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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, 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: 0-20124
NETWORK COMPUTING DEVICES, INC.
(Exact name of registrant as specified in its charter)
Delaware 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 15,942,049
at October 31, 1998.
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NETWORK COMPUTING DEVICES, INC.
INDEX
<TABLE>
<CAPTION>
DESCRIPTION PAGE NUMBER
- --------------------------------------------------------- -----------
<S> <C>
Cover Page 1
Index 2
Part I: Financial Information
Item 1: Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations
for the Three-and Nine-Month Periods Ended
September 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows
for the Nine-Month Periods Ended September 30,
1998 and 1997 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 15
Signature 16
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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,
1998 1997
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<S> <C> <C>
Current assets:
Cash and cash equivalents $ 16,558 $ 21,240
Short-term investments 12,157 10,240
Accounts receivable, net 18,546 25,148
Inventories 12,841 15,412
Refundable and deferred income tax assets 5,508 4,763
Other current assets 2,606 2,843
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Total current assets 68,216 79,646
Property and equipment, net 3,237 4,424
Other assets 2,119 2,444
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Total assets $ 73,572 $ 86,514
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 9,132 $ 11,211
Accrued expenses 5,581 8,955
Income taxes payable 308 597
Current portion of capital lease obligations 91 154
Deferred revenue 2,665 4,918
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Total current liabilities 17,777 25,835
Long-term portion of capital lease obligations 92 160
Shareholders' equity:
Undesignated preferred stock - -
Common stock 57,272 58,630
Retained earnings (1,569) 1,889
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Total shareholders' equity 55,703 60,519
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Total liabilities and shareholders' equity $ 73,572 $ 86,514
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</TABLE>
See accompanying notes.
3
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NETWORK COMPUTING DEVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net revenues:
Hardware products and services $ 20,877 $ 26,532 $ 58,128 $ 76,347
Software licenses and services 5,238 8,114 21,316 23,725
---------- ---------- ---------- ----------
Total net revenues 26,115 34,646 79,444 100,072
Cost of revenues:
Hardware products and services 15,224 19,764 43,123 53,600
Software licenses and services 1,700 2,579 6,952 7,121
---------- ---------- ---------- ----------
Total cost of revenues 16,924 22,343 50,075 60,721
---------- ---------- ---------- ----------
Gross margin 9,191 12,303 29,369 39,351
Operating expenses:
Research and development 3,236 3,703 9,998 10,674
Marketing and selling 7,405 7,379 22,986 22,749
General and administrative 1,427 1,722 3,881 5,064
Credit on litigation settlement - (147) - (147)
---------- ---------- ---------- ----------
Total operating expenses 12,068 12,657 36,865 38,340
---------- ---------- ---------- ----------
Operating income (loss) (2,877) (354) (7,496) 1,011
Interest income, net 413 435 1,290 1,452
Other income 228 - 2,090 200
---------- ---------- ---------- ----------
Income (loss) before income taxes (2,236) 81 (4,116) 2,663
Provision for income taxes (income tax benefit) - 30 (658) 1,063
---------- ---------- ---------- ----------
Net income (loss) $ (2,236) $ 51 $ (3,458) $ 1,600
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income (loss) per share
Basic $ (0.14) $ 0.00 $ (0.21) $ 0.09
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted $ (0.14) $ 0.00 $ (0.21) $ 0.09
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Shares used in per share computations
Basic 16,228 16,355 16,522 16,852
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Diluted 16,228 17,848 16,522 18,520
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
See accompanying notes.
