<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________to______________
Commission File Number 0-20191
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* * * * * *
ODS NETWORKS, INC.
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(Exact name of Registrant as specified in its charter)
Delaware 75-1911917
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1101 East Arapaho Road, Richardson, Texas 75081
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(Address of principal executive offices)
(Zip Code)
(972) 234-6400
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, if changed since last report)
* * * * * *
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days: Yes X No
--- ---
* * * * * *
The number of shares outstanding of the Registrant's Common Stock, $.01 par
value, on July 31, 1998 was 16,887,233.
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<PAGE>
ODS NETWORKS, INC.
INDEX
PART I - FINANCIAL INFORMATION
<TABLE>
PAGE
----
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 1998
and December 31, 1997 . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Operations for the three
months ended June 30, 1998 and June 30, 1997. . . . . . . . 4
Condensed Consolidated Statements of Operations for the six
months ended June 30, 1998 and June 30, 1997. . . . . . . . 5
Condensed Consolidated Statements of Cash Flows for the six
months ended June 30, 1998 and June 30, 1997. . . . . . . . 6
Notes to Condensed Consolidated Financial Statements . . . . . . 7
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition. . . . . . . . . . . 10
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders . . 18
Item 5. Other Information . . . . . . . . . . . . . . . . . . . 18
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . 18
Signature Page . . . . . . . . . . . . . . . . . . . . . . . . . 19
</TABLE>
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<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS.
ODS NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
<TABLE>
<CAPTION>
June 30, Dec. 31,
1998 1997
----------- -------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $12,343 $17,911
Short-term investments 8,960 14,667
Accounts receivable (net) 14,876 8,668
Income taxes receivable 527 3,159
Inventories 16,217 14,671
Deferred tax assets 2,524 1,721
Other assets 1,181 1,221
------- -------
Total current assets 56,628 62,018
Property and equipment (net) 11,912 11,836
Long-term investments 2,756 3,168
Intangibles, net 3,982 -
Equity investments 1,835 -
Other assets 164 156
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TOTAL ASSETS $77,277 $77,178
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------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 7,875 $ 5,381
Accrued expenses 3,896 3,328
Deferred revenue 1,990 1,462
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Total current liabilities 13,761 10,171
Deferred tax liabilities 2,091 628
Capital lease obligations 12 -
Stockholders' Equity:
Preferred stock, $.01 par value,
Authorized shares - 5,000
No shares issued and outstanding
Common stock, $.01 par value,
Authorized shares - 80,000
Issued and outstanding shares - 16,887
in 1998 and 16,486 in 1997 169 165
Additional paid-in capital 22,698 19,488
Retained earnings 38,849 47,032
Foreign currency translation adjustments (303) (306)
------- -------
Total stockholders' equity 61,413 66,379
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $77,277 $77,178
------- -------
------- -------
</TABLE>
See accompanying notes.
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<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
----------------------
June 30, June 30,
1998 1997
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<S> <C> <C>
Net sales $25,215 $27,868
Cost of sales 14,389 16,076
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Gross profit 10,826 11,792
Operating expenses:
Sales and marketing 8,134 7,877
Research and development 2,932 2,823
In-process research and development 5,300 -
General and administrative 1,491 1,258
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Operating loss (7,031) (166)
Interest income, net 356 374
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Income (loss) before income taxes (6,675) 208
Income tax (benefit) provision (538) 79
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Income (loss) before equity in affiliate (6,137) 129
Equity in net income (loss) of affiliate (72) -
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Net income (loss) $(6,209) $ 129
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------- -------
Basic and Diluted income (loss) per share $ (0.37) $ .01
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------- -------
Weighted average common shares outstanding 16,739 16,423
------- -------
------- -------
Weighted averages shares outstanding assuming
dilution 16,739 16,753
------- -------
------- -------
</TABLE>
See accompanying notes.
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<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
Six Months Ended
-----------------------
June 30, June 30,
1998 1997
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<S> <C> <C>
Net sales $ 43,428 $48,029
Cost of sales 24,587 27,241
-------- -------
Gross profit 18,841 20,788
Operating expenses:
Sales and marketing 15,936 15,018
Research and development 5,599 5,653
In-process research and development 5,300 -
General and administrative 2,654 2,520
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Operating loss (10,648) (2,403)
Interest income, net 795 711
-------- -------
Loss before income taxes (9,853) (1,692)
Income tax (benefit) provision (1,742) (643)
-------- -------
Loss before equity in affiliate (8,111) (1,049)
Equity in net income (loss) of affiliate (72) -
-------- -------
Net loss $ (8,183) $(1,049)
-------- -------
-------- -------
Basic and Diluted loss per share $ (0.49) $ (0.06)
-------- -------
-------- -------
Weighted average common shares outstanding 16,625 16,392
-------- -------
-------- -------
Weighted averages shares outstanding assuming
dilution 16,625 16,392
-------- -------
-------- -------
</TABLE>
See accompanying notes.
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<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
Six Months Ended
------------------------
June 30, June 30,
1998 1997
--------- ---------
<S> <C> <C>
Operating Activities:
Net loss ($ 8,183) ($ 1,049)
Adjustments to reconcile net income (loss) to
net cash provided (used) by operating activities:
In-process research and development 5,300 -
Depreciation 1,692 1,530
Amortization 182 -
Equity in net loss of affiliate 72 -
Deferred income taxes (680) (1,265)
Provision for doubtful accounts and returns - 35
Changes in operating assets and liabilities:
Accounts receivable (5,349) 2,571
Inventories (1,200) 6,631
Other assets 9 (39)
Accounts payable and accrued expenses 2,170 (403)
Deferred revenue (12) (337)
Income taxes 2,632 460
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Net cash provided by (used in)
operating activities (3,367) 8,134
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Investing Activities:
Payments for corporate acquisition
(net of cash acquired) (5,604) -
Equity Investment in Blue Ridge Networks (1,250) -
Purchases of short-term investments (2,437) (10,849)
Maturities of short-term investments 9,151 10,932
Purchases of long-term investments (600) (2,495)
Maturities of long-term investments 5 13
Purchases of property and equipment (1,340) (1,943)
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Net cash used in investing activities (2,075) (4,342)
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Financing Activities:
Repayment of Essential Communication Corp.
line of credit (400) -
Exercise of warrants and employee stock options 271 465
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Net cash provided by (used in) financing
activities (129) 465
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Effect of foreign currency translation
adjustment on cash and cash equivalents 3 (8)
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Net increase (decrease) in cash and cash
equivalents (5,568) 4,249
Cash and cash equivalents at beginning of
period 17,911 6,565
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Cash and cash equivalents at end of period $12,343 $10,814
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------- -------
Supplemental disclosure of income taxes paid $ - $ 239
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------- -------
Supplemental schedule of non cash activities:
Tax benefit of stock options exercised
and sold $ - $ 27
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------- -------
</TABLE>
See accompanying notes.
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<PAGE>
ODS NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note A - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. The December 31, 1997 balance
sheet was derived from audited financial statements, but does not include all
the disclosures required by generally accepted accounting principles.
However, the Company believes that the disclosures are adequate to make the
information presented not misleading. In the opinion of management, all the
adjustments (consisting of normal recurring adjustments) considered necessary
for fair presentation have been included. The results of operations for the
six month period ended June 30, 1998 are not necessarily indicative of the
results which may be achieved for the full fiscal year or for any future
period. The condensed consolidated financial statements included herein
should be read in conjunction with the consolidated financial statements and
notes thereto included in the Company's annual report on Form 10-K for the
year ended December 31, 1997.
