<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________
FORM 10-Q
(Mark One)
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended September 30, 1997
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: 0-20124
NETWORK COMPUTING DEVICES, INC.
(Exact name of registrant as specified in its charter)
California 77-0177255
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
350 North Bernardo Avenue, Mountain View, California 94043
(Address of principal executive offices and zip code)
Registrant's telephone number: (650) 694-0650
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 was
16,379,595 at October 31, 1997.
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NETWORK COMPUTING DEVICES, INC.
INDEX
DESCRIPTION PAGE NUMBER
- --------------------------------------------------------- -----------
Cover Page 1
Index 2
Part I: Financial Information
Item 1: Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Operations
for the Three- and Nine-Month Periods Ended
September 30, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows
for the Nine-Month Periods Ended September 30,
1997 and 1996 5
Notes to Condensed Consolidated Financial
Statements 6
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Part II: Other Information
Item 6: Exhibits and Reports on Form 8-K 16
Signature 17
2
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NETWORK COMPUTING DEVICES, INC.
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS
September 30, December 31,
1997 1996
------------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 24,787 $ 23,832
Short-term investments 12,624 11,839
Accounts receivable, net 18,012 21,549
Inventories 14,724 9,776
Refundable and deferred income tax assets 4,395 8,287
Other current assets 2,835 3,652
----------- ----------
Total current assets 77,377 78,935
Property and equipment, net 4,604 4,895
Other assets 1,637 1,863
----------- ----------
Total assets $ 83,618 $ 85,693
----------- ----------
----------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 9,412 $ 4,383
Accrued expenses 9,471 9,337
Current portion of capital lease obligations 198 748
Deferred revenue 4,262 3,486
----------- ----------
Total current liabilities 23,343 17,954
Long-term portion of capital lease obligations 182 314
Shareholders' equity:
Undesignated preferred stock - -
Common stock 59,285 68,217
Retained earnings (accumulated deficit) 808 (792)
----------- ----------
Total shareholders' equity 60,093 67,425
----------- ----------
Total liabilities and shareholders' equity $ 83,618 $ 85,693
----------- ----------
----------- ----------
</TABLE>
See accompanying notes.
3
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NETWORK COMPUTING DEVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED - IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1997 1996 1997 1996
--------------- -------------- --------------- -------------
<S> <C> <C> <C> <C>
Net revenues:
Hardware products and services $ 26,532 $ 22,642 $ 76,347 $ 69,742
Software licenses and services 8,114 5,309 23,725 17,976
--------------- -------------- --------------- -------------
Total net revenues 34,646 27,951 100,072 87,718
Cost of revenues:
Hardware products and services 19,764 14,875 53,600 55,592
Software licenses and services 2,579 1,779 7,121 5,964
--------------- -------------- --------------- -------------
Total cost of revenues 22,343 16,654 60,721 61,556
--------------- -------------- --------------- -------------
Gross margin 12,303 11,297 39,351 26,162
Operating expenses:
Research and development 3,703 3,207 10,674 11,346
Marketing and selling 7,379 6,181 22,749 25,140
General and administrative 1,722 2,219 5,064 8,255
Credit on litigation settlement (147) - (147) -
--------------- -------------- --------------- -------------
Total operating expenses 12,657 11,607 38,340 44,741
--------------- -------------- --------------- -------------
Operating income (loss) (354) (310) 1,011 (18,579)
Interest income, net 435 343 1,452 1,167
Other income - - 200 -
Gain on sale of product lines - - - 6,932
--------------- -------------- --------------- -------------
Income (loss) before income taxes 81 33 2,663 (10,480)
Provision for income taxes (income tax benefit) 30 13 1,063 (4,193)
--------------- -------------- --------------- -------------
Net income (loss) $ 51 $ 20 $ 1,600 $ (6,287)
--------------- -------------- --------------- -------------
--------------- -------------- --------------- -------------
Net income (loss) per share:
Primary $ 0.00 $ 0.00 $ 0.09 $ (0.38)
--------------- -------------- --------------- -------------
--------------- -------------- --------------- -------------
Fully diluted $ 0.00 $ 0.00 $ 0.09 $ (0.38)
--------------- -------------- --------------- -------------
--------------- -------------- --------------- -------------
Shares used in per share computations:
Primary 17,848 17,122 18,520 16,460
--------------- -------------- --------------- -------------
--------------- -------------- --------------- -------------
Fully diluted 17,957 17,700 18,520 16,460
--------------- -------------- --------------- -------------
--------------- -------------- --------------- -------------
</TABLE>
See accompanying notes.
4
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NETWORK COMPUTING DEVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED - IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1997 1996
-------------- --------------
<S> <C> <C>
Cash flows from operations:
Net income (loss) $ 1,600 $ (6,287)
Reconciliation to cash provided (used) by operations:
Depreciation and amortization 2,403 3,227
Gain on sale of product lines - (6,932)
Deferred income taxes 862 (2,563)
Other, net - 526
Changes in:
Accounts receivable, net 3,537 9,634
Inventories (4,948) 445
Refundable income taxes 3,030 -
Other current assets and other 817 (1,945)
Accounts payable 5,029 (8,726)
Accrued expenses 134 (1,948)
Deferred revenue 776 1,179
-------------- --------------
Cash provided (used) by operations 13,240 (13,390)
Cash flows from investing activities:
Short-term investments, net (785) 10,229
Proceeds from sale of product lines - 8,625
Changes in other assets 226 249
Property and equipment purchases, net (2,112) (2,105)
-------------- --------------
Cash provided (used) by investing activities (2,671) 16,998
Cash flows from financing activities:
Principal payments on capital lease obligations (682) (1,037)
Repurchases of common stock (10,719) (89)
Proceeds from issuance of common stock, net 1,787 2,876
-------------- --------------
Cash provided (used) by financing activities (9,614) 1,750
Increase in cash and equivalents 955 5,358
Cash and equivalents:
Beginning of period 23,832 13,364
-------------- --------------
End of period $ 24,787 $ 18,722
-------------- --------------
-------------- --------------
</TABLE>
See accompanying notes.