4
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NETWORK COMPUTING DEVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1998 1997
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<S> <C> <C>
Cash flows from operations:
Net income (loss) $ (3,458) $ 1,600
Reconciliation to cash provided by operations:
Depreciation and amortization 2,273 2,403
Gain on sale of investment (2,090) -
Changes in:
Accounts receivable, net 6,602 3,537
Inventories 2,571 (4,948)
Refundable and deferred income taxes (745) 3,892
Other current assets 237 817
Accounts payable (2,079) 5,029
Income taxes payable (289) (337)
Accrued expenses (3,374) 471
Deferred revenue (2,253) 776
----------- ----------
Cash provided by (used in) operations (2,605) 13,240
Cash flows from investing activities:
Short-term investments, net (1,917) (785)
Proceeds from sale of investment 2,402 -
Changes in other assets 13 226
Property and equipment purchases (1,086) (2,112)
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Cash used in investing activities (588) (2,671)
Cash flows from financing activities:
Principal payments on capital lease obligations (131) (682)
Repurchases of common stock (9,822) (10,719)
Proceeds from issuance of stock, net 8,464 1,787
----------- ----------
Cash used in financing activities (1,489) (9,614)
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Increase (decrease) in cash and equivalents (4,682) 955
Cash and equivalents:
Beginning of period 21,240 23,832
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End of period $ 16,558 $ 24,787
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</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
1997 Annual Report on Form 10-K. The consolidated results of operations for the
three- and nine-month periods ended September 30, 1998 are not necessarily
indicative of the results to be expected for any subsequent quarter or for the
entire year ending December 31, 1998.
COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income," which establishes standards
for reporting and disclosures of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general-purpose
financial statements. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997 and requires reclassification of financial statements
for earlier periods to be provided for comparative purposes. The Company has
not determined the manner in which it will present the information required by
SFAS No. 130 in its annual consolidated financial statements for the year ending
December 31, 1998. The Company's total comprehensive income (loss) for all
periods presented herein would not have differed from those amounts reported as
net income (loss) in the consolidated statements of operations.
NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed using the weighted-average number
of common shares outstanding during the period. Diluted net income (loss) per
share is computed using the weighted-average number of common shares and common
equivalent shares from stock options (1,493,098 and 1,667,469 in the third
quarter and first nine months of 1997, respectively) outstanding, when dilutive,
using the treasury stock method. In the third quarter of 1998 there were
3,771,087 options outstanding that could potentially dilute basic earnings per
share ("EPS") in the future that were not included in the computation of diluted
EPS because to do so would have been antidilutive for that period and for the
nine-month period ended September 30, 1998.
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):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
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<S> <C> <C>
Purchased components and sub-assemblies $ 10,511 $ 13,178
Work in process 616 545
Finished goods 1,714 1,689
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$ 12,841 $ 15,412
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</TABLE>
STOCK REPURCHASE PROGRAM
In April 1997, the Company's Board of Directors adopted a program to repurchase
up to 1,000,000 shares of the Company's common stock during the 12-month period
ended April 30, 1998. 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 September
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 up to 1,000,000 shares of
the Company's common stock during the 12-month period ending October 31, 1998.
In July 1998, the second repurchase program was completed with an aggregate of
1,000,000 shares repurchased at prices ranging from $6.50 to $9.63 at a total
aggregate price
6
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NETWORK COMPUTING DEVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
of $8.5 million. In June 1998, the Company announced an additional program to
repurchase up to 750,000 shares of the Company's common stock. Repurchases of
404,800 shares have been made as of September 30, 1998 under the third program
at prices ranging from $6.25 to $8.25 at a total aggregate price of $2.8
million. Total repurchases of 2,404,800 shares were made under all three
programs at prices ranging from $6.25 to $12.00 per share for a total purchase
price of $22.0 million.
MAJOR CUSTOMERS AND RELATED ACCOUNTS RECEIVABLE
International Business Machines Corporation ("IBM") accounted for approximately
34% and 33% of the Company's revenues for the third quarters of 1998 and 1997,
respectively, and approximately 26% and 25% for the first nine months of 1998
and 1997, respectively. At September 30, 1998, related accounts receivable due
from IBM were approximately $7.5 million.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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, 1997, CONTAINED IN THE COMPANY'S 1997 ANNUAL REPORT ON FORM
10-K.
OVERVIEW
The Company provides thin client hardware and software that delivers
simultaneous, high-performance, easy-to-manage access to any application from
thin client, UNIX and PC desktops. The Company's product lines include the NCD
THINSTAR and NCD EXPLORA family of thin clients, NCD THINSTAR CONNECTIVITY
SUITE, NCD WINCENTER-TM- multi-user WINDOWS NT application server software, and
NCD PC-XWARE-Registered Trademark- software that delivers PC access to UNIX and
multi-user WINDOWS NT PCs. These products are sold through OEMs, system
integrators and distributor/VAR channels worldwide.
The Company sells hardware products to International Business Machines
Corporation ("IBM") pursuant to the joint development agreement dated June 27,
1996 (the "IBM Agreement") of a network application terminal for resale by IBM.