Computation of Net Income Per Share
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
128 on December 31, 1997 and has restated all EPS data presented. Under SFAS
No. 128 the Company is required to report two separate earnings per share
numbers, basic EPS and diluted EPS. Diluted EPS is essentially the same
number the Company has previously reported as primary earnings per share and
includes the dilutive impact of employee stock options and warrants.
Equity Investment
In March 1998, the Company invested $1.25 million in Blue Ridge Networks,
Inc., a privately-held company which provides secure remote access products
for local and wide area virtual private networks. This investment was
accounted for using the equity method of accounting. The Company's share of
earnings or losses of Blue Ridge Networks, Inc. is reported in the income
statement of the Company.
Business Combinations
On May 7, 1998, the Company acquired Essential Communication Corporation
("Essential"), a privately-held company based in Albuquerque, New Mexico.
Essential designs and manufactures high-speed computer network equipment. The
Company exchanged a combination of $5.8 million of cash and approximately
305,000 shares of the Company's common stock for all outstanding shares of
Essential capital stock, and the Company issued 104,000 stock options in
exchange for all unexpired and unexercised options to acquire Essential
capital stock. In connection with the acquisition, the Company recognized a
one-time charge of $5.3 million, or $0.32 per share, for in-process
technology in the second quarter of 1998. Essential's operations have been
included in the Company's condensed consolidated financial statements since
May 7, 1998, and the acquisition was accounted for using the purchase method
of accounting. The total purchase price of $9.0 million was allocated to the
net assets acquired based on their estimated fair market value, which
included approximately $4.1 million of intangible assets to be amortized over
five years on a straight-line basis; and approximately $5.3 million of
in-process research and development. The in-process research and development
was expensed at the date of the acquisition. Pro forma financial information
has not been presented. The acquisition of Essential does not meet the
reporting requirements for a significant subsidiary.
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<PAGE>
Exchange of Stock Options in First Quarter 1998
On January 21, 1998, the Compensation Committee of the Board of
Directors approved a stock option exchange program (the Exchange Program),
pursuant to which certain employees and officers holding incentive stock
options (i) awarded under the Company's 1987 Incentive Stock Option Plan in
1997 and (ii) awarded prior to December 31, 1997, under the Company's 1995
Stock Option Plan (the 1995 Plan), were given the opportunity to exchange
such options (Existing Options) for new options (New Options), based on the
fair market value of the Company's Common Stock at the close of business on
January 30, 1998. All directors of the Company, including the President and
Chief Executive Officer and the Senior Vice President, were ineligible to
participate in the Exchange Program.
As a result of significant declines in the market value of the Company's
Common Stock since issuance of the Existing Options, the Existing Options
were exercisable at prices which substantially exceeded the market value of
the Common Stock. In approving the Exchange Program and in keeping with the
Company's philosophy of utilizing equity incentives to motivate and retain
qualified employees, the Compensation Committee acknowledged that retention
and attraction of qualified employees are critical to the Company's success
and its ability to continue to meet its performance objectives.
Additionally, recognizing that stock options constitute a significant
component of the Company's compensation structure, the Compensation Committee
deemed it important to regain the incentive intended to be provided by the
New Options to purchase shares of the Company's Common Stock and therefore
serve as a significant factor in the Company's ability to continue to attract
and retain the services of superior quality personnel.
Pursuant to the Exchange Program, holders of the Existing Options were
offered the opportunity to exchange, on a share-for-share basis, such options
for New Options having an exercise price of $7.50 per share, the fair market
value of the Company's Common Stock on the exchange date of January 30, 1998.
Each New Option was awarded under the 1995 Plan and vests and is exercisable
with respect to 20% of the shares covered thereby on each anniversary date
thereof. Eligible employees holding Existing Options for an aggregate of
646,800 shares of Common Stock with an average per share exercise price of
approximately $15.87 elected to participate in the Exchange Program and were
issued New Options covering the same aggregate number of underlying shares as
they had held pursuant to their respective Existing Options. Other than the
new exercise price and the commencement of a new vesting schedule, the option
agreements relating to the New Options are substantially identical to the
option agreements of the Existing Options they replaced.
-8-
<PAGE>
Note B - Inventories (in Thousands)
Inventories consist of:
<TABLE>
June 30, Dec. 31,
1998 1997
--------- ---------
<S> <C> <C>
Raw materials $ 5,846 $ 4,077
Work in process 1,884 2,004
Finished products 6,007 6,593
Demonstration systems 2,480 1,997
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$16,217 $14,671
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</TABLE>
Note C - Accrued Expenses (in Thousands)
Included in accrued expenses are the following:
<TABLE>
June 30, Dec. 31,
1998 1997
-------- --------
<S> <C> <C>
Accrued sales commissions $ 897 $ 563
Accrued property taxes 365 689
Accrued vacation expense 881 724
Accrued warranty expense 475 475
Other (individually less than
5% of current liabilities) 1,278 877
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$ 3,896 $ 3,328
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</TABLE>
Note D - Earnings per Share (in Thousands, except per share amounts)
<TABLE>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1998 1997 1998 1997
------- ------- ------- --------
<S> <C> <C> <C> <C>
Numerator:
Net income (loss) $(6,209) $ 129 $(8,183) $ (1,049)
------- ------- ------- --------
Numerator for basic and diluted
earnings per share $(6,209) $ 129 $(8,183) $ (1,049)
Denominator:
Denominator for basic earnings
per share - weighted average
common shares outstanding 16,739 16,423 16,625 16,392
Effect of dilutive securities:
Stock options and warrants 0 330 0 0
Denominator for diluted earnings
per share - adjusted weighted
average common shares out-
standing 16,739 16,753 16,625 16,392
------- ------- ------- --------
------- ------- ------- --------
Basic income (loss) per share $(0.37) $ .01 $(0.49) $(0.06)
------- ------- ------- --------
------- ------- ------- --------
Diluted income (loss) per share $(0.37) $ .01 $(0.49) $(0.06)
------- ------- ------- --------
------- ------- ------- --------
</TABLE>
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<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This quarterly report, other than historical information, may include
forward-looking statements with respect to financial results, product
introductions, market demand, industry trends, sufficiency of cash resources
and certain other matters. These statements are made under the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995 and
involve risks and uncertainties which could cause actual results to differ
materially from those in the forward-looking statements, including those
discussed in the section entitled "Factors That May Affect Future Results of
Operations" and elsewhere in this filing, as well as those discussed in the
Company's Annual Report on Form 10-K and other filings with the Securities
and Exchange Commission.
