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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1996
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-21240
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HDS NETWORK SYSTEMS, INC.
(Exact name of registrant as specified in its charter.)
Delaware 23-2705700
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
400 Feheley Drive, King of Prussia, Pennsylvania 19406
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 277-8300
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None NASDAQ
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Securities registered pursuant to Section 12(g) of the Act:
Units consisting of one share of Common Stock and two Redeemable Common Stock
Purchase Warrants; Common Stock, par value $.001 per share; and Redeemable
Common Stock Purchase Warrants each to purchase one share of Common Stock
for $5.50 per share
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES X NO ___
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
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The aggregate market value of the voting stock held by non-affiliates of the
registrant is approximately $43,513,956. Such aggregate market value was
computed by reference to the last reported sale price of the Common Stock as
reported on the NASDAQ National Market on September 19, 1996. In making such
calculation, the registrant does not determine whether any director, officer or
other holder of Common Stock is an affiliate for any other purpose.
The number of shares of the registrant's Common Stock outstanding as of
September 17, 1996 was 5,731,775.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on December 3, 1996 are incorporated by
reference into Part III. Those portions of the Proxy Statement included in
response to Item 402(k) and 402(1) of Regulation S-K are not incorporated by
reference into Part III.
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TABLE OF CONTENTS PAGE
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PART I......................................................................1
ITEM 1. BUSINESS..........................................1
ITEM 2. PROPERTIES........................................9
ITEM 3. LEGAL PROCEEDINGS.................................9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS...........................................9
PART II.....................................................................9
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED SHAREHOLDER MATTERS.......................9
ITEM 6. SELECTED FINANCIAL DATA..........................11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.......................................12
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......16
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ONACCOUNTING AND FINANCIAL
DISCLOSURE.......................................17
PART III...................................................................17
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT.......................................17
ITEM 11. EXECUTIVE COMPENSATION...........................18
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT............................18
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS.....................................18
PART IV....................................................................18
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K..............................18
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PART I
Forward-Looking Statements
Certain statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in Part II, Item 7 and certain
other statements contained in this Form 10-K are forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
These statements are subject to certain risks and uncertainties, including,
but not limited to, quarterly fluctuations in operating results, general
economic conditions affecting the demand for computer products, the timing of
significant orders, the timing and acceptance of new product introductions
including the Company's new line of network computers and operating system
software, increased competition in the desktop computer market, the mix of
distribution channels through which the Company's products are sold,
the failure to reduce product costs or maintain quality, delays in the
receipt of key components, seasonal patterns of spending by customers,
continued government funding of projects for which the Company is a
subcontractor and the Company's ability to complete strategic acquisitions.
ITEM 1. BUSINESS.
General
HDS Network Systems, Inc. (the "Company") designs, manufactures and
markets a family of network computers that are designed to integrate and
deliver information to the desktop cost effectively in network-centric
environments. The Company's @workStation/(TM)/ and related software combine a
variety of windowed-display, graphical user interface ("GUI") and
communications industry standards to provide the user seamless and
transparent access to all information, including text, graphics, audio and
video data, on any type of network.
The Company, which was formerly known as Information Systems Acquisition
Corporation, was formed in November 1992 as a Specified Purpose Acquisition
Company ("SPAC"), the objective of which was to acquire an operating business
in the information systems industry. During 1993 and 1994, the Company's
efforts were limited to organizational activities, completion of an initial
public offering and evaluation of possible acquisitions. On March 2, 1995,
Human Designed Systems, Inc. ("Human Designed") was merged into a wholly-
owned subsidiary of the Company (the "Merger"). Pursuant to the Merger, all
of the outstanding shares of HDS were converted into the right to receive a
total of 2,810,000 shares of the Company's Common Stock, 618,200 redeemable
common stock purchase warrants and $5,500,000 in cash, in accordance with the
exchange ratios set forth in the Merger Agreement. Upon completion of the
Merger, the former shareholders of Human Designed owned approximately 50.1%
of the outstanding Common Stock of the Company.
