exchange
rate, while equity accounts are translated at historical rates. Income and
expenses are translated at the average exchange rates during the year. The
resulting translation adjustments are made directly to a separate component of
stockholders' equity.
CASH FLOWS
Short-term investments purchased within three months of their maturities are
considered cash equivalents.
REVENUE RECOGNITION
Product sales include hardware sales and software license fees. Revenue is
recognized at the time of shipment for hardware sales and single-fee long-term
software business, provided that no significant vendor or post-contract
obligations remain outstanding and collection of the resulting receivable is
deemed probable. Revenue from monthly software licenses is recognized over the
term of the license agreement. Product sales also include nominal amounts of
other income from various sources. Revenue from services is recognized ratably
over the contractual period or as the services are provided. Provisions for
sales returns, exchanges, and discounts are recorded at the time of sale based
upon historical information adjusted for current trends.
DEFERRED REVENUE
During December 1988, the Company negotiated an extension of its territorial
distribution rights contract with its distributor in Japan. The initial
contract, expiring in December 1989, was extended for an additional five years
ending December 1994. For extending the contract, the Company received a
$10,000,000 payment in January 1989. This payment will be recognized in revenue
over the last five years of the contract as the Company fulfills its obligation
to provide products to the distributor.
INVENTORIES
Inventories are stated at lower of cost (first-in, first-out method) or
market. Network Systems' policy is to employ a systematic methodology that
includes quarterly evaluations of inventory, based upon business trends, to
specifically identify obsolete, slow-moving and nonsalable inventory. Inventory
reserves are evaluated quarterly to ensure they continually reflect the current
business environment and trends.
PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are recorded at cost and are depreciated
using the straight-line method over the estimated useful lives of the related
assets.
F-6
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SOFTWARE DEVELOPMENT
Network Systems capitalizes software development costs subsequent to
establishment of technological feasibility to produce the finished software
product. Costs related to the conceptual formulation and design of software
products are expensed as research and development. Ongoing costs to support or
service software products are expensed. Capitalized software development costs
are amortized, commencing when the software is made available for general
release to customers, over their revenue-producing lives, but not in excess of
three years.
INTANGIBLE ASSETS
The carrying value of goodwill and related purchased intangible assets
related to businesses acquired is reviewed in conjunction with the
identification of facts and circumstances that indicate that recoverability may
be impaired. For the purpose of assessing recoverability, Network Systems uses a
discounted cash flow methodology. If indications are present that costs will not
likely be recovered, the carrying value is reduced accordingly.
INCOME TAXES
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes", was issued by the Financial Accounting Standards Board in February 1992,
effective January 1, 1993 with earlier adoption encouraged. The Company elected
to adopt the new standard effective January 1, 1992. The financial statements
for 1991 have been prepared using the deferred method of determining income tax
expense.
EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE
Earnings per common share is based on the weighted average number of common
and dilutive common equivalent shares outstanding during each period. For the
year ended December 31, 1992, options representing 667,000 weighted average
common equivalent shares were excluded from computing the loss per common share
as their impact would be anti-dilutive. Fully diluted earnings per share are not
presented because the dilutive effect is not significant.
OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
Network Systems enters into foreign exchange forward contracts to hedge
against the effects of movements in foreign currency exchange rates on its
foreign currency denominated receivables from affiliates. The unrealized
exchange rate gains and/or losses on outstanding foreign exchange forward
contracts are included in the results of operations. Because the impact of
movements in currency exchange rates on foreign exchange contracts offsets the
related impact on the underlying items being hedged, these instruments do not
subject Network Systems to risk that would otherwise result from changes in
currency exchange rates. At December 31, 1993, Network Systems' hedging
contracts substantially offset this balance sheet exposure. As of December 31,
1993, Network Systems had approximately $3,800,000 in net forward contracts
outstanding.
The Company distributes its products principally through its direct sales
force to a diverse base of commercial customers and government agencies. The
Company's concentration of credit risk is limited by the size and geographic
diversity of its customer base.
RECLASSIFICATIONS
Certain items in the 1992 and 1991 consolidated financial statements have
been reclassified to conform to the 1993 presentation.