The following table sets forth, for the periods indicated, certain financial
data as a percentage of net sales:
<TABLE>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 57.1 57.7 56.6 56.7
------ ------ ------ ------
Gross profit 42.9 42.3 43.4 43.3
Sales and marketing expenses 32.2 28.3 36.7 31.3
Research and development expenses 11.5 10.1 12.9 11.8
In-process research and development 21.1 - 12.2 -
General and administrative expenses 5.9 4.5 6.1 5.2
------ ------ ------ ------
Operating income (loss) (27.8) (0.6) (24.5) (5.0)
Interest income, net 1.4 1.3 1.8 1.5
------ ------ ------ ------
Income (loss) before income taxes (26.4) 0.7 (22.7) (3.5)
Income tax (benefit) provision (2.1) 0.3 (4.0) (1.3)
------ ------ ------ ------
Income (loss) before equity in
affiliate (24.3) 0.4 (18.7) (2.2)
Equity in net income (loss) of
affiliate (0.3) - (0.1) -
------ ------ ------ ------
Net income (loss) (24.6)% 0.4% (18.8)% (2.2)%
------ ------ ------ ------
------ ------ ------ ------
Switching product sales 52.1% 42.3% 47.5% 35.7%
Shared bandwidth hub sales 40.7 52.3 44.5 58.3
Other sales 7.2 5.4 6.0 6.0
------ ------ ------ ------
Net sales 100.0% 100.0% 100.0% 100.0%
------ ------ ------ ------
------ ------ ------ ------
Domestic sales 75.8% 68.3% 77.7% 72.5
Export sales to:
Europe 14.1 7.7 13.3 8.7
Canada 2.7 2.3 3.5 3.6
Asia 7.2 18.6 5.1 12.5
Latin America .2 3.1 .4 2.7
------ ------ ------ ------
Net sales 100.0% 100.0% 100.0% 100.0%
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
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<PAGE>
RESULTS OF OPERATIONS
NET SALES. Net sales for the quarter and six months ended June 30, 1998
decreased to $25.2 million and $43.4 million, respectively, compared to $27.9
million and $48.0 million, respectively, for the same periods of 1997 as
sales of the Company's new network switching products did not increase
quickly enough to offset the decrease in sales of its prior generation shared
bandwidth intelligent hubs.
Export sales for the quarter and six months ended June 30, 1998
decreased to $6.1 million and $9.7 million, respectively, compared to $8.8
million and $13.2 million, respectively, for the same periods of 1997
primarily due to adverse economic developments in Malaysia and South Korea.
Sales to FORE Systems, Inc. ("FORE Systems") were 15.4% and 10.8%,
respectively, of net sales during the quarter and six months ended June 30,
1998. Direct net sales to various agencies of the U.S. Government were 15.0%
and 14.5%, respectively, of net sales during the quarter and six months ended
June 30, 1998, compared to 13.2% and 11.6%, respectively, of net sales for
the same periods of 1997. Sales to Electronic Data Systems Corporation
("EDS") were 2.2% and 7.0%, respectively, of net sales during the quarter and
six months ended June 30, 1998, compared to 14.6% and 14.5%, respectively, of
net sales for the same periods of 1997. Sales to Sapura Holdings Sdn. Bhd.
("Sapura") were 5.0% and 3.1%, respectively, of net sales during the quarter
and six months ended June 30, 1998, compared to 13.9% and 8.1%, respectively,
of net sales for the same periods of 1997.
GROSS PROFIT. Gross profit decreased to $10.8 million or 42.9% of net
sales for the second quarter of 1998 compared to $11.8 million or 42.3% of
net sales for the second quarter of 1997. Gross profit decreased to $18.8
million or 43.4% of net sales for six months ended June 30, 1998 compared to
$20.8 million or 43.3% of net sales for the same period of 1997. Gross profit
margins in future periods may be affected by several factors such as
continued product transition, declining market demand for prior generation
products, obsolescence or surplus of inventory, shifts in product mix,
changes in channels of distribution, sales volume, fluctuation in
manufacturing costs, pricing strategies of the Company and its competitors
and fluctuations in sales of integrated third-party products. Gross profit
margins are typically lower on sales of integrated third-party products.
SALES AND MARKETING. Sales and marketing expenses increased to $8.1
million or 32.2% of net sales for the second quarter of 1998 from $7.9
million or 28.3% of net sales for the second quarter of 1997. Sales and
marketing expenses increased to $15.9 million or 36.7% of net sales for six
months ended June 30, 1998 compared to $15.0 million or 31.3% of net sales
for the same period of 1997. The increase in sales and marketing expense was
primarily due to the acquisition of Essential on May 7, 1998 and increased
marketing efforts. Sales and marketing expenses may vary as a percentage of
net sales in the future.
RESEARCH AND DEVELOPMENT. Research and development expenses, excluding
the one-time charge for in-process research and development, increased to $2.9
million or 11.5% of net sales for the second quarter of 1998 from $2.8
million or 10.1% of net sales for the second quarter of 1997. Research and
development expenses, excluding the one-time charge for in-process research
and development, decreased to $5.6 million or 12.9% of net sales for six
months ended June 30, 1998 compared to $5.7 million or 11.8% of net sales for
the same period of 1997. The Company expects to continue to invest in
research and development activities in the future in order to broaden its
family of network switching, management and security products.
-11-
<PAGE>
IN-PROCESS RESEARCH AND DEVELOPMENT. During the second quarter of 1998,
the Company incurred a one-time charge associated with the acquisition of
Essential of $5.3 million to expense the purchased in-process research and
development that had not reached technological feasibility.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
increased to $1.5 million or 5.9% of net sales for the second quarter of 1998
from $1.3 million or 4.5% of net sales for the second quarter of 1997.
General and administrative expenses increased to $2.7 million or 6.1% of net
sales for six months ended June 30, 1998 compared to $2.5 million or 5.2% of
net sales for the same period of 1997. The increase in general and
administrative expenses for the second quarter of 1998 was primarily due to
the amortization of intangibles related to the acquisition of Essential on
May 7, 1998. General and administrative expenses may vary as a percentage of
net sales in the future.
INTEREST. Net interest income remained relatively constant at $0.4
million and $0.8 million, respectively, for the quarter and six months ended
June 30, 1998 compared to $0.4 million and $0.7 million, respectively, for
the same periods of 1997. Net interest income may vary in the future based
on the Company's cash flow and rate of return on investments.
INCOME TAXES. The Company's effective income tax rate was 8% and 17.7%,
respectively, for the quarter and six months ended June 30, 1998 compared to
the 38.0% for the same periods of 1997. The effective tax rate represented
by the Company's provision for income taxes in the second quarter ended June
30, 1998 would have been approximately 37.1%, disregarding the expenses
associated with the Company's write-off of purchased research and development
costs which were not deductible for tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of liquidity at June 30, 1998 were $12.3
million of cash and cash equivalents, $9.0 million of short-term investments,
$2.8 million of highly liquid investments with a stated maturity beyond one
year and an available line of credit. As of June 30, 1998, working capital
was $42.9 million compared to $51.8 million as of December 31, 1997.
Cash flows used in operations for the first six months of 1998 were $3.4
million, primarily due to an increase in inventory and accounts receivable
balances and a net loss for the period partially offset by an increase in
accounts payable. Future fluctuations in accounts receivable and inventory
balances will be dependent upon several factors, including but not limited to
quarterly sales, ability to collect accounts receivable timely, the Company's
strategy as to building inventory in advance of receiving orders from
customers, and the accuracy of the Company's forecasts of product demand and
component requirements.
Cash used in investing activities in the first six months of 1998 was
$2.1 million, primarily due to property and equipment purchases of $1.3
million, an equity investment in Blue Ridge Networks, Inc. of $1.25 million
and cash used in the acquisition of Essential Communications Corporation
of $5.6 million offset by net maturities of short-term and long-term
investments of $6.1 million.
Cash used in financing activities in the first six months of 1998 was
$0.1 million, due to the repayment of Essential's line of credit in the
amount of $0.4 million offset by the issuance of Common Stock relating to the
exercise of certain employee stock options in the amount of $0.3 million.