Immediately prior to the consummation of the Merger, all of the
directors of the Company, other than Arthur R. Spector, resigned from the
Board of Directors and the director elected Mark A. Gelberg, Michael G.
Kantrowitz, John M. Ryan and Howard L. Morgan (each of whom was designated by
Human Designed), and Samuel A. Plum and Carl G. Sempier (the Company's
designees) to serve as the new directors of the Company and the Subsidiary.
In connection with the merger, the Company changed its name to HDS Network
Systems, Inc., and the Subsidiary assumed Human Designed's name and
operations. In April 1996 HDS was merged into the Company.
In August 1996, the Company formed a new subsidiary, Information
Technology Consulting, Inc. for the purpose of acquiring companies in the
network computer services field, including information technology staffing
companies and client-server consulting companies. The Company has hired James
W. Dixon as President and Chief Executive Officer of the subsidiary and
anticipates that it will commence making acquisitions during the second
quarter of fiscal 1997. Mr. Dixon was also appointed to fill a vacancy on the
Company's Board of Directors.
Industry Background
Organizations have been implementing enterprise-wide networks
incorporating PCs, legacy equipment such as mainframes, and communications
facilities in order to improve productivity and provide more computing power
to users. Many organizations have moved from the traditional host/slave
environment of the mainframe, toward distributed client/server computing with
power, applications, and management decentralized across the enterprise. With
increased use of the Internet, users now have access to information from any
type of computer around the world. As a result, organizations continue to
seek secure, powerful networks that are user-friendly and cost-efficient.
A new set of technologies has emerged, designed to improve delivery of
applications to end users. Network-centric computing using Internet
technologies has become the foundation for many organizations' internal
networks, or intranets, utilizing open, standards-based solutions. In the
intranet model, remote servers and desktop clients cooperate over an internal
network using the enabling technologies of the Internet, such as web browsing
and Java, that can run on a variety of platforms. Using web browsers, users
access applications through simple "point and click" commands.
The Company's @workStation line of network computers is designed to
implement this intranet computing model. Users of @workStation network
computers can plug into existing networks and run existing PC, mainframe and
UNIX applications in addition to Java and Internet applications. The products
are specifically designed for networking, to allow access to any type of
computer.
Products
The functionality of the Company's network computers is derived
primarily from the Company's netOS operating system, an operating system
based on open systems technologies. The operating system provides a compact
foundation for the @workStation's features, including integrated Internet and
Windows applications access, Java applications, videoconferencing, and
multimedia. The netOS supports a range of industry standard communications
and networking protocols and enables users to access any type of data or
application on any platform, such as Windows NT, Windows 95, Windows 3.1,
mainframe and UNIX.
The Company has incorporated Sun Microsystems, Inc.'s Java/(TM)/
technology and Spyglass, Inc.'s web browser technologies into its netOS to
provide cost-effective access to information and applications within the
organization's enterprise and on the Internet. The Company's netVideo
mulimedia applications provide video teleconferencing across the enterprise
or around the world across the Internet, as well as full motion video for
remote training and enhanced information presentation. The Company's network
computers provide certain advantages over PCs, workstations and traditional
terminals, particularly with respect to lower administrative costs, reduced
obsolescence and improved ease of use.
The Company's network computer product line was introduced in June 1996.
Prior to the introduction of the network computer, the Company manufactured
and marketed a family of desktop computing devices, including multimedia-
capable X Window terminals. The X terminal product line was designed around
industry standards and allowed users to access multiple forms of information
simultaneously, using the industry standard X protocol and industry standard
networking interfaces. The Company's new line of network computers utilizes
many of the same open systems technologies which had been used in its X
terminal products. The Company believes that its new line of network
computers should have a broader market appeal than its X terminal products.