The IBM Agreement provides for IBM to purchase a substantial portion of its
requirements for such products from the Company through December 31, 2000.
RECENT DEVELOPMENTS
During the first quarter of 1998, the Company signed a non-exclusive three-year
agreement with Intel Corporation under which the Company and Intel will
collaborate to produce desktop devices based on guidelines for Lean Client
systems outlined by Intel in December 1997. Under the terms of the agreement,
the Company will develop a "reference platform design" consisting of
Pentium-based lean client hardware integrated with software technology from both
companies. Subject to the Company's successful completion of the development
project, including the Company's demonstration of volume production, Intel has
agreed to (i) reference the Company's lean client design(s) as the "preferred
design" for the lean client marketplace and (ii) refrain from developing a board
level product(s) substantially equivalent to the Company's lean client design(s)
for a specified period of time. The agreement provides that the Company will
develop new product designs based on Intel architecture and will have a limited
period of exclusivity for such design(s). Thereafter, Intel shall have the
option to acquire a non-exclusive license to any Company lean client design(s)
developed by the Company under the auspices of the agreement. The agreement
further contemplates that Intel may elect to terminate the agreement for
convenience prior to the Company's completion of its development efforts upon
Intel's payment to the Company of substantial specified lump sum payments.
In June 1998, the Company announced that it had developed a WINDOWS-based
terminal, endorsed by Microsoft, based on Microsoft's CE operating system. This
new WINDOWS-based terminal, which utilizes Microsoft's RDP protocol and/or
Citrix's ICA protocol, can access Microsoft's NT operating system from multiple
desktops. In September 1998, the Company commenced volume shipments of the NCD
THINSTAR Windows-based terminals. In addition, in October 1998, the Company
announced companion software for the NCD THINSTAR product line, NCD THINSTAR
PLUS and NCD THINSTAR LOAD BALANCING, which are designed to give NCD
Windows-based terminal customers a cost effective, flexible choice in selecting
the capabilities they need with either Microsoft RDP or Citrix ICA protocols.
RESULTS OF OPERATIONS
TOTAL NET REVENUES
Total net revenues for the third quarters of 1998 and 1997 were $26.1 million
and $34.6 million, respectively, representing a decrease of 25%. Revenues for
the first nine months of 1998 and 1997 were $79.4 and $100.1 million,
respectively,
8
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representing a decrease of 21%. Sales related to the IBM Agreement accounted
for approximately 34% and 33% of revenues in the third quarters of 1998 and
1997, respectively, and approximately 26% and 25% in the first nine months of
1998 and 1997, respectively.
HARDWARE REVENUES
Hardware revenues consist primarily of revenues from the sale of thin client
products and related hardware, and to a lesser extent, fees for related
service activities. Hardware revenues were $20.9 million and $26.5 million
for the third quarters of 1998 and 1997, respectively, and $58.1 million and
$76.3 million for the first nine months of 1998 and 1997, respectively. The
decline from the third quarter of 1997 to the third quarter of 1998 reflects
decreased shipments to IBM and a change in the mix of products sold,
reflecting substantially lower average selling prices. The decline in the
first nine months of 1998 compared with the same period in 1997 was due to
these same factors, offset partially by increased shipments of monitors in
the first quarter of 1998.
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 (i) NCD WINCENTER, the Company's multi-user WINDOWS
NT application server software, (ii) NCD PC-XWARE, the Company's thin client
software for PCs, and (iii) NCDWARE, the Company's proprietary thin client
software. Revenues from software and related services were $5.2 million and
$8.1 million for the third quarters of 1998 and 1997, respectively, and $21.3
million and $23.7 million for the first nine months of 1998 and 1997,
respectively. The decline in revenues in the third quarter of 1998 compared to
the third quarter of 1997 reflects decreases in all software revenue product
lines, the most significant of which was NCD WINCENTER, which reflects the
Company's transition from an OEM of Citrix's WinFrame for NT 3.5 product to a
provider of value-add to that product, and the market's move from Citrix
WinFrame for NT 3.5 to MetaFrame for NT 4.0 concurrently with the availability
of multi-user Windows NT 4.0 from Microsoft. The decline in revenues for the
first nine months of 1998 compared to the same period in 1997 primarily reflects
decreases in sales of the Company's PC-XWARE product line. Revenues for the
third quarter and first nine months of 1997 included revenues from AT&T of
$166,000 and $1.2 million, respectively, related to an agreement with AT&T that
terminated in September 1997. The Company's OEM relationship with Citrix ended
on September 30, 1998. This will result in significantly reduced sales of
WINCENTER products, and, potentially, total software revenues in future periods
if the Company's newly announced software products do not achieve sufficient
marketplace acceptance.