During the first six months of 1998 the Company funded its operations
solely
-12-
<PAGE>
through cash flows from operations. The Company has a bank line of credit
agreement with $15.0 million of maximum available borrowings. Borrowings
under this line are secured by the Company's accounts receivable and
inventory and are subject to certain limitations and conditions, including
the maintenance of certain financial ratios and minimum net tangible worth
amounts. Borrowings on this line accrue interest at prime with interest due
monthly and principal due April 12, 1999. As of June 30, 1998, the Company
had no borrowings outstanding under its bank credit facility and had $15.0
million available for allowable borrowings at an applicable interest rate of
8.5% per annum.
The Company intends to seek acquisitions of businesses, products and
technologies that are complementary to those of the Company. The Company is
continuing to identify and prioritize additional networking and security
technologies which it may wish to develop, either internally or through the
licensing or acquisition of products from third parties. While the Company
engages from time to time in discussions with respect to potential
acquisitions, there can be no assurances that any such acquisitions will be
made or that the Company will be able to successfully integrate any acquired
business. In order to finance such acquisitions, it may be necessary for the
Company to raise additional funds through public or private financings. Any
equity or debt financings, if available at all, may be on terms which are not
favorable to the Company and, in the case of equity financings, may result in
dilution to the Company's stockholders.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
As noted above, this report includes foregoing discussions including
forward-looking statements that involve risks and uncertainties. In addition
to those factors discussed elsewhere in this quarterly report and those
discussed in the Company's annual report on Form 10-K and other filings with
the Securities and Exchange Commission, the Company identifies the following
factors which could affect the Company's actual results and cause actual
results to differ materially from those in the forward-looking statements.
TECHNOLOGICAL CHANGES. The market for the Company's products is
characterized by frequent product introductions, rapidly changing technology
and continued evolution of new industry standards. The market for network
intelligent hubs, switches, management and security products requires the
Company's products to be compatible and interoperable with products and
architectures offered by various vendors, including other networking
products, workstation and personal computer architectures and computer and
network operating systems. The Company's success will depend to a
substantial degree upon its ability to develop and introduce in a timely
manner new products and enhancements to its existing products that meet
changing customer requirements and evolving industry standards. The
development of technologically advanced products is a complex and uncertain
process requiring high levels of innovation as well as the accurate
anticipation of technological and market trends. There can be no assurance
that the Company will be able to identify, develop, manufacture, market and
support new or enhanced products successfully in a timely manner. Further,
the Company or its competitors may introduce new products or product
enhancements that shorten the life cycle of or obsolete the Company's
existing product lines which could have a material adverse effect on the
Company's business, operating results and financial condition.
COMPETITION AND MARKET ACCEPTANCE. The market for network intelligent hubs,
switches, management and security products is intensely competitive and subject
to frequent product introductions with improved price/performance
characteristics. Even if the Company does introduce advanced products which
meet evolving customer requirements in a timely manner, there can be no
assurance that the new Company
-13-
<PAGE>
products will gain market acceptance. Many networking companies, including
Cisco Systems, Inc. ("Cisco"), Cabletron Systems, Inc. ("Cabletron"), Bay
Networks, Inc. ("Bay Networks"), FORE Systems, Xylan Corporation ("Xylan")
and others, have substantially greater financial, technical, sales and
marketing resources, better name recognition and a larger customer base than
the Company. Many of the Company's large competitors offer customers a
broader product line which provides a more comprehensive networking solution
than the Company currently offers. The Company anticipates increased
competition from large telecommunication equipment vendors which are
expanding their capabilities in the data networking market. For example,
Lucent Technologies and Nortel have acquired several networking companies to
enhance their capabilities in data networking. Further the Company
anticipates increased competition from private "start-up" companies that have
developed or are developing advanced network switching and security products.
Increased competition in the networking industry could result in significant
price competition, reduced profit margins or loss of market share, any of
which could have a material adverse effect on the Company's business,
operating results and financial condition.
The Company is pursuing a strategy to increase the percentage of its
revenue generated through indirect sales channels including value added
resellers, system integrators, original equipment manufacturers and network
service providers. There can be no assurance that the Company's products
will gain market acceptance in these indirect sales channels. Further,
competition among networking and security companies to sell products through
these indirect sales channels could result in significant price competition
and reduced profit margins.
The Company is also pursuing a strategy to broaden and further
differentiate its product line by introducing complementary network
switching, management and security products and incorporating new
technologies into its existing product line. There can be no assurance that
the Company will successfully introduce these products or that such products
will gain market acceptance. The Company anticipates competition from
networking companies, network security companies and others in each of its
product lines. The Company anticipates that profit margins will vary among
its product lines and that product mix fluctuations could have an adverse
effect on the Company's overall profit margins.
ACQUISITIONS. Cisco, Cabletron, Bay Networks, FORE Systems, Lucent
Technologies, Nortel and other competitors have recently acquired several
networking and security companies with complementary technologies, and the
Company anticipates that such acquisitions will continue in the future. These
acquisitions may permit such competitors to accelerate the development and
commercialization of broader product lines and more comprehensive networking
solutions than the Company currently offers. In the past, the Company has
relied upon a combination of internal product development and partnerships
with other networking vendors to provide competitive networking solutions to
customers. Certain of the recent and future acquisitions by the Company's
competitors may have the effect of limiting the Company's access to
commercially significant technologies. Further, the business combinations and
acquisitions in the networking and security industry are creating companies
with larger market shares, customer bases, sales forces, product offerings
and technology and marketing expertise. There can be no assurance that the
Company will be able to compete successfully in such an environment.
In March 1998, the Company invested $1.25 million in Blue Ridge Networks,
Inc. a private corporation which provides secure remote access products for
local and wide area virtual private networks. On May 7, 1998, the Company
acquired Essential Communication Corporation, a privately-held company based
in Albuquerque, New Mexico. Essential designs and manufactures high-speed
computer network equipment. The Company may, in the future, acquire or invest
in additional companies, business units, product lines, or technology to
accelerate the development
-14-
<PAGE>
of products and sales channels complementary to the Company's existing
products and sales channels. Acquisitions involve numerous risks, including
difficulties in assimilation of operations, technologies, and products of the
acquired companies; risks of entering markets in which the Company has no or
limited direct prior experience and where competitors in such markets have
stronger market positions; the potential loss of key employees of the
acquired company; and the diversion of management's attention from normal
daily operation of the Company's business. There can be no assurance that any
potential acquisition or investment will be consummated or that anticipated
benefits of such acquisition or investment will be realized.
PRODUCT TRANSITIONS. Once current networking products have been in the
market place for a period of time and begin to be replaced by higher
performance products (whether of the Company's or a competitor's design), the
Company expects the net sales of such networking products to decrease. In
order to achieve revenue growth in the future, the Company will be required
to design, develop and successfully commercialize higher performance products
in a timely manner. For example, the market for shared bandwidth
intelligent hubs, sales of which represented the majority of the Company's
net sales over the past several years, decreased in the first half of 1998
compared to the same period of 1997 and may continue to decrease as switching
products with enhanced price/performance characteristics gain market
acceptance. There can be no assurance that the Company will be able to
introduce new products and gain market acceptance quickly enough to avoid
adverse revenue transition patterns during current or future product
transitions.
MANUFACTURING AND AVAILABILITY OF COMPONENTS. The Company's manufacturing
operations consist primarily of final assembly, testing and quality control
of subassemblies and finished units. Materials used by the Company in its
manufacturing processes include semiconductors such as microprocessors,
memory chips and application specific integrated circuits ("ASICs"), printed
circuit boards, power supplies and enclosures. All of the materials used in
the Company's products are purchased under contracts and purchase orders with
third parties. While the Company believes that many of the materials used in
the production of its products are generally readily available from a variety
of sources, certain components are available from one or a limited number of
suppliers. For example, certain ASICs designed into the Company's
InfiniteSwitch products are supplied by FORE Systems (see "Factors That May
Affect Future Results of Operations -Competition and Market Acceptance").