5
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NETWORK COMPUTING DEVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
The unaudited condensed consolidated financial information of Network Computing
Devices, Inc. (the "Company") furnished herein reflects all adjustments,
consisting only of normal recurring adjustments, which in the opinion of
management are necessary to fairly state the Company's consolidated financial
position, results of operations and cash flows for the periods presented. This
Quarterly Report on Form 10-Q should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
1996 Annual Report on Form 10-K. The consolidated results of operations for the
three- and nine-month periods ended September 30, 1997 are not necessarily
indicative of the results to be expected for any subsequent quarter or for the
entire year ending December 31, 1997. Certain financial statement amounts from
1996 have been reclassified to conform to the current year's presentation.
PER SHARE INFORMATION
Per share information is computed using the weighted-average number of common
and dilutive common equivalent shares outstanding. For primary and fully
diluted earnings per share, common equivalent shares consist of the incremental
shares issuable upon the assumed exercise of dilutive stock options (using the
treasury stock method). The effect of common equivalent shares is not included
in earnings per share calculations during periods in which such effect would be
antidilutive. The Financial Accounting Standards Board recently issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." SFAS No. 128 requires the presentation of basic earnings per share
("EPS") and, for companies with complex capital structures, diluted EPS. SFAS
No. 128 is effective for annual and interim periods ending after December 15,
1997. The Company expects that for profitable periods, basic EPS will be higher
than primary earnings per share as presented in the accompanying consolidated
financial statements, and diluted EPS will not differ materially from fully
diluted earnings per share as presented in the accompanying financial
statements. Computations for loss periods should not change significantly.
INVENTORIES
Inventories, stated at the lower of standard cost, which approximates actual
cost on a first-in, first-out basis, or market, consisted of (in thousands):
September 30, December 31,
1997 1996
---- ----
Purchased components and sub-assemblies $ 12,650 $ 8,396
Work in process 761 240
Finished goods 1,313 1,140
-------- -------
$ 14,724 $ 9,776
-------- -------
-------- -------
INTEREST AND TAX PAYMENTS
Interest payments, primarily related to interest on capital lease liabilities,
were $9,000 and $33,000 for the third quarters of 1997 and 1996, respectively,
and $45,000 and $98,000 for the first nine months of 1997 and 1996,
respectively. Income tax payments were $71,300 and $185,000 for the third
quarter and first nine months of 1997, while income tax refunds of $27,800 and
$3.0 million were received during the third quarter and first nine months of
1997. Income tax payments were $209,000 for the first nine months of 1996.
1997 STOCK REPURCHASE PROGRAM
In April 1997, the Company's Board of Directors adopted a program to repurchase
from time to time at management's discretion up to 1,000,000 shares of the
Company's common stock on the open market during the 12-month period ending
April 30, 1998 at prevailing market prices. Repurchases were made under the
program using the Company's cash resources.
6
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NETWORK COMPUTING DEVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Shares repurchased are available for the issuance under the Company's stock
plans and for other corporate purposes. In the third quarter of 1997, a
total of 708,500 shares were repurchased at prices ranging from $8.38 to
$12.00 per share for a total purchase price of $7.3 million. Through
September 30, 1997, the repurchase program was completed with an aggregate of
1,000,000 shares repurchased at prices ranging from $8.38 to $12.00 per share
for a total purchase price of $10.7 million.
In November 1997, the Company's Board of Directors adopted an additional program
to repurchase from time to time at management's discretion up to 1,000,000
shares of the Company's common stock on the open market during the 12 month
period ending October 31, 1998 at prevailing market prices.
MAJOR CUSTOMERS AND RELATED ACCOUNTS RECEIVABLE
International Business Machines Corporation ("IBM") accounted for approximately
33% and 25% of the Company's revenues for the third quarter and first nine
months of 1997, respectively. At September 30, 1997, related accounts
receivable due from IBM were approximately $5.2 million, or 29% of the total
accounts receivable balance.
7
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NETWORK COMPUTING DEVICES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
THIS DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS, INCLUDING BUT NOT
LIMITED TO STATEMENTS WITH RESPECT TO THE COMPANY'S FUTURE FINANCIAL
PERFORMANCE, OPERATING RESULTS, PLANS AND OBJECTIVES. ACTUAL RESULTS MAY
DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED DEPENDING UPON A VARIETY
OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "FUTURE
PERFORMANCE AND RISK FACTORS."
THE FOLLOWING DISCUSSION SHOULD BE READ ONLY IN CONJUNCTION WITH THE
UNAUDITED CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS AND NOTES
THERETO INCLUDED IN PART I -- ITEM 1 OF THIS QUARTERLY REPORT ON FORM 10-Q,
AND THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO AND
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996, CONTAINED IN THE COMPANY'S
1996 ANNUAL REPORT ON FORM 10-K.
The Company provides network computer hardware and software that delivers
high-performance, easy-to-manage, simultaneous access to any application on
an enterprise network from any desktop. The Company's product lines include
the EXPLORA and HMX families of Universal Network Computers, WINCENTER
PRO-TM-multi-user WINDOWS NT-Registered Trademark- application server
software, and PC-XWARE-Registered Trademark- network computer software for
PCs.