GROSS MARGIN ON HARDWARE REVENUES
The Company's gross margin percentages on hardware revenues were 27% and 26%
for the third quarters of 1998 and 1997, respectively, and 26% and 30% for
the first nine months of 1998 and 1997, respectively. The slight increase in
margin in the third quarter of 1998 compared to the third quarter of 1997
reflects higher margins on the Company's thin client computing products sold,
offset partially by lower margins on products sold to IBM on an OEM basis.
The decrease in margin for the first nine months of 1998 reflects lower
margins on products sold to IBM on an OEM basis and increased sales of low
margin monitors. 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 percentage of revenues
generated through indirect channels. The combined impact of these changes is
likely to result in continued pressure on gross margin percentages for
hardware revenues in future periods.
GROSS MARGIN ON SOFTWARE REVENUES
The Company's gross margin percentages on software revenues were 68% for the
third quarters of both 1998 and 1997, and 67% and 70% for the first nine months
of 1998 and 1997, respectively. The decrease in gross margin percentages for
the first nine months of 1998 is related to the combined impact of high-margin
AT&T revenues recognized in 1997 which were not recognized in 1998 and the
reduction of NCD PC-XWARE sales. Certain technology used in the Company's
products is licensed from third parties on a royalty-bearing basis; accordingly,
royalties are a significant component of total software cost of sales for 1998
and 1997.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development ("R&D") expenses were $3.2 million and $3.7 million for
the third quarters of 1998 and 1997, respectively, and $10.0 million and $10.7
million for the first nine months of 1998 and 1997, respectively. Although R&D
expenses decreased slightly in absolute dollars, the investment in R&D as a
percentage of net revenues increased as the
9
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Company continued to invest in R&D in a period of lower revenues. As a
percentage of net revenues, R&D expenses were 12% and 11% for the third quarters
of 1998 and 1997, respectively, and 13% and 11% for the first nine months of
1998 and 1997, respectively.
MARKETING AND SELLING EXPENSES
Marketing and selling expenses were $7.4 million for the third quarters of both
1998 and 1997, and $23.0 million and $22.7 million for the first nine months of
1998 and 1997, respectively. Although marketing and selling expenses remain
relatively static in absolute dollars, these expenses increased as a percentage
of net revenues as the Company continued to invest in its marketing and sales
programs in a period of lower revenues. As a percentage of net revenues,
marketing and selling expenses were 28% and 21% for the third quarters of 1998
and 1997, respectively, and 29% and 23% for the first nine months of 1998 and
1997, respectively.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative ("G&A") expenses were $1.4 million and $1.7 million
for the third quarters of 1998 and 1997, respectively, and $3.9 million and $5.1
million for the first nine months of 1998 and 1997, respectively. The decrease
in the third quarter and first nine months of 1998 primarily reflects increased
efficiencies and continued cost controls related to personnel costs, facilities
costs and outside service fees. As a percentage of net revenues, G&A expenses
were 5% for the third quarters and first nine months of both 1998 and 1997.
INTEREST INCOME, NET
Interest income, net of interest expense, was $413,000 and $435,000 for the
third quarters of 1998 and 1997, respectively, and $1.3 million and $1.5 million
for the first nine months of 1998 and 1997, respectively. The decreases were
primarily due to lower average balances in interest-earning accounts.
OTHER INCOME, NET
Other income includes non-operating income, net of non-operating expense. Other
income for the third quarter and first nine months of 1998 reflects the sale of
the Company's interest in Precept Software, Inc. ("Precept") after Precept was
acquired by Cisco Systems in March 1998, resulting in a net gain of
approximately $228,000 and $2.1 million, respectively. The Company acquired
shares of Precept in 1995 in return for providing specialized software. Other
income in the first nine months of 1997 reflects the receipt of insurance
proceeds for certain legal expenses incurred in association with the securities
litigation costs.