The lead times for delivery of components vary significantly and exceed
twelve weeks for certain components. If the Company should fail to forecast
its requirements accurately for components, it may experience excess
inventory or shortages of certain components which could have an adverse
effect on the Company's business and operating results. Further, any
interruption in the supply of any of these components, or the inability of
the Company to procure these components from alternative sources at
acceptable prices within a reasonable time, could have additional adverse
effect on the Company's business and operating results.
THIRD-PARTY PRODUCTS. The Company believes that it is beneficial to work
with third parties with complementary technologies to broaden the appeal of
the Company's switches, intelligent hub and network security products. These
alliances allow ODS to provide integrated solutions to its customers,
combining ODS developed technology with third-party products such as certain
routers from Cisco, ATM switches from FORE Systems and Gigabit Ethernet
switch technology from Lucent Technologies. As the Company also competes
with these technology partners in certain segments of the market, there can
be no assurance that the Company will have access to all of the third-party
products which may be desirable to offer fully integrated solutions to ODS
customers.
-15-
<PAGE>
DEPENDENCE ON KEY CUSTOMERS. A relatively small number of customers have
accounted for a significant portion of the Company's revenue. U.S. Government
agencies and strategic network integrators are expected to continue to
account for a substantial portion of the Company's net revenue. The Company
continuously faces competition from Cisco, Cabletron, Bay Networks, FORE
Systems, Xylan and others for U.S. Government networking projects and
corporate networking installations. Any reduction or delay in sales of the
Company's products to these customers could have a material adverse effect on
the Company's operating results.
INTERNATIONAL OPERATIONS. Export sales accounted for approximately 24.3% of
the Company's revenue in the second quarter of 1998. The Company expects
that export sales will represent a significant portion of its business in the
future. The Company's international operations may be affected by changes in
demand resulting from fluctuations in currency exchange rates and local
purchasing practices, including seasonal fluctuations in demand, as well as
by risks such as increases in duty rates, difficulties in distribution and
other constraints upon international trade. For example, the fluctuations in
currency exchange rates and adverse economic developments in Malaysia, South
Korea and certain other countries adversely affected demand for the Company's
products in those countries in the fourth quarter of 1997 and the first half
of 1998. These conditions may continue to adversely affect demand for the
Company's products in those countries throughout 1998. Additionally, while
the Company's current products are designed to meet relevant regulatory
requirements of the foreign markets in which they are sold, any inability to
obtain any required foreign regulatory approvals on a timely basis could have
a material adverse effect on the Company's operating results.
INTELLECTUAL PROPERTY. The Company's success and its ability to compete is
dependent, in part, upon its proprietary technology. The Company does not
hold any issued patents and currently relies on a combination of contractual
rights, trade secrets and copyright laws to establish and protect its
proprietary rights in its products. There can be no assurance that the steps
taken by the Company to protect its intellectual property will be adequate to
prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent
or superior to the Company's technology.
The Company is also subject to the risk of adverse claims and litigation
alleging infringement of intellectual property rights of others. The Company
could incur substantial costs in defending itself and its customers against
any such claim regardless of the merits of such claims. In the event of a
successful claim of infringement, the Company may be required to obtain one
or more licenses from third parties. There can be no assurance that the
Company could obtain the necessary licenses on reasonable terms.
IMPACT OF YEAR 2000. Some of the Company's older computer programs were
written using two digits rather than four to define the applicable year. As a
result, those computer programs have time-sensitive software that recognize a
date using "00" as the year 1900 rather than the year 2000. Accordingly the
date January 1, 2000 could cause a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities.
The Company has completed an assessment and will have to modify or replace
portions of its software so that its computer systems will function properly
with respect to dates in the year 2000 and thereafter. The total Year 2000
project cost is estimated to be immaterial.
-16-
<PAGE>
The Company has initiated communications with all of its significant
suppliers and large customers to determine the extent to which the Company's
interface systems are vulnerable to those third parties' failure to remediate
their own Year 2000 issues. There can be no guarantee that the systems of
other companies on which the Company's systems rely will be timely converted
and would not have an adverse effect on the Company's systems. The Company
has determined it has immaterial exposure to contingencies related to the
Year 2000 issue for the products it has sold.
The Company's Year 2000 project is estimated to be completed not later than
December 31, 1998, which is prior to any anticipated impact on its operating
systems. The Company believes that with modifications to existing software
and conversions to new software, the Year 2000 issue will not pose
significant operational problems for its computer systems. However, if such
modifications and conversions are not made, or are not completed timely, the
Year 2000 issue could have a material impact on the operations of the Company.
The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future
events, including the continuous availability of certain resources and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are
not limited to, the availability and cost of personnel trained in this area,
the ability to locate and correct all relevant computer codes, and similar
uncertainties.
The Company is concerned that many enterprises will be devoting a substantial
portion of their information systems spending to resolving this upcoming year
2000 problem. This may result in spending being diverted from networking
solutions over the next two years. The year 2000 issue could lower demand
for the Company's products. This factor, while not quantified, could have a
material adverse impact on the Company's financial results.
GENERAL. Sales of networking products fluctuate, from time to time, based on
numerous factors, including customers' capital spending levels and general
economic conditions. While certain industry analysts believe that there is a
significant market for network intelligent hubs, switches, management and
security products, there can be no assurance as to the rate or extent of the
growth of such market or the potential adoption of alternative technologies.
Future declines in networking product sales as a result of general economic
conditions, adoption of alternative technologies or any other reason could
have a material adverse effect on the Company's business, operating results
and financial condition.
Due to the factors noted above and elsewhere in Management's Discussion and
Analysis of Financial Condition and Results of Operations, the Company's
future earnings and stock price may be subject to significant volatility,
particularly on a quarterly basis. Past financial performance should not be
considered a reliable indicator of future performance and investors should
not use historical trends to anticipate results or trends in future periods.
Any shortfall in revenue and earnings from the levels anticipated by
securities analysts could have an immediate and significant effect on the
trading price of the Company's common stock in any given period. Also, the
Company participates in a highly dynamic industry which often results in
volatility of the Company's common stock price.
-17-
<PAGE>
PART II - OTHER INFORMATION
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting of Stockholders was held on April 21, 1998 at the
Holiday Inn Richardson Select in Richardson, Texas. The following
is a brief description of each matter voted upon by stockholders,
including number of votes cast for, against, or withheld with regard
to each matter of nominee.
(1) Election of five (5) directors to serve until the next Annual
Meeting of Stockholders and until their respective successors
are duly elected and qualified.
<TABLE>
FOR WITHHELD
--- --------
<S> <C> <C>
G. Ward Paxton 14,979,571 140,512
Robert Anderson 14,979,121 140,962
J. Fred Bucy 14,982,825 137,258
T. Joe Head 14,985,320 134,763
Donald M. Johnston 14,986,070 134,013
</TABLE>
(2) Ratification and approval of selection by the Board of Directors
of Ernst & Young LLP as independent auditors of the Registrant
for the fiscal year ending December 31, 1998.
<TABLE>
FOR AGAINST WITHHELD
--- ------- --------
<S> <C> <C> <C>
15,062,577 19,969 37,537
</TABLE>
Item 5. OTHER INFORMATION.