During 1996, the Company underwent significant changes to its operations,
including changes in senior management, product focus, and business unit
organization. During the first half of the year, the Company initiated and
completed the disposition of two software product lines, MARINER and
Z-MAIL-Registered Trademark-. Also during the first half of 1996, the
Company recorded operating losses of $18.3 million, and combined cash and
short-term investments had declined from $36.2 million at December 31, 1995
to $26.4 million at June 30, 1996. By the end of the second quarter, the
Company announced that it had appointed a new President and Chief Executive
Officer, Robert G. Gilbertson, and a new Executive Vice President of
Operations & Finance and Chief Financial Officer, Rudolph G. Morin. Shortly
thereafter, Doug Klein, a founder of the Company, was appointed to Senior
Vice President & Chief Technology Officer and Lorraine Hariton, the Vice
President of Business Development, was added to the senior management team.
In September 1996, Cecil M. Dye was appointed Senior Vice President of Sales
& Marketing. This new senior management team initiated a "turnaround"
program that included recombining its Systems and Software business units,
spending and hiring controls, significant reorganization of the Research &
Development and Sales & Marketing functions and asset management initiatives.
By the end of the second half, profitable, cash-flow positive operations had
been achieved. The Company's ability to continue this trend is subject to
various risks and uncertainties, however, and there is no assurance that this
trend toward profitability will continue into the future. See below under
"Future Performance and Risk Factors."
In June 1996, the Company announced an agreement with International Business
Machines Corporation ("IBM") for the joint development of a network
application terminal for resale by IBM. In November 1997, the agreement (the
"IBM Agreement") was amended to include a renewal through December 31, 2000.
Under the IBM Agreement as amended, IBM agreed to fund a portion of the
Company's development efforts through the first quarter of 1998. The IBM
Agreement as amended further provides for IBM to purchase a substantial
portion of its requirements for such products from the Company during 1997
through December 31, 2000. In March 1997, IBM commenced shipping production
versions of such products. However, the volume of sales to IBM under the IBM
Agreement may be difficult to predict. See below under "Future Performance
and Risk Factors --Fluctuations in Operating Results."
During 1995, the Company took various actions to reorganize the two basic
components of its business into two separate business units: the Systems
business, consisting of the Company's network computers and related software;
and the Software business, consisting of its lines of PC connectivity
software and, initially, its electronic messaging software and its MARINER
Internet access software. In addition, the Company took steps to consolidate
the management and sales organizations of the geographically separated
segments of its Software business and reoriented its software sales strategy
toward the increased use of distributors, value added resellers ("VARs") and
other resellers.
During the third quarter of 1995, the Company created and began implementing a
plan to restructure the business to improve its operating performance. The plan
included substantial modifications to the Company's manufacturing processes,
phasing out lower margin products, a reduction in the amount of leased space,
and a reduction in the number of employees. During
8
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NETWORK COMPUTING DEVICES, INC.
the third quarter of 1995, the Company recognized charges totaling $7.5
million for the implementation of this plan. Included in these restructuring
charges were amounts related to the severance of personnel, phase-out of
certain products, and costs associated with the termination of lease
obligations. In the fourth quarter of 1996, the Company substantially
concluded such restructuring activities and determined that $1.1 million in
related accruals was in excess of amounts required. As a result, the Company
recognized a $1.1 million credit for business restructuring during the fourth
quarter of 1996. The credit relates primarily to lease obligations that were
exited or subleased at dates or rates more favorable than those anticipated
at the time of the initial restructuring plan.
In 1994, the Company began the development of MARINER, an Internet access and
navigation tool which it intended to market to large enterprises, as well as
to original equipment manufacturers ("OEMs") and VARs. In January 1995, the
Company entered into a software development and licensing agreement with AT&T
to develop a custom version of MARINER for AT&T (the "AT&T Agreement"). The
AT&T Agreement provided for total minimum royalties of $15 million through
1998, and contemplated the development of additional Internet access products
for license to AT&T. In September 1995, the AT&T Agreement was amended to
terminate these provisions for additional product development and to provide
instead that the Company would be paid fees totaling $9 million through 1996
for development work completed at the time of the amendment and for a license
to evaluate the MARINER product. In 1995, the Company recognized license
fees totaling $6.8 million under the AT&T Agreement and received $500,000 in
fees for non-recurring engineering costs that offset research and development
expenses. In 1995, the Company also recognized revenues of $300,000 from
other customers related to the MARINER product line. In 1996 and the first
nine months of 1997, the Company recognized license fees totaling $426,000
and $1.2 million, respectively. No additional related revenues will be
recognized in the future. In light of the Company's inability to develop a
long-term relationship with AT&T, as well as other changes in the Internet
market, including the development of intense price competition among vendors
of Internet access products, the Company determined in late 1995 to sell the
MARINER product line and focus its attention on its core business of
providing desktop information access solutions for network computing
environments. In February 1996, the Company sold the MARINER product line to
FTP Software, Inc. ("FTP") for $9.8 million. The Company paid FTP a one-time
license fee of $2.5 million for the right to incorporate MARINER technology
into future versions of the Company's hardware and software products. The
net gain recognized on this transaction was $7.0 million.
In February 1994, the Company acquired all of the outstanding stock of Z-Code
Software Corp. ("Z-Code"), a developer of electronic mail and messaging
application products (collectively, "Z-MAIL") for open system environments.