INCOME TAXES AND INCOME TAX BENEFIT
The Company recognized no income tax benefit for the third quarter of 1998 and
an income tax benefit of $658,000 in the first nine months of 1998, compared to
income tax provisions of $30,000 and $1.1 million in the third quarter and first
nine months of 1997, respectively. At September 30, 1998, the Company's gross
deferred tax assets are approximately $5.9 million.
FINANCIAL CONDITION
Total assets of $73.6 million at September 30, 1998 decreased from $86.5 million
at December 31, 1997. The change in total assets reflects decreases in accounts
receivable, combined cash and equivalents and short-term investments, and
inventories of $6.6 million, $2.8 million and $2.6 million, respectively.
Combined cash and equivalents and short-term investments decreased primarily due
to repurchases of common stock of $9.8 million, offset partially by accounts
receivable collections of $6.6 million. Total liabilities as of September 30,
1998 decreased by $8.1 million from December 31, 1997. The decrease was
primarily related to decreases in accrued expenses, deferred revenue and
accounts payable of $3.4 million, $2.3 million and $2.1 million, respectively.
CAPITAL REQUIREMENTS
Capital spending requirements for the remainder of 1998 are estimated at
approximately $360,000. At September 30, 1998, the Company had commitments for
capital expenditures of approximately $260,000, primarily related to
manufacturing tooling, information technology and facilities.
10
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LIQUIDITY
As of September 30, 1998, the Company had combined cash and equivalents and
short-term investments totaling $28.7 million, with no significant debt. Cash
used in operations in the first nine months of 1998 of $2.6 million primarily
reflects a net loss of $3.5 million and decreases in accrued expenses,
deferred revenue and accounts payable of $3.4 million, $2.3 million and $2.1
million, respectively, partially offset by decreases in accounts receivable
and inventories of $6.6 and $2.6 million, respectively. This compares to
cash provided by operations of $13.2 million in the first nine months of 1997.
Cash used in investing activities in 1998 primarily reflects an increase
in short-term investments and capital purchases of $1.9 million and $1.1
million, respectively, offset by proceeds from the sale of the Precept
investment of $2.4 million. Cash used in financing activities in 1998
primarily reflects corporate common stock repurchases of $9.8 million
partially offset by Intel's investment in the Company's common stock.
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.
YEAR 2000 ISSUES
In the next two years, most companies could face a potentially serious
information systems problem because many software applications and operational
programs written in the past were designed to handle date formats with two-digit
years and thus may not properly recognize calendar dates beginning in the Year
2000. This problem could result in computers either outputting incorrect data or
shutting down altogether when attempting to process a date such as "01/01/00."
In response to this, the Company has formed a task force (the "Task Force")
specifically assigned to addressing Year 2000 issues.
The Task Force is composed of members from all essential functional groups
within the Company. The Task Force meets regularly, and the meeting minutes
are reviewed on a regular basis at the Executive Staff's operational meeting.
The Company has reviewed all of its current product offerings and believes
that its current products are Year 2000 compliant. As to the Company's
internal operations, the Task Force's general plan of action includes
inventorying all essential systems, equipment and facilities, contacting
suppliers to ascertain vendor readiness for Year 2000, testing all critical
systems and resolving all mission critical problems by the end of the third
quarter of 1999. The Company is currently on schedule to complete all mission
critical Year 2000 problems by the end of the third quarter of 1999.
The Company is currently in the process of completing a comprehensive inventory
and evaluation of its systems, equipment and facilities. The Company has also
identified all essential suppliers and has contacted them to determine whether
these suppliers' operations, products and services are, or will be, Year 2000
ready. The Company expects to receive all supplier responses by the end of
this year. In addition, the Company plans to audit its largest supplier to
ensure Year 2000 readiness. The Company has a number of projects underway to
replace or upgrade systems, equipment and facilities that are not currently
Year 2000 ready. To date, the Company has not identified any specific
contingency plans should the replacement or upgrade of these systems not be
completed on a timely basis. The Company is working to have contingency plans
documented for mission critical areas by the end of this year.