Stockholder Proposals
Stockholders may submit proposals on matters appropriate for stockholder
action at subsequent annual meetings of the stockholders consistent with Rule
14a-8 promulgated under the Exchange Act. For such proposals to be considered
for inclusion in the Proxy Statement and Proxy relating to the 1999 Annual
Meeting of Stockholders, such proposals must be received by the Company not
later than November 20, 1998. Such proposals should be directed to ODS
Networks, Inc., 1101 East Arapaho Road, Richardson, Texas 75081, Attention:
Secretary (telephone: (972) 234-1467; telecopy: (972) 234-1467.
Pursuant to new amendments to Rule 14a-4(c) of the Securities Exchange Act of
1934, as amended, if a stockholder who intends to present a proposal at the
1999 annual meeting of stockholders does not notify the Company of such
proposal on or prior to February 3, 1999, then management proxies would be
allowed to use their discretionary voting authority to vote on the proposal
when the proposal is raised at the annual meeting, even though there is no
discussion of the proposal in the 1999 proxy statement.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A.) EXHIBITS. The following exhibits are included herein:
(10.13) First Amendment Agreement to Third Amended and
Restated Revolving Credit Loan Agreement, dated
April 30, 1998, between NationsBank of Texas,
N.A. (formerly, NCNB Texas National Bank) and the
Company.
(10.14) Amendment to the ODS 401(K) Savings Plan, Effective
May 29, 1998
(27) Financial Data Schedule
(B.) FORM 8-K. On May 21, 1998, the Company filed a report on
Form 8-K (Item 2) to announce the acquisition of
Essential Communications Corporation.
-18-
<PAGE>
S I G N A T U R E S
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
ODS NETWORKS, INC.
(Company)
Date: August 14, 1998 BY: /s/ TIMOTHY W. KINNEAR
--------------------------------------
Timothy W. Kinnear
Chief Financial Officer
(Principal Financial Officer)
BY: /s/ KANDIS TATE THOMPSON
--------------------------------------
Kandis Tate Thompson
Controller - Finance and Accounting
(Principal Accounting Officer)
-19-
<PAGE>
EXHIBIT INDEX
<TABLE>
EXHIBIT
-------
<S> <C>
10.13 First Amendment Agreement to Third Amended and Restated Revolving
Credit Loan Agreement, dated April 30, 1998, between NationsBank
of Texas, N.A. (formerly NCNB Texas National Bank) and the
Company.
10.14 Amendment to the ODS 401(K) Savings Plan, Effective May 29, 1998.
27 Financial Data Schedule
</TABLE>
-20-
<PAGE>
EXHIBIT 10.13
FIRST AMENDMENT AGREEMENT
TO
THIRD AMENDED AND RESTATED REVOLVING CREDIT LOAN AGREEMENT
Date: As of April 30, 1998
NationsBank of Texas, N.A.
Attention: Mr. Frank Izzo
901 Main Street, 7th Floor
Dallas, Texas 75201
Ladies and Gentlemen:
The undersigned, ODS Networks, Inc. (formerly known as Optical Data
Systems, Inc.), a Texas corporation ("Borrower"), entered into a Third
Amended and Restated Revolving Credit Loan Agreement (the "Loan Agreement")
dated December 31, 1997, with NationsBank of Texas, N.A., a national banking
association ("Bank"). Pursuant to the Loan Agreement, Bank agreed, under
certain terms and conditions, to extend a loan (the "Loan") to Borrower
evidenced by a Ninth Renewal Promissory Note (the "Note") dated December 31,
1997, executed by Borrower and payable to the order of Bank in the original
principal amount of $15,000,000.00.
Borrower has informed Bank that it desires, through its wholly-owned
subsidiary ECC Acquisition Corp., to merge (such merger herein referred to as
the "Essential Merger") with Essential Communication Corporation, a Delaware
corporation, with Essential Communication Corporation being the surviving
entity.
Borrower has also informed Bank that Borrower desires to purchase (such
purchase referred to herein as the "Blue Ridge Investment") convertible
preferred stock in Blue Ridge Networks, Inc. ("Blue Ridge") for a maximum
consideration of $1,250,000, which shares are convertible into common voting
stock of Blue Ridge in an amount, if converted, equal to a minimum of 25% of
the then outstanding voting interests of Blue Ridge.
Borrower has requested that Bank consent to Borrower's departure from
the covenants set forth in SECTIONS 7.5, 7.6, 7.9 and 7.11 of the Loan
Agreement (collectively, the "Applicable Covenants") to allow the Essential
Merger and the Blue Ridge Investment. Upon the terms and subject to the
conditions set forth in this First Amendment Agreement (the "Agreement",
terms used in this Agreement shall have the same meaning as in the Loan
Agreement, if defined therein, unless otherwise defined in this Agreement),
Bank consents to Borrower's departure
<PAGE>
from the Applicable Covenants for the sole purpose of allowing the Essential
Merger and the Blue Ridge Investment.
Borrower has also requested that Bank make certain modifications to the
terms of the Loan Agreement. Bank has advised Borrower that Bank is willing
to do so upon the terms and subject to the conditions of this Agreement. In
consideration for the above premises and mutual promises and covenants herein
contained, Borrower and Bank do hereby agree as follows:
1. CONSENT.
(a) The Bank hereby consents to Borrower's departure from the
Applicable Covenants of the Loan Agreement to the extent such
covenants would be violated by either the Essential Merger or the Blue
Ridge Investment.
(b) The consent specifically described in clause 1(a) above shall not
constitute and shall not be deemed a waiver of any Event of Default or
a consent to the departure from any provisions to the Loan Agreement
other than the Applicable Covenants, or a waiver of any rights or
remedies arising as a result of any Event of Default. The failure to
comply with the covenants described in clause 1(a) above for any
activity other than the Essential Merger or the Blue Ridge Investment
shall constitute an Event of Default.
2. AMENDMENTS TO THE LOAN AGREEMENT. Effective as of the date hereof,
the Loan Agreement is hereby amended as follows:
(a) The first sentence in SECTION 2.4 is amended and restated to read
in its entirety as follows: "Borrower agrees to pay Bank a commitment
fee of one-fourth of one percent (0.25%) per annum on the daily
unused portion of the Revolving Credit Commitment."
(b) SECTION 7.12 is amended and restated to read in its entirety as
follows:
7.12 CONSOLIDATED TANGIBLE NET WORTH. Borrower will not
permit, as of the last day of any calendar quarter, the
Consolidated Tangible Net Worth for such day to be less than the
amount opposite the applicable date in the following chart:
<TABLE>
--------------------------------------------------------
Minimum Consolidated
Date Tangible Net Worth
--------------------------------------------------------
<S> <C>
December 31, 1997 $66,000,000
March 31, 1998 $63,000,000
June 30, 1998 $55,100,000
September 30, 1998 $55,050,000
--------------------------------------------------------
December 31, 1998 and the
last day of each fiscal
quarter thereafter $55,500,000
--------------------------------------------------------
</TABLE>
<PAGE>
(c) The first sentence in SECTION 7.13 is amended and restated to
read in its entirety as follows: "Borrower will at all times maintain
a Current Ratio of not less than 1.35 to 1.00."