The Company's Z-MAIL electronic messaging product was a part of the Company's
Software business unit. In light of disappointing operating results,
intensifying competition in this market, and other related factors, the
Company determined during the second quarter of 1996 to sell or discontinue
this product line. In June 1996, the Company sold its Z-MAIL product line to
NetManage, Inc. for a total sales price of $1.3 million. The net loss
recognized on this transaction was $27,000.
RESULTS OF OPERATIONS
As mentioned above under "Overview," the Company determined to recombine its
two former business units (i.e., "Systems" and "Software") into a single
operation in June 1996. Although the Company is now managed as one operating
entity, the Company is reporting hardware and software revenues
independently. Revenues, cost of revenues and gross margins relating to
prior operating periods have been conformed to the current presentation, and
the following discussions of net revenues and gross margins address the
revised presentation.
TOTAL NET REVENUES
Total net revenues were $34.6 million and $28.0 million for the third
quarters of 1997 and 1996, respectively, representing an increase of 24%, and
$100.1 million and $87.7 million for the first nine months of 1997 and 1996,
respectively, representing an increase of 14%. Total international revenues
were 34% and 32% of total net revenues for the third quarters of 1997 and
1996, respectively, and 33% and 32% for the first nine months of 1997 and
1996, respectively. International revenues excluding revenues related to the
IBM Agreement were 28% and 29% for the third quarter and first nine months of
1997, down from 32% for the same periods of 1996. There were no
international IBM revenues recognized in the third quarter and first nine
months of 1996. Revenues under the IBM Agreement accounted for approximately
33% and 25% of the Company's revenues for the third quarter and first nine
months of 1997, respectively. No single customer accounted for greater than
10% of the Company's revenues in the same periods of 1996.
9
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NETWORK COMPUTING DEVICES, INC.
HARDWARE REVENUES
Hardware revenues consist primarily of revenues from the sale of network
computers, related hardware, and to a lesser extent, fees for related service
activities. Hardware revenues were $26.5 million and $22.6 million for the
third quarters of 1997 and 1996, respectively, and $76.3 million and $69.7
million for the first nine months of 1997 and 1996, respectively. The
increases in revenues were due to increased unit volume shipments, including
revenues from IBM related to the IBM Agreement, partially offset by lower
average selling prices.
SOFTWARE REVENUES
Software revenues consist primarily of revenues from the licensing of
software products and related support services. Current software products
that are generating revenue include WINCENTER, the Company's multi-user
WINDOWS NT application server software, PC-XWARE, the Company's network
computer software for PCs, and NCDWARE-Registered Trademark-, the Company's
proprietary network computer software. Revenues from software and related
services were $8.1 million and $5.3 million for the third quarters of 1997
and 1996, respectively, and $23.7 million and $18.0 million for the first
nine months of 1997 and 1996, respectively. The increase in the software
revenues resulted primarily from higher sales of WINCENTER and the related
support revenues. This increase was offset in part for the first nine months
by declines in revenues related to PC-XWARE and the absence of revenues
related to the former Z-MAIL product line, which was sold during the second
quarter of 1996. Revenues related to the former Z-MAIL product line of $1.1
million had been recognized in the first nine months of 1996, while no such
revenues were recognized during the first nine months of 1997. In addition,
revenues related to the AT&T Agreement of $166,000 were recognized in the
third quarter of 1997 while no such revenues were recognized in the third
quarter of 1996. Revenues related to the AT&T Agreement of $1.2 million were
recognized in the first nine months of 1997 compared to $426,000 in the first
nine months of 1996. No additional revenues related to the AT&T Agreement
will be recognized in the future.
GROSS MARGIN ON HARDWARE REVENUES
The Company's gross margin percentages on hardware revenues were 26% and 34%
for the third quarters of 1997 and 1996, respectively, and 30% and 20% for
the first nine months of 1997 and 1996, respectively. The decrease in margin
for the third quarter was primarily related to sale of IBM network computers
which have lower margins than other NCD product lines. The dramatic increase
in margin in the first nine months of 1997 compared to the same period in
1996 is primarily due to a charge of approximately $3.0 million incurred in
the second quarter of 1996 to reduce the value of certain inventories to
market price. Also benefiting margin percentages in 1997 were declines in
material costs, reflecting declines in the cost of certain semiconductor and
other components. In addition, the Company benefited from certain reduced
component prices related to volume purchase discounts in association with the
IBM Agreement during the third quarter and first nine months of 1997 while no
such purchasing benefits were realized in the same periods of 1996. The
Company currently anticipates that the mix of hardware OEM revenues as a
component of total hardware revenues will continue to rise. In addition, the
Company plans to increase the mix of revenues generated through indirect
channels. The anticipated changes in the mix of revenues by sales channel
are likely to result in overall reduced gross margin percentages on hardware
revenues in future periods.