F-7
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
CONSOLIDATED BALANCE SHEET DETAILS (IN THOUSANDS)
<TABLE>
<CAPTION>
1993 1992
--------- ---------
<S> <C> <C>
Inventories:
Raw material............................................................................. $ 10,210 $ 5,504
Work in process.......................................................................... 7,200 7,838
Finished goods........................................................................... 9,189 4,103
--------- ---------
Total inventories.................................................................... $ 26,599 $ 17,445
--------- ---------
--------- ---------
Property, plant, and equipment:
Land..................................................................................... $ 1,071 $ 1,071
Buildings and leasehold improvements..................................................... 9,185 8,317
Production, test, and data processing equipment.......................................... 76,645 71,145
Furniture and other equipment............................................................ 8,937 8,520
--------- ---------
Total property, plant, and equipment................................................. $ 95,838 $ 89,053
--------- ---------
--------- ---------
Goodwill and other intangible assets, net:
Goodwill................................................................................. $ 17,495 $ --
Other intangible assets.................................................................. 21,344 --
--------- ---------
38,839 --
Less accumulated amortization............................................................ 2,305 --
--------- ---------
Total goodwill and other intangible assets, net...................................... $ 36,534 $ --
--------- ---------
--------- ---------
Other assets:
Finance receivables...................................................................... $ 1,629 $ 2,995
Software development, less accumulated
amortization of $8,686 ($8,839 in 1992)................................................. 4,194 4,950
Cash value of company-owned life insurance,
net of policy loans of $281 in 1992..................................................... 20,656 17,187
Income tax deposit, including interest of $3,171 ($1,505 in 1992)........................ 39,804 12,471
Other.................................................................................... 2,348 1,373
--------- ---------
Total other assets................................................................... $ 68,631 $ 38,976
--------- ---------
--------- ---------
Accrued liabilities:
Employee compensation.................................................................... $ 5,557 $ 5,545
Accrued vacation......................................................................... 3,014 2,741
Taxes, other than income................................................................. 1,624 1,955
Restructuring costs...................................................................... 8,532 10,196
Unearned revenue......................................................................... 7,355 6,597
Other.................................................................................... 15,049 8,853
--------- ---------
Total accrued liabilities............................................................ $ 41,131 $ 35,887
--------- ---------
--------- ---------
</TABLE>
F-8
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
ACQUISITIONS
In April 1993, the Company announced its intention to acquire the assets of
Bus-Tech, Inc. ("BTI"). In May 1993, the Company concluded the acquisition by
forming a subsidiary that acquired all the assets and assumed certain
liabilities of BTI in return for cash. BTI designs, manufactures, markets, and
supports data communications products for the interconnect controller market.
The accompanying financial statements include BTI's results of operations since
May 1993. The purchase price, including acquisition costs, totaled approximately
$24,700,000. The acquired assets and liabilities have been recorded at their
estimated fair values at the date of acquisition. The value of the technology
acquired and covenants not to compete totaled approximately $21,300,000. These
assets are being amortized to cost of sales and general and administrative
expense over their estimated lives ranging from 3 to 7 years.
In November 1993, the Company concluded its September 1993 cash tender offer
to purchase all the outstanding shares of Bytex Corporation ("Bytex"). The
closing of the tender offer was followed by a merger in which any Bytex shares
remaining outstanding will be exchanged for the cash price. Bytex designs,
manufactures, markets, and supports fault-tolerant systems and related data
communications products which increase the availability of both wide and local
area networks. The transaction was accounted for as a purchase. The accompanying
financial statements include Bytex's results of operations since November 1993.
The purchase price and expenses associated with the acquisition of approximately
$47,100,000 exceeded the fair value of Bytex's net assets by approximately
$17,500,000. The excess has been assigned to goodwill and will be amortized over
its estimated 7 year life. The Company views this purchase price allocation to
be final and not subject to further adjustment.
Excluded from the Consolidated Statement of Cash Flows for 1993 were the
following effects of noncash investing and financing activities related to the
acquisitions of BTI and Bytex:
<TABLE>
<CAPTION>
(IN THOUSANDS)
---------------
<S> <C>
Accrual for acquisition related costs................................. $ 1,894
Accrual for Bytex shares not tendered by the date of merger........... 2,413
-------
$ 4,307
-------
-------
</TABLE>
In June 1991, the Company concluded its May 1991 cash tender offer to
purchase all the outstanding shares of Vitalink Communications Corporation
("Vitalink"). The closing of the tender offer was followed by a merger in which
any Vitalink shares remaining outstanding will be exchanged for the cash price.
Vitalink designs, manufactures, markets, and supports data communications
products that connect local area networks. The transaction was accounted for as
a purchase. The accompanying financial statements include Vitalink's results of
operations since June 1991. The purchase price, including acquisition related
costs, totaled approximately $164,400,000. The value of technology, customer
relationships, and goodwill totaled approximately $53,600,000. During 1991 and
1992 these assets were amortized over estimated lives of 2 to 20 years.
F-9
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
ACQUISITIONS (CONTINUED)
Excluded from the Consolidated Statement of Cash Flows for 1991 were the
following effects of noncash investing and financing activities related to the
acquisition of Vitalink:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Accrual for acquisition related costs................................. $ 4,286
Accrual for Vitalink shares not tendered by the date of merger........ 13,722
--------------
18,008
Issuance of stock options at a discount for the conversion of Vitalink
employee stock options............................................... 4,410
--------------
$ 22,418
--------------
--------------
</TABLE>
The following represents the unaudited pro forma results of operations as if
the above noted business combinations had occurred at the beginning of the
respective year in which the companies were acquired as well as the beginning of
the immediately preceding year:
<TABLE>
<CAPTION>
1993 1992 1991
----------- ----------- -----------
(IN THOUSANDS EXCEPT PER-SHARE DATA)
(UNAUDITED)
<S> <C> <C> <C>
Total revenues......................................... $ 249,019 $ 266,534 $ 218,901
Net income (loss)...................................... $ (2,630) $ (44,700) $ 16,692
Earnings per common and common
equivalent share...................................... $ (.09) $ (1.47) $ .54
</TABLE>
The pro forma information is based on the unaudited historical results of
operations of the companies, giving effect to certain pro forma adjustments. The
pro forma financial information does not purport to be indicative of either
results of operations that would have occurred had the purchase been made at the
beginning of the periods presented, or future results of operations of the
combined companies.