(d) Exhibit "C" to the Loan Agreement is amended by adding the
following location to the list of U.S. Offices:
4374 Alexander Blvd., N.E., Suite T
Albuquerque, NM 87107
3. CONDITIONS PRECEDENT. Bank's willingness to enter into this Agreement
is subject to the conditions precedent that, as of the date hereof:
(a) Bank shall receive the following (the "Amendment Documents"),
duly executed by each party thereto, other than Bank, each in form
and substance satisfactory to Bank:
(i) this Agreement;
(ii) a Subsidiary Joinder Agreement executed by
Essential Communication Corporation;
(iii) a certificate from the appropriate
governmental authority evidencing Essential
Communication Corporation's existence and good
standing in the state of its incorporation;
(iv) final, executed copies of each of the
agreements, bills of sale and other documents
effecting the Essential Merger and the Blue Ridge
Investment; and
(v) all other documents that Bank may request
with respect to any matter relevant to this
Agreement or the transactions contemplated hereby.
(b) The representations and warranties of Borrower
contained herein shall be true and correct in all material
respects on and as of the date hereof, and Borrower shall have
complied with all of the terms and conditions herein. The
execution by Borrower of this Agreement is hereby deemed to
constitute a
<PAGE>
representation and warranty by Borrower to the foregoing effect.
4. REPRESENTATIONS AND WARRANTIES. In order to induce Bank to enter into
this Agreement, Borrower hereby represents and warrants to Bank that:
(a) The Loan Papers are the legal, valid and binding obligations of
Borrower, enforceable in accordance with their respective terms,
except as limited by bankruptcy, insolvency or other laws of general
application relating to the enforcement of creditors' rights;
(b) Neither the execution and delivery of this Agreement nor the
consummation of any of the transactions herein contemplated, nor
compliance with the terms and provisions hereof will contravene or
conflict with any provision of law, statute or regulation to which
Borrower is subject or any judgment, license, order or permit
applicable to Borrower or any indenture, mortgage, deed of trust or
other instrument to which Borrower may be subject; no consent,
approval, authorization or order of any court, governmental authority
or third party is required in connection with the execution, delivery,
or performance by Borrower of this Agreement or to consummate the
transactions contemplated herein;
(c) To the best of Borrower's knowledge, all financial statements
delivered by Borrower to Bank prior to the date hereof are true and
correct, fairly present the financial condition of Borrower and have
been prepared in accordance with generally accepted accounting
principles, consistently applied; as of the date hereof, there are no
obligations, liabilities or indebtedness (including contingent and
indirect liabilities) which are material to Borrower and not reflected
in such financial statements;
(d) To the best of Borrower's knowledge, no litigation,
investigation, or governmental proceeding is pending, or, to the
knowledge of any of Borrower's officers, threatened against or
affecting Borrower, which may result in any material adverse change in
Borrower's business, properties or operations, except as has been
previously disclosed by Borrower to Bank;
(e) To the best of Borrower's knowledge, Borrower owns all of the
assets reflected on its most recent balance sheet free and clear of
all liens, security interests or other encumbrances, other than those
(if any) in favor of Bank;
(f) To the best of Borrower's knowledge, Borrower is not in violation
of any law, ordinance, governmental rule or regulation to which it is
subject, and is not in default under any material agreement, contract
or understanding to which it is a party, except as has been previously
disclosed by Borrower to Bank; and
<PAGE>
(g) All of the representations and warranties contained in SECTION 5
of the Loan Agreement are true and correct on and as of the date
hereof with the same force and effect as if made on and as of the date
hereof, provided that the representations and warranties contained in
SECTIONS 5.8 and 5.9 of the Loan Agreement are made with respect to
the financial statements most recently submitted to Bank pursuant to
SECTION 6.5 of the Loan Agreement.
(h) Borrower has (i) begun analyzing the operations of Borrower and
its subsidiaries and affiliates that could be adversely affected by
failure to become Year 2000 compliant (that is, that computer
applications, imbedded microchips and other systems will be able to
perform date-sensitive functions prior to and after December 31, 1999)
and; (ii) developed a plan for becoming Year 2000 compliant in a
timely manner, the implementation of which is on schedule in all
material respects. Borrower reasonably believes that it will become
Year 2000 compliant for its operations and those of its subsidiaries
and affiliates on a timely basis except to the extent that a failure
to do so could not reasonably be expected to have a material adverse
effect upon the financial condition of Borrower.
(i) Borrower reasonably believes any suppliers and vendors that are
material to the operations of Borrower or its subsidiaries and
affiliates will be Year 2000 compliant for their own computer
applications except to the extent that a failure to do so could not
reasonably be expected to have a material adverse effect upon the
financial condition of Borrower.
(j) Borrower will promptly notify Bank in the event Borrower
determines that any computer application which is material to the
operations of Borrower, its subsidiaries or any of its material
vendors or suppliers will not be fully Year 2000 compliant on a timely
basis, except to the extent that such failure could not reasonably be
expected to have a material adverse effect upon the financial
condition of Borrower.
5. MISCELLANEOUS.
(a) WAIVER. No failure to exercise, and no delay in exercising, on
the part of Bank, any right hereunder shall operate as a waiver thereof,
nor shall any single or partial exercise thereof preclude any other or
further exercise thereof or the exercise of any other right. The rights of
Bank hereunder and under the other Loan Papers shall be in addition to all
other rights provided by law. No notice or demand given in any case shall
constitute a waiver of the right to take other action in the same, similar
or other instances without such notice or demand.
(b) GOVERNING LAW. THIS AGREEMENT IS BEING EXECUTED AND DELIVERED,
AND IS INTENDED TO BE PERFORMED, IN THE STATE OF TEXAS, AND THE SUBSTANTIVE
LAWS OF TEXAS SHALL GOVERN THE VALIDITY, CONSTRUCTION, ENFORCEMENT AND
INTERPRETATION OF
<PAGE>
THIS AGREEMENT AND ALL OTHER LOAN PAPERS, EXCEPT TO THE EXTENT: (i) OTHERWISE
SPECIFIED THEREIN; (ii) THE FEDERAL LAWS GOVERNING NATIONAL BANKS EXPRESSLY
SUPERSEDE AND HAVE CONTRARY APPLICATION; OR (iii) FEDERAL LAWS GOVERNING
MAXIMUM INTEREST RATES SHALL PROVIDE FOR RATES OF INTEREST HIGHER THAN THOSE
PERMITTED UNDER THE LAWS OF THE STATE OF TEXAS.
(c) INVALID PROVISIONS. If any provision of this Agreement is held to
be illegal, invalid or unenforceable under present or future laws effective
during the term of this Agreement, such provision shall be fully severable
and this Agreement shall be construed and enforced as if such illegal,
invalid or unenforceable provision had never comprised a part of this
Agreement, and the remaining provisions of this Agreement shall remain in
full force and effect and shall not be affected by the illegal, invalid or
unenforceable provision or by its severance from this Agreement.
(d) ENTIRETY AND AMENDMENTS. The Loan Papers embody the entire
agreement between the parties and supersede all prior agreements and
understandings, if any, relating to the subject matter hereof and thereof,
and this Agreement and the other Loan Papers may be amended only by an
instrument in writing executed by the party, or an authorized officer of the
party, against whom such amendment is sought to be enforced.
(e) PARTIES BOUND. This Agreement shall be binding upon and inure to
the benefit of the parties hereto and their respective successors, assigns
and legal representatives; provided, however, that Borrower may not, without
the prior written consent of Bank, assign any rights, powers, duties or
obligations hereunder.
(f) PAYMENT OF EXPENSES. Borrower agrees to pay all costs and expenses
of Bank (including, without limitation, the reasonable attorneys' fees of
Bank's legal counsel) incurred by Bank in connection with the preparation of
this Agreement and the preservation and enforcement of Bank's rights under
this Agreement and the other Loan Papers.