GROSS MARGIN ON SOFTWARE REVENUES
The Company's gross margin percentages on software revenues were 68% and 66%
for the third quarters of 1997 and 1996, respectively, and 70% and 67% for
the first nine months of 1997 and 1996, respectively. The increase in the
gross margin percentage for the third quarter of 1997 was primarily due to
increased support revenues related to the WINCENTER product line. This was
offset slightly by a higher mix of WINCENTER revenues in 1997, which carry a
lower margin due to higher third-party royalty costs. The gross margin
percentage for the first nine months of 1997 increased from the same period
of 1996 due to increased sales of high margin WINCENTER software support and
from increased AT&T revenues recognized in 1997 of $1.2 compared to $426,000
in 1996, partially offset by reduced margin from increased WINCENTER sales
and the absence of sales of higher margin Z-MAIL products and the reduction
of PC-XWARE sales. Certain technology used in the Company's products is
licensed from third parties on a royalty-bearing basis. The costs associated
with such royalties increased substantially during 1996, and will continue to
be a significant component of total software cost of sales.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development ("R&D") expenses were $3.7 million and $3.2 million for
the third quarters of 1997 and 1996, respectively, and $10.7 million and $11.3
million for the first nine months of 1997 and 1996, respectively. Increases in
the
10
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NETWORK COMPUTING DEVICES, INC.
third quarter of 1997 are primarily due to increased investment in research
and development in the area of network computing products. This increase is
partially offset for the first nine months of 1997 by the absence of R&D
expenses related to the MARINER and Z-MAIL product lines while spending on
such product line development was a significant component of R&D expenses
during the same period of 1996. As a percentage of net revenues, R&D expenses
were 11% for the third quarters of 1997 and 1996, and 11% and 13% for the
first nine months of 1997 and 1996, respectively. The Company plans to
maintain its current level of investment in research and development in the
area of network computing products through 1997.
MARKETING AND SELLING EXPENSES
Marketing and selling expenses were $7.4 million and $6.2 million for the
third quarters of 1997 and 1996, respectively, and $22.7 million and $25.1
million for the first nine months of 1997 and 1996, respectively. The
increase in the third quarter 1997 expenses primarily relates to increased
headcount necessary for increased sales. The decreases in the first nine
months of 1997 reflects lower labor and other employee-related expenses due
to decreased headcount from the sale of the Z-MAIL and MARINER product lines.
The Company also experienced increased efficiencies in these areas resulting
from the reconsolidation of the Company's remaining business units, which
commenced in June of 1996. As a percentage of net revenues, marketing and
selling expenses were 21% and 22% for the third quarters of 1997 and 1996,
respectively, and 23% and 29% for the first nine months of 1997 and 1996,
respectively.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative ("G&A") expenses were $1.7 million and $2.2
million for the third quarters of 1997 and 1996, respectively, and $5.1
million and $8.3 million for the first nine months of 1997 and 1996,
respectively. The decreases were primarily related to cost containment
measures implemented by new senior management, including reductions in legal
costs and outside consulting fees and the reconsolidation of separate
business units into a single operating entity. G&A expenses for the third
quarter and first nine months of 1996 included increased expense related to
both the severance costs associated with the elimination of certain positions
within the Company and to increased personnel costs that resulted from the
division of the Systems and Software businesses into separate business units.
As a percentage of net revenues, G&A expenses were 5% and 8% for the third
quarters of 1997 and 1996, respectively, and 5% and 9% for the first nine
months of 1997 and 1996, respectively.
CREDIT ON LITIGATION SETTLEMENT
A credit of $147,000 was recognized in the third quarter of 1997, reflecting
the remainder of the $1.1 million dollar accrual that was made in the fourth
quarter of 1996 to account for legal costs to settle all pending litigation
associated with the shareholder lawsuit. No further charges related to such
settlement will be incurred in the future.
INTEREST INCOME
Interest income, net of interest expense, was $435,000 and $343,000 for the
third quarters of 1997 and 1996, respectively, and $1.5 million and $1.2 for
the first nine months of 1997 and 1996, respectively. The increase was
primarily due to higher average balances in interest-bearing accounts.
OTHER INCOME
Other income for the first nine months of 1997 includes the receipt of
insurance proceeds for certain legal expenses incurred in association with
securities litigation costs.
GAIN ON SALE OF PRODUCT LINES
The gain on the sale of product lines for the first nine months of 1996
represents the net gain recognized on the sale of the Company's MARINER
product line in February 1996, offset slightly by the net loss on the sale of
Z-MAIL in June 1996.
INCOME TAXES AND INCOME TAX BENEFIT
The Company recognized an income tax provision of $30,000, $13,000 and $1.1
million for the third quarters of 1997 and 1996 and the first nine months of
1997, respectively, and an income tax benefit of $4.2 million for the first
nine months of 1996.
11
<PAGE>
NETWORK COMPUTING DEVICES, INC.
FINANCIAL CONDITION
Total assets as of September 30, 1997 decreased by $2.1 million, or 2%, from
December 31, 1996. The change in total assets reflected decreases in
refundable and deferred income tax assets of $3.9 million and in accounts
receivable of $3.5 million, partially offset by a $4.9 million increase in
inventory and a $1.7 million increase in cash and short-term investments.
The decrease in refundable and deferred income tax assets was primarily
related to income tax refunds received, while the decrease in accounts
receivable was primarily related to increased collections. The increase in
inventory was primarily related to lower than budgeted sales volumes, while
the increase in cash and short-term investments was related to increased
collections, income tax refunds received and increased accounts payable,
partially offset by repurchases of the Company's common stock.
Total liabilities as of September 30, 1997 increased by $5.3 million, or 29%,
from December 31, 1996. This increase was primarily due to an increase of
$5.0 million in accounts payable which was primarily related to increased
inventory receipts.
CAPITAL REQUIREMENTS
Capital spending requirements for the remainder of 1997 are estimated at
approximately $1.0 million, and at September 30, 1997, the Company had
commitments for capital expenditures of approximately $500,000, primarily
related to manufacturing tooling and information technology.