ACQUISITION, RESTRUCTURING, AND ACQUIRED RESEARCH AND DEVELOPMENT COSTS
During the fourth quarter of 1993, Network Systems completed its acquisition
of Bytex and a strategic plan for reengineering Network Systems. In connection
with these events Network Systems recorded a pre-tax charge of $15,642,000
($9,700,000 net of tax benefits, or $.33 per share) which included a write-off
of $7,060,000 of fair value allocated to research and development costs relating
to unfinished product development in connection with the valuation of the Bytex
acquisition. The remaining $8,582,000 of charges were associated with moving the
Bytex operation from Boston to Minneapolis and completing the move of the
remaining Vitalink operations from Fremont to Minneapolis which was part of a
restructuring plan that was finalized and approved by Network Systems' Board of
Directors in December of 1993.
The primary components of the $8,582,000 restructuring charge discussed
above included $4,127,000 of costs associated with severance and relocation of
employees; $1,927,000 for the write-off of non-productive or abandoned fixed
assets, leasehold improvements, and inventory; $1,490,000 of accrual of costs
relating to the complete abandonment of the Vitalink facility which is to be
completed in 1994; and $550,000 of costs associated with modifying current
automated accounting and service support systems to accommodate Vitalink and
Bytex requirements.
During the fourth quarter of 1992, Network Systems recorded a restructuring
charge of $60,310,000 to cover the costs associated with a major restructuring
of Network Systems' Vitalink operations. The majority of the charge, or
$48,401,000, was for the write-off of the unamortized
F-10
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
ACQUISITION, RESTRUCTURING, AND ACQUIRED RESEARCH AND DEVELOPMENT COSTS
(CONTINUED)
goodwill and intangible assets of Vitalink which was necessitated by the fact
that the projected discounted cash flows of the Vitalink operation no longer
reflected recovery of the goodwill and intangible assets. The remaining charge
of $11,909,000 was for various costs associated with the reorganization of
Vitalink and Network Systems' Minneapolis and European operations. These costs
included $5,268,000 for employee severance, and $2,108,000 for non-productive or
abandoned fixed assets and inventory. The restructuring charges also included
$3,095,000 of costs associated with eliminating duplicative sales, general and
administrative functions for Vitalink, Minneapolis, and Europe -- the primary
components of which are $1,092,000 for the accrual of costs relating to the
abandonment of the manufacturing facilities at Vitalink and the abandonment
duplicate United States field offices; $614,000 for recruiting fees relating to
the replacement of personnel unwilling to relocate; $298,000 for employee
relocation costs; $260,000 for automated systems integration costs; and the
residual relating primarily to moving costs. The remaining $1,438,000 of
restructuring charges relate to the costs associated with integrating the
Vitalink manufacturing facilities in Minneapolis. The after-tax effect of the
restructuring charge was to decrease income for the fourth quarter of 1992 and
for all of 1992 by $56,070,000. The per share effect was to decrease earnings
per share by $1.85 for the fourth quarter and $1.84 for 1992.
The $60,310,000 restructuring reserve recorded in 1992 was reduced to an
accrual balance at December 31, 1992 of $10,196,000 through the write-off of
goodwill and property of $48,401,000 and $94,000, respectively, and cash
payments made of $1,619,000. The activity in the restructuring reserves for 1993
included the 1993 provision of $8,582,000, which was reduced by property write
offs of $1,676,000 and cash disbursements related to accruals of $7,478,000
leaving a remaining restructuring accrual at December 31, 1993 of $9,624,000.
This reserve includes $2,265,000 for property yet to be disposed of and
$7,359,000 for future cash disbursements. Network Systems expects that payments
relating to the remaining accrual at December 31, 1993 will occur primarily in
1994.
LEASES
The Company leases field offices and certain equipment under noncancelable
operating leases. Minimum future obligations under operating leases at December
31, 1993, excluding rentals on leases with initial terms of one year or less,
are: $7,475,000 in 1994, $6,424,000 in 1995, $4,588,000 in 1996, $2,976,000 in
1997, $2,359,000 in 1998, and $7,087,000 thereafter. Total rental expense,
including rentals on leases with terms of one year or less, was approximately
$6,666,000 in 1993, $5,430,000 in 1992, and $5,383,000 in 1991.
F-11
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
CASH AND SHORT-TERM INVESTMENTS AND MARKETABLE SECURITIES (IN THOUSANDS)
<TABLE>
<CAPTION>
1993 1992
--------- -----------
<S> <C> <C>
Cash and short-term investments:
Cash................................................................................... $ 22,079 $ 28,534
Government securities.................................................................. 1,175 2,256
Corporate obligations.................................................................. 2,657 7,285
--------- -----------
Total cash and short-term investments.............................................. 25,911 38,075
Marketable securities maturing within one year:
Government securities.................................................................. 151 239
Corporate obligations.................................................................. 4,438 9,078
Municipal bonds........................................................................ 3,081 10,791
Mutual funds........................................................................... 232 --
--------- -----------
7,902 20,108
Marketable securities maturing beyond one year:
Government securities.................................................................. -- 45,204
Corporate obligations.................................................................. -- 11,956
Redeemable preferred securities........................................................ -- 12,551
--------- -----------
-- 69,711
--------- -----------
Total marketable securities........................................................ 7,902 89,819
--------- -----------
Total cash and short-term investments and marketable securities.................... $ 33,813 $ 127,894
--------- -----------
--------- -----------
</TABLE>
Short-term investments and marketable securities are accounted for on the
basis of lower of cost or market. At December 31, 1993, the aggregate market
value of the total cash and short-term investments and marketable securities is
approximately $33,851,000.