(g) HEADINGS. Section headings are for convenience of reference only
and shall in no way affect the interpretation of this Agreement.
(h) COUNTERPARTS. This Agreement may be executed in any number of
counterparts, each of which shall for all purposes be deemed an original and
all of which are identical.
6. NO ORAL AGREEMENTS. THIS AGREEMENT, TOGETHER WITH THE OTHER LOAN
PAPERS AS WRITTEN, REPRESENTS THE FINAL
<PAGE>
AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF
PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE
ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES.
If Bank agrees to the foregoing, Bank should execute this Agreement in the
space indicated below.
BORROWER:
ODS NETWORKS, INC.
(formerly known as Optical Data Systems, Inc.)
By: /s/ Timothy Kinnear
---------------------------------
Name: Timothy Kinnear
Title: Vice President and CFO
ACCEPTED:
NATIONSBANK OF TEXAS, N.A.
By: /s/ Frank Izzo
---------------------------------
Name: Frank Izzo
Title: Senior Vice President
<PAGE>
SUBSIDIARY JOINDER AGREEMENT
This SUBSIDIARY JOINDER AGREEMENT (the "Agreement") dated as of April
30, 1998, is executed by the undersigned (the "Debtor") for the benefit of
NATIONSBANK OF TEXAS, N.A., (the "Bank") in connection with that certain
Third Amended and Restated Revolving Credit Loan Agreement dated as of
December 31, 1997, between the Bank and Optical Data Systems, Inc., now known
as ODS Networks, Inc. (the "Borrower) (as modified from time to time, the
"Credit Agreement", and capitalized terms not otherwise defined herein being
used herein as defined in the Credit Agreement).
The Debtor is a newly formed or newly acquired Granting Subsidiary and
is required to execute this Agreement pursuant to the Credit Agreement.
NOW THEREFORE, in consideration of the premises and other good and
valuable consideration, the receipt and sufficiency of which are hereby
acknowledged, the Debtor hereby agrees as follows:
1. The Debtor assumes all the obligations of a "Debtor" under the
Subsidiaries Security Agreement and agrees that it is a "Debtor" and bound as
a "Debtor" under the terms of the Subsidiaries Security Agreement as if it
had been an original signatory thereto. In furtherance of the foregoing, the
Debtor hereby assigns, pledges and grants to Bank a security interest in all
of its right, title and interest in and to Debtor's Collateral (as defined in
the Subsidiaries Security Agreement) to secure the Obligations (as defined in
the Subsidiaries Security Agreement) under the terms of the Subsidiaries
Security Agreement.
2. Schedules 3.1 and 3.2 of the Subsidiaries Security Agreement are
hereby amended to add the information relating to Debtor set out on Schedules
3.1 and 3.2 hereof. The Debtor hereby confirms that the representations and
warranties set forth in Article 3 of the Subsidiaries Security Agreement
applicable to it and its Collateral and the representations and warranties
set forth in the Credit Agreement are true and correct after giving effect to
such amendment to the Schedules.
3. In furtherance of its obligations under Section 4.2 of the
Subsidiaries Security Agreement, Debtor agrees to execute and deliver such
UCC (as defined in the Subsidiaries Security Agreement) financing statements
naming the Debtor as debtor, the Bank as secured party and describing its
Collateral and such other documentation as the Bank may require to evidence,
protect and perfect the Liens created by the Subsidiaries Security Agreement
as modified hereby.
4. This Agreement shall be deemed to be part of, and a modification
to, the Subsidiaries Security Agreement and shall be governed by all the
terms and provisions
<PAGE>
of the Subsidiaries Security Agreement, which terms are incorporated herein
by reference, and which is ratified and confirmed and shall continue in full
force and effect as a valid and binding agreement of Debtor enforceable
against Debtor. The Debtor hereby waives notice of Bank's acceptance of this
Agreement.
IN WITNESS WHEREOF, the Debtor has executed this Agreement as of the
day and year first written above.
DEBTOR:
ESSENTIAL COMMUNICATION CORPORATION
By: /s/ Timothy W. Kinnear
----------------------------------
Name: Timothy W. Kinnear
Title: CFO and Secretary
<PAGE>
SCHEDULE 3.1
TO
SUBSIDIARY JOINDER AGREEMENT
LOCATIONS
I. PRINCIPAL PLACE OF BUSINESS
4374 Alexander Blvd. N.E., Suite T
Albuquerque, NM 87107
II. OTHER LOCATIONS
None
<PAGE>
SCHEDULE 3.2
TO
SUBSIDIARY JOINDER AGREEMENT
TRADE AND OTHER NAMES; TAX ID NUMBER
Trade Name: Essential Communications Corporation
Tax ID#: 85-0401328
<PAGE>
EXHIBIT 10.14
AMENDMENT TO
ODS 401(k) SAVINGS PLAN
WHEREAS, ODS Networks, Inc. (the "Employer") heretofore adopted the ODS
401(k) Savings Plan (the "Plan"); and
WHEREAS, the Employer reserved the right to amend the Plan; and
WHEREAS, the Employer desires to amend the Plan;
NOW, THEREFORE, the Plan is hereby amended, effective as of May 29, 1998, as
follows:
1. Section 2.1 of the Plan shall be amended by adding the following
paragraph to the conclusion of such Section:
Any Employee who was employed by Essential Communications Corporation
("Essential Communications") as of the date of its acquisition by the
Employer, shall be credited with any prior service with Essential
Communications in determining such Employee's Year(s) of Service.
2. Section 3.1 of the Plan shall be amended by adding the following
paragraph to the conclusion of such Section:
Notwithstanding the foregoing provisions of this Section 3.1, any Employee
who was employed by Essential Communications Corporation ("Essential
Communications") as of the date of its acquisition by the Employer, shall
be credited with any prior service with Essential Communications in
determining such Employee's Month(s) of Service. In this regard, any such
Employee who was credited with at least three (3) Months of Service
pursuant to the preceding sentence, shall become a Participant under the
Plan as of May 29, 1998, or as soon as administratively practical
thereafter, subject to the terms hereof.
3. Except as hereinabove amended, the provisions of the Plan shall continue
in full force and effect.
IN WITNESS WHEREOF, the Employer, by its duly authorized officer, has caused
this Amendment to be executed on the 21st day of April, 1998.
ODS NETWORKS, INC.
By /s/ Timothy W. Kinnear
--------------------------------------
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF INCOME FOUND
ON PAGES 3-5 OF THE COMPANY'S 10-Q FOR THE YEAR TO DATE, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 12,343
<SECURITIES> 8,960
<RECEIVABLES> 15,765
<ALLOWANCES> 889
<INVENTORY> 16,217
<CURRENT-ASSETS> 56,628
<PP&E> 27,625
<DEPRECIATION> 15,713
<TOTAL-ASSETS> 77,277
<CURRENT-LIABILITIES> 13,761
<BONDS> 0
0
0
<COMMON> 169
<OTHER-SE> 61,244
<TOTAL-LIABILITY-AND-EQUITY> 77,277
<SALES> 43,428
<TOTAL-REVENUES> 43,428
<CGS> 24,587
<TOTAL-COSTS> 24,587
<OTHER-EXPENSES> 29,489
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (9,853)
<INCOME-TAX> (1,742)
<INCOME-CONTINUING> (8,111)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8,183)
<EPS-PRIMARY> (0.49)
<EPS-DILUTED> (0.49)
</TABLE>