LIQUIDITY
In April 1997, the Company's Board of Directors adopted a program to
repurchase from time to time at management's discretion up to 1,000,000
shares of the Company's common stock on the open market during the 12-month
period ending April 30, 1998 at prevailing market prices. Repurchases were
made under the program using the Company's cash resources. Shares
repurchased are available for the issuance under the Company's stock plans
and for other corporate purposes. In the third quarter of 1997, a total of
708,500 shares were repurchased at prices ranging from $8.38 to $12.00 per
share for a total purchase price of $7.3 million. Through September 30,
1997, the repurchase program was completed with an aggregate of 1,000,000
shares repurchased at prices ranging from $8.38 to $12.00 per share for a
total purchase price of $10.7 million.
In November 1997, the Company's Board of Directors adopted an additional
program to repurchase from time to time at management's discretion up to
1,000,000 shares of the Company's common stock on the open market during the
12 month period ending October 31, 1998 at prevailing market prices.
As of September 30, 1997, the Company had combined cash and equivalents and
short-term investments totaling $37.4 million, with no significant debt. The
Company believes that its existing sources of liquidity, including cash
generated from operations, will be sufficient to meet operating cash
requirements and capital lease repayment obligations at least through the
next twelve months.
FUTURE PERFORMANCE AND RISK FACTORS
THE COMPANY'S FUTURE BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION ARE
SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES, INCLUDING THOSE DESCRIBED BELOW.
EVOLVING NETWORK COMPUTING MARKET
The Company derives a majority of its revenues from the sale of network
computer products and related software. During the past several years, the
Company and other manufacturers of network computing systems and products
have experienced intense competition from alternative desktop computing
products, particularly personal computers, which has slowed the growth and
development of the network computing market. Until recently, the absence of
X protocol support from Microsoft Corporation ("Microsoft"), combined with
the proliferation of off-the-shelf Windows-based application software,
constituted an obstacle to the expansion of the network computing model into
Windows-based environments. The introduction of the Company's WINCENTER
multi-user WINDOWS NT application server software and new, lower-priced
network computers have allowed the Company to offer network computing systems
that provide users with access to Windows applications, although sales of
these new products have been limited to date. The Company's future success
will depend in substantial part upon increased acceptance of the network
computing model and the successful marketing of the Company's new network
12
<PAGE>
NETWORK COMPUTING DEVICES, INC.
computing products. There can be no assurance that the Company's new network
computing products will compete successfully with alternative desktop
solutions or that the network computing model will be widely adopted in the
rapidly evolving desktop computer market. The failure of new markets to
develop for the Company's network computing products would have a material,
adverse effect on the Company's business, operating results and financial
condition. See "Item 1. Business - Industry Background" and "Business -
Markets and Applications" in the Company's Annual Report on Form 10-K for the
year ended December 31, 1996.
COMPETITION
The desktop computer and information access markets are characterized by
rapidly changing technology and evolving industry standards. The Company
experiences significant competition from other network computer
manufacturers, suppliers of personal computers and workstations and software
developers. Competition within the network computing market has intensified
over the past several years, resulting in price reductions and reduced profit
margins. The Company expects this intense competition to continue, and there
can be no assurance that the Company will be able to continue to compete
successfully against current and future competitors as the desktop computer
market evolves and competition increases. The Company's software products
also face substantial competition from software vendors that offer similar
products, including several large software companies. See "Item 1. Business
- - Competition" in the Company's Annual Report on Form 10-K for the year ended
December 31, 1996.
FLUCTUATIONS IN OPERATING RESULTS
The Company's operating results have varied significantly, particularly on a
quarterly basis, as a result of a number of factors, including general
economic conditions affecting industry demand for computer products, the
timing and market acceptance of new product introductions by the Company and
its competitors, the timing of significant orders from and shipments to large
customers, periodic changes in product pricing and discounting due to
competitive factors, and the availability and pricing of key components, such
as DRAMs, video monitors, integrated circuits and electronic sub-assemblies,
some of which require substantial order lead times. The Company's operating
results may fluctuate in the future as a result of these and other factors,
including the Company's success in developing and introducing new products,
its product and customer mix, licensing costs, the level of competition that
it experiences and its ability to develop and maintain strategic business
alliances.
The Company has committed significant resources, including research and
development, manufacturing and sales and marketing resources, to the
implementation of the IBM Agreement (see "Overview"). The production cycle
of related product requires the Company to rely on IBM to provide accurate
product requirement forecasts, which have in the past and will in the future,
be subject to changes by IBM. Should the Company commence production of
related product based on provided forecasts that are subsequently reduced,
the Company bears the risk of increased levels of unsold inventories. Should
the expected business volumes associated with the IBM Agreement not occur, or
occur in volumes below management's expectations, there would be a material,
adverse effect on the Company's operating results.
The Company currently anticipates that the mix of hardware revenues as a
component of total revenues may rise as a result of the IBM Agreement and the
Company's current efforts to develop other OEM relationships for its network
computers. In addition, the Company plans to increase its revenues generated
through indirect sales. This change in the mix of revenues by product type
and by sales channel is likely to result in overall reduced gross margin
percentages on hardware revenues and on total revenues. In addition, the
Company operates with a relatively small backlog. Revenues and operating
results therefore generally depend on the volume and timing of orders
received, which are difficult to forecast and which may occur
disproportionately during any given quarter or year. The Company's expense
levels are based in part on its forecast of future revenues. If revenues are
below expectations, the Company's operating results may be adversely
affected. The Company has experienced a disproportionate amount of shipments
occurring in the last month of its fiscal quarters. This trend increases the
risk of material quarter-to-quarter fluctuations in the Company's revenues
and operating results. In the past, the Company has experienced reduced
orders during the first and third quarters due to buying patterns common in
the computer industry. In addition, sales in Europe have been adversely
affected in the third calendar quarter, when many European customers reduce
their business activities.