INCENTIVE PLANS
The Company has stock incentive plans which permit the granting of incentive
stock options, nonqualified stock options and restricted stock. Incentive stock
option provisions of the plan allow for granting of options to purchase shares
of the Company's common stock at not less than 100 percent of market value at
date of grant. Under the nonqualified stock option provisions, options may be
granted to purchase shares of the Company's common stock at not less than 15
percent of market value at date of grant. Under the restricted stock provisions,
shares of the Company's common stock may be granted subject to restrictions and
forfeiture provisions determined by the Board of Directors.
On April 29, 1993, the stockholders approved an increase to the number of
shares reserved for issuance under the Company's 1989 Long-Term Stock Incentive
Plan from 3,000,000 shares to 4,500,000 shares. At December 31, 1993, there were
1,078,828 shares available for future grants, and options to purchase 736,146
shares were exercisable under the stock option plans. There were no restricted
stock awards during 1993, 1992, or 1991.
F-12
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
INCENTIVE PLANS (CONTINUED)
Stock option activity under all employee incentive plans is summarized as
follows:
<TABLE>
<CAPTION>
AVERAGE
PRICE PER
SHARES SHARE
------------ -----------
<S> <C> <C>
Outstanding at December 31, 1991.................................... 3,052,984 $ 8.32
Granted........................................................... 1,343,000 12.77
Exercised......................................................... (1,235,650) 7.38
Cancelled......................................................... (477,809)
------------
Outstanding at December 31, 1992.................................... 2,682,525 10.72
Granted........................................................... 2,180,675 8.45
Exercised......................................................... (446,508) 7.17
Cancelled......................................................... (1,062,434)
------------
Outstanding at December 31, 1993.................................... 3,354,258 9.47
------------
------------
</TABLE>
Additionally, the Company's 1988 Nonemployee Director Stock Option Plan
provides for the granting of options to purchase a maximum of 120,000 shares of
the Company's common stock by nonemployee directors. During 1988, 65,625 options
were granted at $7.13, fair market value at date of grant. During 1992, 9,375
options under the plan were exercised by a former director of the Company. At
December 31, 1993, 46,875 options remain outstanding, all of which are
exercisable.
Subject to shareholder approval, the Company's 1993 Nonemployee Director
Stock Option Plan provides for the granting of options to purchase a maximum of
191,875 shares of the Company's common stock by nonemployee directors. During
1993, 91,875 options were granted at $7.88, fair market value at date of grant.
These options become exercisable on a cumulative basis, one-third on the date of
each successive annual stockholder meeting.
In the event that certain changes in control of the Company occur, all stock
options under the Long-Term Stock Incentive Plan and the Nonemployee Director
Stock Option Plans become immediately exercisable, and all restrictions under
any outstanding restricted stock grants will immediately lapse.
The Company has deferred compensation and supplemental retirement agreements
with its executive officers under which the Company has agreed to pay certain
amounts annually over a period of fifteen years subsequent to retirement. The
Company also has deferred compensation agreements with certain key employees.
The charges to expense under these agreements are based on the present value
method and were approximately $2,340,000 in 1993, $2,046,000 in 1992, and
$1,689,000 in 1991. The Company has insured the lives of certain employees to
assist in the funding of the deferred compensation liability. The Company is the
owner and beneficiary of the insurance policies.
EMPLOYEE STOCK PURCHASE PLAN
The Company's 1989 Employee Stock Purchase Plan, a qualified plan pursuant
to Internal Revenue Code Section 423, became effective April 1, 1989. The plan
gives eligible employees an opportunity to purchase the Company's common stock
through a series of consecutive annual offerings beginning April 1, 1989.
Payroll deductions not exceeding 10% of eligible compensation may be used to
purchase stock at a per-share price of 85% of the lesser of the fair market
value on April 1, the beginning of each annual offering period, or March 31, the
end of each annual offering period. Effective April 1, 1993, the stockholders
approved an increase in the number of shares reserved for issuance under the
plan from 500,000 shares to 750,000 shares. In addition, the stockholders
approved
F-13
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
EMPLOYEE STOCK PURCHASE PLAN (CONTINUED)
changes to the plan that authorize the Board of Directors to establish for each
annual offering period the maximum number of shares that may be purchased by a
participant. Shares issued under the plan were 30,698 in 1993, 23,403 in 1992,
and 21,874 in 1991. The plan will terminate when the 750,000 shares authorized
for issuance under the plan have been purchased.
COMMON AND PREFERRED STOCK
The Company's Board of Directors is authorized to issue 5,000,000 shares of
special preference stock, par value $.02, in one or more series, and to
determine voting rights, dividend rates, redemption rights, convertibility, and
other preferences of each series. No stock has been issued under this
authorization.
In 1988, the Company amended its shareholder rights plan which was adopted
in 1986. On adopting the plan, the Company distributed one preferred stock
purchase right for each outstanding share of the Company's common stock. The
rights will become exercisable only in certain limited circumstances involving a
potential business combination transaction of the Company. Under these
circumstances, holders can exercise their right to purchase common stock of the
Company or, in certain circumstances, securities of an acquiror, having a value
of twice the exercise price of $70. The rights have the effect of causing
significant dilution in the case of an attempt to acquire the Company on terms
not approved by the Company's Board of Directors. The rights should not
interfere with any business combination approved by the Board of Directors,
since the rights may be redeemed by the Company at $.05 per right. The rights
expire on July 28, 1996.