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Product Strategy
The Company's objective is to maintain a leadership position in the
evolving market for network computer products. Prior to the introduction of
its network computer product family in June 1996, the Company was a leading
provider of X Window terminals. The Company believes the market potential of
the network computer is significantly larger than that of the X terminal
market, and has invested significant resources in sales and marketing and
research and development in the current year to introduce and market the new
product family. The Company's network computer products incorporate
the following elements:
. Efficient, standards-based Operating System. During the current
year, the Company developed netOS , an operating system for
network computers based on industry standard protocols and
technologies. The operating system allows users to access
applications and information on multiple platforms, including
Windows95(R), WindowsNT(R), Windows 3.1, UNIX(TM), mainframes, the
Internet and Java(TM). The netOS operating system is used within
the Company's own network computer product line, and the Company
has made the operating system available for licensing to other
manufacturers of network-centric computing devices.
. Cost-effective, High-Performance Network Computer Family. The
Company offers a full line of network computers, which are bundled
with the netOS operating system. The HDS @workStation product
family offers a choice of four model lines (@work Basic, Prima,
Supra and Duo) with different levels of performance and capability.
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Each model uses an Intel i960 RISC processor, and the @work Supra
models include additional hardware acceleration for faster
performance. The @work Duo models incorporate the capability to
connect two monitors to one network computer base, keyboard and
mouse for applications that require additional screen space. The
@workStation models can be paired with monitors ranging from a 14"
monochrome monitor to a 21" color monitor.
. Focus on Multi-vendor Open System Desktop Solutions. The Company
concentrates all of its corporate resources on open system
technologies designed around industry standards. The Company
believes this focus, coupled with its vendor-independent solutions,
provides a competitive advantage over its broader based computer
systems competitors and independent competitors who traditionally
have emphasized proprietary technologies instead of those based on
open systems.
. Diverse Technology Expertise. The Company has significant
expertise in a wide range of technical disciplines, including
system, windowing and networking software, applications software
development, monitor design, graphics acceleration, multimedia
design and compression algorithms.
. Low-Cost Design and Manufacturing. The Company plans, implements
and manages the manufacturing of its products to take advantage of
industry-standard components that are widely available in the
personal computer industry. This reduces the Company's risks and
costs, and allows the Company more easily to increase production of
products quickly to meet customer demand. The Company uses a common
hardware architecture and integrated circuits which are common
throughout its product line and employs industry-standard ASICs to
reduce part counts and costs.
. Multimedia. A full range of multimedia options can be added to
certain HDS network computer models through additional hardware and
software. Through its HDS netVideo technology, the Company lets a
network computer user display full motion video from a camera, VCR
or TV tuner in a window. The HDS Conference application, which runs
on video-capable HDS network computers, enables users to send audio
and video signals over a local area network or the Internet,
enabling video teleconferencing. Video is converted by the HDS
network computer from analog to digital form so that it can be sent
over a network to other individual users, or to groups via an
industry-standard technology called IP Multicasting.
. Modularity and Use of Standard Peripherals. The HDS line of
network computers is designed to be compatible with a wide range of
standard off-the-shelf peripherals, ranging from keyboards and
monitors to local hard drives and multimedia options such as video
cameras, microphones and VCRs.
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Customers
The Company's customers span a wide range of industries, including
aerospace, automotive, education, financial services, government, healthcare,
manufacturing and telecommunications.
The following is a representative list of ongoing and significant
customers which have generated a substantial portion of HDS's sales:
Representative HDS Customers
Aerospace Corporation Loral Vought Systems
Argonne National Laboratory Martin Marietta
Arizona State University McDonnell Douglas Aircraft
Bell Atlantic NASA Ames Research Center
The Boeing Company New York City Health and Hospitals
Boston University North American Van Lines
Bose Corporation PRC
BP Exploration Penn State University
California Institute of Technology Pizza Hut
Cerner Purdue University
Dallas Semiconductor Rockwell International
Data General SAIC
Dow Jones Telerate Sandia National Laboratories
Drexel University Stanford University
E-Systems Southwestern Bell
Fairchild Space and Defense TASC
Flight Safety International The Toro Company
General Datacom TRW
Goddard Space Flight Center Unitrode Integrated Circuits
Harris United States Air Force
Hot Wired University of California
Hughes Aircraft Company U.S. Department of Commerce
International Business Machines U.S. Geological Survey
Intel Westinghouse Electric
Product Development
The Company believes that its ability to expand the market for its
network computer products will depend in large part upon its ability to
enhance its netOS operating system and its existing line of network computers
and to continue developing, introducing and delivering new products which
incorporate the latest improvements in multimedia, desktop integration and
open systems technology. Accordingly, the Company is committed to investing
significant resources in software and hardware development activities.