NEW PRODUCT DEVELOPMENT AND TIMELY INTRODUCTION OF NEW AND ENHANCED PRODUCTS
The markets for the Company's products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. The Company's future results will depend to a
considerable
13
<PAGE>
NETWORK COMPUTING DEVICES, INC.
extent on its ability to continuously develop, introduce and deliver in
quantity new hardware and software products that offer its customers enhanced
performance at competitive prices. The development and introduction of new
products is a complex and uncertain process requiring substantial financial
resources and high levels of innovation, accurate anticipation of
technological and market trends and the successful and timely completion of
product development. Once a hardware product is developed, the Company must
rapidly bring it into volume production, a process that requires accurate
forecasting of customer requirements in order to achieve acceptable
manufacturing costs. The introduction of new or enhanced products also
requires the Company to manage the transition from older, displaced products
in order to minimize disruption to customer ordering patterns, avoid
excessive levels of older product inventories and ensure that adequate
supplies of new products can be delivered to meet customer demand. As the
Company is continuously engaged in this product development and transition
process, its operating results may be subject to considerable fluctuation,
particularly when measured on a quarterly basis. The inability to finance
important research and development projects, delays in the introduction of
new and enhanced products, the failure of such products to gain market
acceptance, or problems associated with new product transitions could
adversely affect the Company's operating results. See "Item 1. Business
- -Industry Background" and "Business - Product Development" in the Company's
Annual Report on Form 10-K for the year ended December 31, 1996.
RELIANCE ON INDEPENDENT DISTRIBUTORS AND RESELLERS
The Company increasingly relies substantially on independent distributors and
resellers, particularly in European markets, for the marketing and
distribution of its products, particularly its software products. During
1995, the Company consolidated its Software sales operations by creating a
single organization devoted to the sale of the Company's PC connectivity and
messaging software and re-oriented its software sales strategy toward the
increased use of distributors, VARs and other resellers. In early 1996, the
Company experienced significant returns of its software products from its
distributors. There can be no assurance that the Company will not experience
some level of returns in the future. In addition, there can be no assurance
that the Company's distributors and resellers will continue their current
relationships with the Company or that they will not give higher priority to
the sale of other products, which could include products of the Company's
competitors. A reduction in sales effort or discontinuance of sales of the
Company's products by its distributors and resellers could lead to reduced
sales and could adversely affect the Company's operating results. In
addition, there can be no assurance as to the continued viability or the
financial stability of the Company's distributors and resellers, the
Company's ability to retain its existing distributors and resellers or the
Company's ability to add distributors and resellers in the future. See "Item
1. Business - Marketing and Sales" in the Company's Annual Report on Form
10-K for the year ended December 31, 1996.
RELIANCE ON INDEPENDENT CONTRACTORS
The Company relies on independent contractors for virtually all of the
sub-assembly of the Company's network computer products. The Company's
reliance on these independent contractors limits its control over delivery
schedules, quality assurance and product costs. In addition, a number of the
Company's independent suppliers are located abroad. The Company's reliance
on these foreign suppliers subjects the Company to risks such as the
imposition of unfavorable governmental controls or other trade restrictions,
changes in tariffs and political instability. The Company currently obtains
all of the sub-assemblies used for its network computer products (consisting
of all major components except monitors and cables) from a single supplier
located in Thailand. Any significant interruption in the supply of
sub-assemblies from this contractor would have a material adverse effect on
the Company's business and operating results. Although the Company is
currently planning to develop alternative locations in different countries
from which to obtain sub-assemblies, there is no assurance that the Company
will be successful in this pursuit. Disruptions in the provision of
components by the Company's other suppliers, or other events that would
require the Company to seek alternate sources of supply, could also lead to
supply constraints or delays in delivery of the Company's products and
adversely affect its operating results. The operations of certain of the
Company's foreign suppliers were briefly disrupted during 1992 due to
political instability in Thailand. See "Item 1. Manufacturing and Supplies"
in the Company's Annual Report on Form 10-K for the year ended December 31,
1996.
INTERNATIONAL SALES
A majority of the Company's international sales are denominated in U.S. dollars,
and an increase in the value of the U.S. dollar relative to foreign currencies
could make the Company's products less competitive in those markets. Over the
past two years, from time to time, a significant portion of international
revenues have been derived from sales to a customer in the United Kingdom that
have been denominated in pound sterling and sales denominated in foreign
currencies may increase in the future. These sales are subject to exchange rate
fluctuations which could affect the Company's operating results negatively
14
<PAGE>
NETWORK COMPUTING DEVICES, INC.
or positively, depending on the value of the U.S. dollar against the other
currency. Where the Company believes foreign currency-denominated sales
could pose significant exposure to exchange rate fluctuations, the Company
acquires forward exchange contracts in an effort to reduce such exposure.
International sales and operations may also be subject to risks such as the
imposition of governmental controls, export license requirements,
restrictions on the export of technology, political instability, trade
restrictions, changes in tariffs and difficulties in staffing and managing
international operations and managing accounts receivable. In addition, the
laws of certain countries do not protect the Company's products and
intellectual property rights to the same extent as the laws of the United
States. There can be no assurance that these factors will not have an
adverse effect on the Company's future international sales and, consequently,
on the Company's operating results.