F-14
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
GEOGRAPHIC AREA AND MAJOR CUSTOMER INFORMATION
Information about the Company's operations by geographic area is summarized
as follows:
<TABLE>
<CAPTION>
1993 1992 1991
----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Total revenues:
United States:
Unaffiliated customers................................................. $ 163,358 $ 152,626 $ 137,009
Transfers between geographic areas..................................... 18,987 20,273 23,370
----------- ----------- -----------
182,345 172,899 160,379
Subsidiaries in Canada and Europe........................................ 52,200 66,492 61,719
Eliminations............................................................. (18,987) (20,273) (23,370)
----------- ----------- -----------
$ 215,558 $ 219,118 $ 198,728
----------- ----------- -----------
----------- ----------- -----------
Income (loss) before income taxes:
United States............................................................ $ (3,005) $ (47,002) $ 5,385
Subsidiaries in Canada and Europe........................................ (980) 7,343 9,004
----------- ----------- -----------
Total operating income (loss).......................................... (3,985) (39,659) 14,389
General corporate expenses............................................... (1,867) (1,854) (1,531)
Interest income.......................................................... 7,522 8,714 11,787
Interest and other expense............................................... (183) (1,285) (1,241)
----------- ----------- -----------
$ 1,487 $ (34,084) $ 23,404
----------- ----------- -----------
----------- ----------- -----------
Total assets:
United States............................................................ $ 229,208 $ 119,843 $ 181,645
Subsidiaries in Canada and Europe........................................ 24,354 29,920 41,994
Eliminations............................................................. (2,550) (1,941) (11,765)
----------- ----------- -----------
Total identifiable assets.............................................. 251,012 147,822 211,874
Corporate assets......................................................... 54,469 145,603 130,937
----------- ----------- -----------
$ 305,481 $ 293,425 $ 342,811
----------- ----------- -----------
----------- ----------- -----------
Export sales:
Asia/Pacific............................................................. $ 25,864 $ 17,357 $ 19,125
Other international locations............................................ 10,134 7,841 7,459
----------- ----------- -----------
$ 35,998 $ 25,198 $ 26,584
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
Sales to unaffiliated customers outside the United States, including export
sales to independent distributors, were $88,198,000, $91,690,000, and
$88,303,000 for 1993, 1992, and 1991, respectively, which represented 40.9%,
41.8%, and 44.4%, of total revenues.
Manufacturing operations are located in the United States. Sales to
affiliates are accounted for at amounts which are above cost. Operating income
is sales less cost of sales and operating expenses.
Identifiable assets are those assets used in each geographic area. Corporate
assets consist of cash and short-term investments, marketable securities, notes
receivable from officers, and cash surrender value of Company-owned life
insurance, net of policy loans.
Foreign currency transaction losses of approximately $240,000 in 1993,
$1,225,000 in 1992, and $724,000 in 1991 have been included in net income
(loss).
F-15
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
GEOGRAPHIC AREA AND MAJOR CUSTOMER INFORMATION (CONTINUED)
The Company sells to various government agencies; no individual agency
constituted more than ten percent of total revenues in any of the three years in
the period ended December 31, 1993.
INCOME TAXES
<TABLE>
<CAPTION>
FEDERAL STATE FOREIGN TOTAL
--------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
1993 (LIABILITY METHOD)
Current........................................... $ (4,360) $ (900) $ 910 $ (4,350)
Deferred.......................................... 3,380 730 (480) 3,630
--------- --------- --------- ---------
$ (980) $ (170) $ 430 $ (720)
--------- --------- --------- ---------
--------- --------- --------- ---------
1992 (LIABILITY METHOD)
Current........................................... $ 320 $ 30 $ 4,160 $ 4,510
Deferred.......................................... 280 120 680 1,080
--------- --------- --------- ---------
$ 600 $ 150 $ 4,840 $ 5,590
--------- --------- --------- ---------
--------- --------- --------- ---------
1991 (DEFERRED METHOD)
Current........................................... $ 5,530 $ 1,420 $ 3,860 $ 10,810
Deferred.......................................... (2,120) (440) (60) (2,620)
--------- --------- --------- ---------
$ 3,410 $ 980 $ 3,800 $ 8,190
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The foreign provision for income taxes is based on foreign pretax income
(loss) of $(536,000) in 1993, $8,167,000 in 1992, and $9,785,000 in 1991.
Effective January 1, 1992, the Company changed its method of accounting for
income taxes from the deferred method to the liability method required by
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes". As permitted under the new rules, prior year's financial statements have
not been restated. The cumulative effect of adopting Statement No. 109 was not
material.