The Company's current research and development programs include:
. Development of new versions of its netOS operating system that will
run on a diverse
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range of microprocessors.
. Development of new software and hardware products targeted at
desktop multimedia applications.
. Development of lower cost versions of its hardware products.
The market for the Company's products is characterized by rapidly
changing technologies, evolving industry standards, frequent new product
introductions and short product life cycles. There can be no assurance that
any of the Company's development efforts will result in the timely
introduction of new products or that any such products will be commercially
successful. Delays in the introduction of new or enhanced products or the
failure of the products to gain commercial acceptance could adversely affect
the Company's future results.
Marketing and Sales
The principal objectives of the Company's marketing strategy are to
increase awareness of the benefits of the Company's network computer products
and netOS operating system, maintain the Company's position as a recognized
innovator in the network computing industry and differentiate the Company's
products from other network computers and personal computers. The Company's
marketing activities include participation in trade shows and conferences,
advertising and press relations with leading trade publications and the
publication of technical articles.
The Company distributes its products in North America through direct
sales to end user customers, through resellers and through systems
integration partners. The Company's products are currently sold by systems
integrators for several government procurements, including the U.S. Forest
Service's Project 615, in which the Company is a subcontractor to IBM. Sales
to IBM for this project, which accounted for 27% and 12% of revenues for the
years ended June 30, 1996 and 1995, respectively, are subject to continued
government funding, and there is no assurance that IBM will receive adequate
funding to allow it to continue to purchase the Company's products. During
the 1995 fiscal year, the Company was a principal subcontractor to The Boeing
Company under the RCAS (Reserve Component Automation System) project. As a
result of a reduction in government appropriations for the RCAS project
related to the Army's review of the project and its proposal to significantly
change the system's architecture, Boeing's purchase of the Company's products
since March 1995 have been insignificant, and the Company anticipates that
they will continue to be insignificant. Revenues under this contract
accounted for 25% and 35% of revenues for the years ended June 30, 1995 and
1994, respectively. Revenues to Intel Corporation, the Company's other
significant customer, accounted for 16% and 11% of revenues for the years
ended June 30, 1996 and 1995, respectively. Additionally, the timing of
sales to the Company's customers and the continued evolution of the market
for network computers will influence the Company's future operating results.
The Company has distributors for its products throughout the world,
including long-term relationships with distributors in Great Britain, France,
Scandinavia, Germany, Switzerland, Italy, Spain, Russia, Israel, Jordan,
Australia, Japan, Hong Kong, China and India. Foreign revenues, which
accounted for approximately 3%, 6% and 10% of net revenues, respectively, in
1996, 1995 and 1994,
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may be subject to government controls and other risks, including export
licenses, federal restrictions on the export of technology, changes in demand
resulting from currency exchange fluctuations, political instability, trade
restrictions and changes in tariffs. To date, the Company has experienced no
material difficulties due to these factors.
Service and Support
The Company believes that its ability to provide service and support is
and will continue to be an important element in the marketing of its
products. The Company maintains in-house repair facilities and also provides
telephone and electronic mail access to its technical support staff. The
Company's technical support specialists not only provide assistance in
diagnosing problems but work closely with customers to address system
integration issues and to assist in increasing the efficiency and
productivity of their systems. The Company provides system level hardware
support through its factory-based technical maintenance organization and
primarily through contracted field system engineers.