DEPENDENCE ON KEY PERSONNEL
The Company's success depends to a significant degree upon the continuing
contributions of its senior management and other key employees, particularly
Robert G. Gilbertson, its President and Chief Executive Officer, and Rudolph
G. Morin, its Executive Vice President of Operations & Finance and Chief
Financial Officer. The loss of these individuals or other key management
personnel could have a material adverse effect on the Company's business,
operating results or financial condition. The Company believes that its
future success will depend in large part on its ability to attract and retain
highly-skilled engineering, managerial, sales and marketing personnel.
Competition for such personnel is intense, and there can be no assurance that
the Company will be successful in attracting, integrating and retaining such
personnel. Failure to attract and retain key personnel could have a material
adverse effect on the Company's business, operating results or financial
condition.
VOLATILITY OF STOCK PRICE
The market price of the Company's common stock has fluctuated significantly
over the past several years and is subject to material fluctuations in the
future in response to announcements concerning the Company or its competitors
or customers, quarterly variations in operating results, announcements of
technological innovations, the introduction of new products or changes in
product pricing policies by the Company or its competitors, general
conditions in the computer industry, developments in the financial markets
and other factors. In particular, shortfalls in the Company's quarterly
operating results from historical levels or from levels forecast by
securities analysts could have an adverse effect on the trading price of the
common stock. The Company may not be able to quantify such a quarterly
shortfall until the end of the quarter, which could result in an immediate
and adverse effect on the common stock price. In addition, the stock market
has, from time to time, experienced extreme price and volume fluctuations
that have particularly affected the market prices for technology companies
and which have been unrelated to the operating performance of the affected
companies. Broad market fluctuations of this type may adversely affect the
future market price of the Company's common stock.
15
<PAGE>
NETWORK COMPUTING DEVICES, INC.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed herewith:
Exhibit 11.1 Statement Regarding Computation of Shares Used in Income
(Loss) Per Share Computations.
Exhibit 27 Financial Data Schedule.
(b) The Company filed a report on Form 8-K on August 12, 1997 which reported,
under Item 5, the distribution to its shareholders of rights to repurchase
1/100 share of Series A Participating Preferred Stock, no par value,
under terms and conditions set forth in a Rights Agreement dated
August 12, 1997 between the Company and ChaseMellon Shareholder
Services, L.L.C.
16
<PAGE>
NETWORK COMPUTING DEVICES, INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Network Computing Devices, Inc.
(Registrant)
Date: November 6, 1997
By: /s/ Rudolph G. Morin
---------------------------------------
Rudolph G. Morin
Executive Vice President, Operations
& Finance and Chief Financial Officer
(Duly Authorized and Principal
Financial and Accounting Officer)
17
<PAGE>
Exhibit 11.1
NETWORK COMPUTING DEVICES, INC.
Statement Regarding Computation of Shares
Used in Income (Loss) Per Share Computations
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1997 1996 1997 1996
-------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Primary:
Weighted average common shares
outstanding during the period 16,355 16,615 16,852 16,460
Common share equivalents:
Dilutive effect of stock options 1,493 507 1,668 -
-------------- -------------- ------------- --------------
Total 17,848 17,122 18,520 16,460
-------------- -------------- ------------- --------------
-------------- -------------- ------------- --------------
Net income (loss) $ 51 $ 20 $ 1,600 $ (6,287)
-------------- -------------- ------------- --------------
-------------- -------------- ------------- --------------
Primary income (loss) per share $ 0.00 $ 0.00 $ 0.09 $ (0.38)
-------------- -------------- ------------- --------------
-------------- -------------- ------------- --------------
Fully Diluted:
Weighted average common shares
outstanding during the period 16,355 16,615 16,852 16,460
Common share equivalents:
Dilutive effect of stock options 1,602 1,085 1,668 -
-------------- -------------- ------------- --------------
Total 17,957 17,700 18,520 16,460
-------------- -------------- ------------- --------------
-------------- -------------- ------------- --------------
Net income (loss), adjusted
for fully diluted calculations $ 51 $ 20 $ 1,600 $ (6,287)
-------------- -------------- ------------- --------------
-------------- -------------- ------------- --------------
Fully diluted income (loss) per share $ 0.00 $ 0.00 $ 0.09 $ (0.38)
-------------- -------------- ------------- --------------
-------------- -------------- ------------- --------------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 24,787
<SECURITIES> 12,624
<RECEIVABLES> 20,571
<ALLOWANCES> 2,559
<INVENTORY> 14,724
<CURRENT-ASSETS> 77,377
<PP&E> 26,260
<DEPRECIATION> (21,656)
<TOTAL-ASSETS> 83,618
<CURRENT-LIABILITIES> 23,343
<BONDS> 0
0
0
<COMMON> 59,285
<OTHER-SE> 808
<TOTAL-LIABILITY-AND-EQUITY> 83,618
<SALES> 100,072<F1>
<TOTAL-REVENUES> 100,072
<CGS> 60,721<F2>
<TOTAL-COSTS> 60,721
<OTHER-EXPENSES> 38,340
<LOSS-PROVISION> 99
<INTEREST-EXPENSE> 45
<INCOME-PRETAX> 2,663
<INCOME-TAX> 1,063
<INCOME-CONTINUING> 1,600
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,600
<EPS-PRIMARY> 0.09
<EPS-DILUTED> 0.09
<FN>
<F1>Includes revenues from licensing of software and support services.
<F2>Includes costs from licensing of software and support services.
</FN>
</TABLE>