F-16
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
INCOME TAXES (CONTINUED)
Deferred income taxes reflect the net effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
1993 1992
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Inventory reserves................................................... $ 1,198 $ 1,110
Deferred revenue..................................................... 570 2,538
Deferred compensation................................................ 4,302 3,728
Acquisition and restructuring costs.................................. 6,697 4,467
Net operating loss carryforwards..................................... 11,452 4,188
Other................................................................ 4,533 3,247
--------- ---------
28,752 19,278
Tax credit carryforwards............................................. 3,687 404
Valuation reserve for deferred tax assets............................ (5,700) (4,477)
--------- ---------
Total deferred tax assets.......................................... 26,739 15,205
--------- ---------
Deferred tax liabilities:
Tax depreciation over book........................................... 2,768 2,150
Net capitalized software............................................. 2,020 1,881
Gross margin deferral on receivables................................. 1,150 1,572
Interest included in tax deposits.................................... 5,331 572
--------- ---------
Total deferred tax liabilities..................................... 11,269 6,175
--------- ---------
Net deferred tax assets.......................................... $ 15,470 $ 9,030
--------- ---------
--------- ---------
</TABLE>
The components of the provision for deferred income taxes for the year ended
December 31, 1991 are:
<TABLE>
<CAPTION>
1991
---------------
(IN THOUSANDS)
<S> <C>
Excess tax depreciation over book depreciation........................ $ 248
Transactions with international subsidiaries.......................... (180)
Software development cost capitalized for book purposes,
net of amortization.................................................. 87
Inventory reserves.................................................... (161)
Deferred revenue...................................................... 760
Deferred compensation, net............................................ (757)
Costs related to acquisition.......................................... (992)
Reserves for discontinuance of third-party arrangements............... (889)
Other, net............................................................ (736)
-------
$ (2,620)
-------
-------
</TABLE>
F-17
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
INCOME TAXES (CONTINUED)
Differences between the federal statutory income tax rate and the effective
tax rate are:
<TABLE>
<CAPTION>
1993 1992 1991
------- ------- ------
<S> <C> <C> <C>
Federal statutory rate....................................... 35.0% (34.0)% 34.0%
State tax, net of federal tax benefit........................ (5.8) .7 3.0
Amortization of intangibles.................................. 9.8 3.2 2.9
Write-off of intangibles..................................... -- 48.3 --
Purchase accounting adjustments.............................. -- .2 2.4
FSC benefits................................................. (59.3) (2.2) (3.3)
Dividend exclusion and municipal bond interest............... (25.2) (1.3) (1.6)
Increase in cash surrender value, net........................ (9.4) -- --
Foreign tax rate differential................................ 12.3 .2 1.2
Foreign net operating losses, net of utilization............. 32.2 4.9 .8
Foreign tax credits.......................................... (40.7) (.4) (.4)
Change in deferred tax asset valuation reserve............... -- (2.3) --
Reduction of taxes previously provided....................... -- -- (4.3)
Other, net................................................... 2.7 (.9) .3
------- ------- ------
Effective tax rate........................................... (48.4)% 16.4% 35.0%
------- ------- ------
------- ------- ------
</TABLE>
Aggregate unremitted earnings of foreign subsidiaries for which U.S. federal
and state income taxes have not been provided totaled approximately $28,800,000
at December 31, 1993. Deferred income taxes have not been provided on these
earnings because the Company considers them to be indefinitely reinvested,
except for repatriations to the extent of available foreign tax credits.
Determination of the amount of unrecognized deferred U.S. income tax liability
is not practicable because of the complexities and uncertainties involved with
its hypothetical calculation.
At December 31, 1993, the Company had foreign net operating loss
carryforwards of approximately $8,780,000 available to offset future taxable
income. Approximately $6,810,000 of these carryforwards have an unlimited
carryforward period. The remaining $1,970,000 begins to expire in years after
1997. The Company has established a tax valuation reserve for the entire
deferred tax asset related to its foreign net operating loss carryforwards. The
Company also has U.S. federal net operating loss carryforwards of approximately
$16,200,000 available to offset future taxable income for which no tax valuation
reserve has been established. Tax credit carryforwards of approximately
$3,687,000 consist of $2,307,000 of U.S. general business credits and
alternative minimum tax credits. The remaining $1,380,000 consists of U.S.
foreign tax credits which expire in 1999. The Company has established a tax
valuation reserve of approximately $911,000 for the deferred tax asset related
to its tax credit carryforwards. Network Systems has determined that no
additional reserves are necessary on the $15,470,000 of net deferred tax assets
at December 31, 1993 because it is more likely than not to be fully realized.
The net deferred tax asset is expected to be completely recovered either through
operating loss carryback claims that are available of approximately $2,000,000,
through the use of tax planning strategies used to generate taxable income
primarily through the sale of appreciated assets, or through deductions against
future taxable income. Based upon the facts and circumstances at this time and
Network Systems' lengthy history of profitable operating results, including
cumulative net income over the past three years of $26,100,000 absent goodwill
write-offs, Network Systems believes that realization of the asset is probable.
The Internal Revenue Service (IRS) has examined the Company's consolidated
income tax returns through December 31, 1990. The IRS assessed against the
Company an accumulated earnings
F-18
<PAGE>
NETWORK SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1993, 1992, AND 1991
INCOME TAXES (CONTINUED)
tax of approximately $2,600,000 for 1983, $4,500,000 for 1984, and $3,900,000
for 1985. In May 1991, the Company paid the imposed tax and in October 1991, the
Company filed suit in Federal District Court against the IRS for the refund of
the imposed tax together with interest. In February 1993, the Federal District
Court ruled that the IRS had improperly applied the accumulated earnings tax to
the Company for the years 1983 through 1985. The judgment awards the Company the
return of $10,966,042 of tax previously paid to the IRS plus interest. In
November 1993, the IRS filed an appeal of this judgment with the United States
Court of Appeals. In January 1994, the United States Court of Appeals granted a
dismissal of the IRS appeal. In anticipation of a full refund, the Company
recorded the tax paid as a long-term deposit bearing interest at the IRS refund
rate.