The Company estimates the total Year 2000 costs to be between $1.0 million
and $1.4 million. As of September 30, 1998, the Company has spent
approximately $75,000 related to Year 2000 issues. The Company has budgeted
all Year 2000 costs independently of the Company's information technology
budget. All costs will be paid from the Company's operating funds.
In addition to potential costs or losses directly associated with the Year 2000
issue, the Company could experience reduced revenues resulting from other
companies' information systems budgets being allocated to solving Year 2000
issues, thus reducing amounts available to purchase the Company's products. The
Company could also be exposed to a potential adverse impact resulting from the
failure of key suppliers, financial institutions and other third parties to
adequately address the Year 2000 problem, despite assurances to the contrary
given to the Company. However, the Company cannot currently estimate the
incidental costs and losses which may be incurred from reliance on these third
parties, nor can any assurance be given that the Year 2000 problem will not
have a material adverse effect on the Company's business, operating results or
financial condition.
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FUTURE PERFORMANCE AND RISK FACTORS
THE COMPANY'S FUTURE BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION ARE
SUBJECT TO VARIOUS ADDITIONAL RISKS AND UNCERTAINTIES, INCLUDING THOSE DESCRIBED
BELOW.
EVOLVING THIN CLIENT COMPUTING MARKET
The Company derives a majority of its revenues from the sale of thin client
network computing products and related software. Until several years ago,
the Company's thin client product offerings primarily focused on the UNIX
marketplace using the Company's X protocol. The Company's introduction of
its WINCENTER multi-user WINDOWS NT application server software and new,
lower-priced thin client network computing devices allowed the Company to
offer thin client network computing systems that provide users with access to
Windows applications. The Company's expansion of its thin client computing
model into the WINDOWS-based environment has been limited because of the
Company's inability to offer an endorsed Microsoft solution within the
WINDOWS market prior to the introduction of the WINDOWS-based terminal in
June 1998 and intense competition from alternative desktop systems,
particularly personal computers, whose selling prices are at historic lows
for relatively high performance configurations. The Company's future success
will depend substantially upon increased acceptance of the thin client
computing model and the successful marketing of the Company's new thin client
computing products. There can be no assurance that the Company's new thin
client computing products will compete successfully with alternative desktop
solutions or that the thin client computing model will be widely adopted in
the rapidly evolving desktop computer market. The failure of new markets to
develop for the Company's thin client computing products would have a
material, adverse effect on the Company's business, operating results and
financial condition.
RELIANCE ON OEM RELATIONSHIPS
The Company has committed significant resources, including research and
development, manufacturing and sales and marketing resources, to the execution
of the IBM Agreement. 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 potential OEM relationships
for the Company's thin client computing products, which would likely lead to
overall reduced gross margins on total revenues.
OTHER RISK FACTORS
The Company experiences significant competition from other thin client
manufacturers, suppliers of personal computers and workstations and software
developers. Competition within the thin client 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. Additionally, as the Company
expands the network computing model into the Windows-based environment, the
Company's software products will face increased competition in this evolving
market, including new product offerings from Microsoft and Citrix.
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.
12
<PAGE>
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 which it experiences
and its ability to develop and maintain strategic business alliances.
The Company's future results will depend to a considerable 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 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.
The Company has significant deferred tax assets and will have to generate a
significant amount of future taxable income to realize its deferred tax assets.
If the Company is unable to realize its deferred tax assets, it will have to
establish a valuation allowance which could have a material adverse effect on
future operating results. There can be no assurance that future levels of
pretax earnings for financial reporting purposes will be sufficient to realize
the deferred tax assets.
The Company relies substantially on independent distributors and resellers,
particularly in European markets, and is expanding that model in the US for the
marketing and distribution of its products. 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.
The Company relies on independent contractors for virtually all of the
sub-assembly of the Company's thin client computing 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 thin client computing 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.
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.
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.
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, President and Chief Executive Officer and Rudolph G.
Morin, Executive Vice President of Operations & Finance and Chief Financial
Officer. 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,
13
<PAGE>
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.
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.
See Part II - Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Future Performance and Risk Factors
contained in the Company's 1997 Annual Report on Form 10-K.
14
<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 27 Financial Data Schedule.
(b) The Company filed no reports on Form 8-K during the three-month period
ended September 30, 1998.
15
<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 12, 1998
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)
16
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<PAGE>
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<PERIOD-START> JAN-01-1998
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0
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