During 1991, the IRS completed its examination of the Company's consolidated
income tax returns for the years 1986, 1987, and 1988. In July 1991, the IRS
again proposed the imposition of an accumulated earnings tax of approximately
$5,100,000 for 1986, $5,600,000 for 1987, and $4,100,000 for 1988. In April
1993, the Company paid the imposed tax and in May 1993, it paid interest on the
tax amounting to $10,858,000. During May 1993, the Company filed suit in Federal
District Court against the IRS for the refund of the imposed tax, together with
interest. In anticipation of a full refund, the Company has recorded the tax and
interest paid as a long-term deposit bearing interest at the IRS refund rate.
During 1992, the IRS completed its examination of the Company's consolidated
income tax returns for the years 1989 and 1990. In October 1992, the IRS again
proposed the imposition of an accumulated earnings tax of approximately
$5,000,000 for 1989 and $4,400,000 for 1990. The Company has administratively
appealed these proposed assessments.
The Company and its special tax counsel believe that the IRS position for
taxable years 1986 through 1990 is substantially without merit and will
vigorously defend against the IRS proposals to impose an accumulated earnings
tax. Although the ultimate resolution of this matter cannot be determined at the
present time, management believes a material loss is unlikely. Accordingly, the
Company has made no provision with respect to these matters. With respect to all
other tax matters, the Company considers its tax accruals adequate to cover any
domestic or foreign tax deficiencies not recoverable through deductions in
future years.
CONTINGENCIES
Network Systems is a party to litigation which arises in the normal course
of business. Management regularly analyzes current information and, as
necessary, provides accruals for probable liabilities on the eventual
disposition of these matters. Management's estimate of the reasonably possible
loss from all ongoing litigation is in a range from $200,000 to $2,400,000.
Approximately $1,400,000 of accruals established in connection with the Vitalink
acquisition remain at both December 31, 1993 and 1992. The accrual represents
management's best estimate of the probable losses associated with all
litigation. Management believes that the effect on Network Systems' financial
condition, if any, for the disposition of these matters will not be material.
However, depending on the amount and timing of an unfavorable resolution of
these contingencies it is possible that Network Systems' future results of
operations or cash flows could be materially affected in a particular period.
F-19
<PAGE>
NETWORK SYSTEMS CORPORATION
QUARTERLY FINANCIAL DATA (UNAUDITED)
(IN THOUSANDS EXCEPT PER-SHARE DATA)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER*
--------- --------- --------- ----------
<S> <C> <C> <C> <C>
1993
Total revenues.................................................... $ 46,047 $ 49,061 $ 53,340 $ 67,110
Total cost of revenues............................................ 22,793 24,772 26,675 34,850
--------- --------- --------- ----------
Gross profit...................................................... 23,254 24,289 26,665 32,260
Operating expenses................................................ 21,857 22,544 24,123 43,796
--------- --------- --------- ----------
Income (loss) from operations..................................... 1,397 1,745 2,542 (11,536)
Net interest income............................................... 2,385 1,919 1,536 1,499
--------- --------- --------- ----------
Income (loss) before income taxes................................. 3,782 3,664 4,078 (10,037)
Provision for (benefit from) income taxes......................... 1,390 1,350 1,500 (4,960)
--------- --------- --------- ----------
Net income (loss)................................................. $ 2,392 $ 2,314 $ 2,578 $ (5,077)
--------- --------- --------- ----------
Earnings per common and common equivalent share................... $ 0.08 $ 0.08 $ 0.09 $ (0.17)
--------- --------- --------- ----------
--------- --------- --------- ----------
Average common and common equivalent shares....................... 30,415 30,175 30,052 29,707
--------- --------- --------- ----------
--------- --------- --------- ----------
1992
Total revenues.................................................... $ 48,711 $ 54,129 $ 57,340 $ 58,938
Total cost of revenues............................................ 23,672 25,546 27,056 26,455
--------- --------- --------- ----------
Gross profit...................................................... 25,039 28,583 30,284 32,483
Operating expenses................................................ 23,658 24,300 24,742 85,202
--------- --------- --------- ----------
Income (loss) from operations..................................... 1,381 4,283 5,542 (52,719)
Net interest income............................................... 1,561 1,727 2,345 1,796
--------- --------- --------- ----------
Income (loss) before income taxes................................. 2,942 6,010 7,887 (50,923)
Provision for (benefit from) income taxes 1,130 2,340 3,090 (970)
--------- --------- --------- ----------
Net income (loss)................................................. $ 1,812 $ 3,670 $ 4,797 $ (49,953)
--------- --------- --------- ----------
Earnings per common and common equivalent share................... $ 0.06 $ 0.12 $ 0.16 $ (1.65)
--------- --------- --------- ----------
--------- --------- --------- ----------
Average common and common equivalent shares....................... 31,385 30,934 30,688 30,324
--------- --------- --------- ----------
--------- --------- --------- ----------
<FN>
- ------------------------
* The fourth quarter 1993 reflects an after-tax charge to earnings of
approximately $9,700,000, or $.33 per share, to record acquisition,
restructuring, and acquired research and development costs. The charge
records the write-off of $7,060,000 of fair value allocated to research and
development costs relating to unfinished products in connection with the
valuation of the Bytex acquisition. The $8,582,000 balance of the charge
was established to cover the cost of employee severance and relocation
obligations, the cost of consolidation of facilities, and the write-down of
nonproductive assets. The fourth quarter sales are also significantly
higher due to the November 1993 acquisition of Bytex, which contributed
$7,400,000 of revenue for the quarter.
The fourth quarter 1992 reflects an after-tax charge to earnings of
approximately $56,100,000, or $1.85 per share, to record a charge related
to a major restructuring of the Company. The charge consists primarily of
$48,401,000 relating to the decision made in the fourth quarter to write
off goodwill and other intangible assets in connection with the Company's
acquisition of Vitalink. The balance of the charge covers severance
obligations, the cost of eliminating duplicate support functions,
integration costs, and the restructuring of the Company's Minneapolis and
European operations.
</TABLE>
F-20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned hereunto duly authorized.
NETWORK SYSTEMS CORPORATION
By /s/ Malcolm D. Reid
----------------------------------
Malcolm D. Reid
Vice President, Secretary
and General Counsel
Dated: January 6, 1995
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
ITEM NO. DESCRIPTION PAGE NO.
- ------------- ----------------------------------------------------------------------------------- ------------------
<S> <C> <C>
3(a) Restated Certificate of Incorporation.............................................. filed previously
(b) Amendment to Bylaws................................................................ filed previously
4(a) See Exhibits 3(a) and 3(b)......................................................... filed previously
(b) Network Systems Corporation Savings and Stock Ownership Plan Annual Report on Form
11-K for the year ended December 31, 1993.......................................... filed previously
(c) Form of Rights Agreement, dated as of July 16, 1986 between Network Systems
Corporation and Norwest Bank Minneapolis, N.A. which includes as Exhibit B thereto
the Form of Rights certificate. Description of Registrant's Securities to be
Registered. Amended and Restated Rights Agreement dated as of July 16, 1986, as
amended and restated as of September 29, 1988...................................... filed previously
10(a) Key Employees December 1981 Nonqualified Stock Option Plan, as amended............. filed previously
(b) Amendment to Key Employees December 1981 Nonqualified Stock Option Plan, approved
by the stockholders April 26, 1983................................................. filed previously
(c) Key Employees March 1980 Stock Option Plan, as amended............................. filed previously
(d) Amendment to Key Employees December 1981 Nonqualified Stock Option Plan, approved
by the stockholders May 5, 1987.................................................... filed previously
(e) 1993 Management Incentive Plan..................................................... filed previously
(f) Network Systems Corporation Deferred Compensation Plan............................. filed previously
(g) Supplemental Retirement Plan & Agreement........................................... filed previously
(h) Death Benefit Plan................................................................. filed previously
(i) Disability Benefit written description............................................. filed previously
(j) Form of an indemnification agreement between the Company and its directors and
officers effective as of January 20, 1987, approved by the stockholders May 5,
1987............................................................................... filed previously
(k) Severance agreement forms covering the Company's officers.......................... filed previously
(l) Sumitomo Corporation distributor agreement dated December 1984 and December 1988
extension agreement................................................................ filed previously
(m) Network Systems Corporation 1989 Long-Term Stock Incentive Plan as amended......... filed previously
(n) Retirement and consulting arrangement with the Chairman
of the Board....................................................................... filed previously
(o) Network Systems Corporation Nonemployee Directors
Stock Option Plan.................................................................. filed previously
(p) Network Systems Corporation 1993 Nonemployee Directors Stock Option Plan........... filed previously
(q) Network Systems Corporation 1994 Deferred Compensation Plan for Key Employees...... filed previously
22 Subsidiaries of the Company........................................................ filed previously
23 Consent of Ernst & Young, Independent Auditors..................................... filed herewith
25 Power of Attorney.................................................................. filed previously
</TABLE>
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 2-88704) pertaining to the March 1980 and December 1981 Employee
Stock Option Plans, (Form S-8 No. 33-18408) pertaining to the Employee Savings
and Stock Ownership Plan of Network Systems Corporation, (Form S-8 No. 33-3812)
pertaining to the Network Systems Corporation 1986 Employee Stock Purchase Plan,
(Form S-8 No. 33-27434) pertaining to the Network Systems Corporation 1989
Employee Stock Purchase Plan, (Form S-8 No. 33-32390) pertaining to the Network
Systems Corporation 1989 Long-Term Stock Incentive Plan, (Form S-8 No. 33-35478)
pertaining to the Network Systems Corporation Nonemployee Directors Stock Option
Plan, (Form S-8 No. 33-41849) pertaining to the conversion to Network Systems
Corporation of the Vitalink 1990 Stock Option and Vitalink 1982 Incentive Stock
Option Plans, (Form S-8 No. 33-52501) pertaining to the Network Systems
Corporation 1989 Employee Stock Purchase Plan, (Form S-8 No. 33-52787)
pertaining to the Network Systems Corporation 1989 Long-Term Stock Incentive
Plan, and in the Related Prospectuses of our report dated January 28, 1994, with
respect to the consolidated financial statements and schedules of Network
Systems Corporation included in the Annual Report on Form 10-K/A, as amended for
the year ended December 31, 1993.
ERNST & YOUNG
Minneapolis, Minnesota
January 6, 1995