The Company typically warrants its products against defects in materials
and workmanship for one year after purchase by the end user, and offers an
extended warranty of up to an additional two years. To date, the Company has
not encountered any material product maintenance problems.
Competition
The desktop computer market is characterized by rapidly changing
technology and evolving industry standards. The Company experiences
significant competition from suppliers of workstations and personal
computers, as well as providers and prospective providers of network
computers.
Competitive network computer products are, or are expected to be,
offered by a number of established computer manufacturers, including
International Business Machines Corporation ("IBM"), Sun Microsystems, Inc.
("Sun") and Oracle Corporation. Each of these companies has substantially
greater name recognition, engineering, manufacturing and marketing
capabilities and greater financial resources than those of the Company. The
Company also competes with a number of other suppliers, including Boundless
Technologies, Inc. and Network Computing Devices, Inc. The Company believes
that the principal competitive factors among network computer suppliers
include breadth of product line, product price/performance, capabilities of
the operating system used in the product, software features, network
expertise, service and support, and market presence. The Company believes
that it competes favorably with respect to these factors. Workstation
manufacturers who also offer network computer products may have advantages
over independent network computer vendors, including the Company, based on
their ability to "bundle" their network computers, workstations and personal
computers in certain large system sales. The Company anticipates increased
competition from these system suppliers as the network computer market
evolves and also expects that other established domestic and foreign computer
equipment manufacturers may enter the network computer market.
The Company, as well as other manufacturers of network computers, also
face competition from established computer manufacturers whose personal
computer and workstation products offer alternatives to network computers for
most applications. In the high-performance, technical segment of the market,
network computers compete with workstation networks offered by such
manufacturers as Digital Equipment Corporation, Hewlett Packard Corporation,
IBM and Sun. Because network-based
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computing does not require application processing capability on every
desktop, network computers compete favorably on a price/performance basis
with workstation networks and offer cost advantages in initial system
installation, as well as subsequent system upgrading and administration.
However, the significant market presence and reputation of the larger
workstation manufacturers, and customer perceptions regarding their need for
desktop application processing capability, constitute obstacles to the
penetration of this market segment by network computer manufacturers.
Increased competition could result in price reductions, reduced profit
margins and loss of market share, which would adversely affect the Company's
operating results. There can be no assurance that the Company will be able to
continue to compete successfully against current and future competitors as
the network computer market evolves and competition increases.
At the low end of the commercial segment of the desktop computer market,
the Company competes with suppliers of lower cost ASCII and 3270 terminals.
These products do not offer the graphics and windowing capabilities offered
by the Company's network computers, but are still appealing to certain price
sensitive customers. The Company believes that, as lower priced network
products become available, network computers will become increasingly
competitive with ASCII and 3270 terminal systems.
In all segments of the Company's market, the Company competes with
personal computers made by companies such as Compaq Computer Corporation,
Dell Computer Corporation and IBM. The Company believes its network
computers compete favorably with personal computers in this environment,
primarily because of their better integration in a network environment,
reduced system administration costs, bundled software features and enhanced
ease of use.
Manufacturing and Suppliers
The Company's production activities are conducted at its King of
Prussia, Pennsylvania facility. These operations consist primarily of final
assembly, configuration, testing and quality control of material components,
sub-assemblies and systems. The Company utilizes an automated manufacturing
control system which integrates purchasing, inventory control and cost
accounting. The Company tests each HDS network computer in a network
environment. In addition, the Company maintains an approved vendor list and
control of engineering changes of parts and components. Incoming material is
inspected for conformance with the Company specifications and the Company
conducts regular on-site inspection at its vendors' facilities to maintain
quality control.
The components and sub-assemblies used in the Company's products are
either standard, commercially available components or are manufactured to the
Company's specifications by independent suppliers, including foreign
suppliers who are subject to risks associated with foreign operations such as
the imposition of unfavorable governmental controls or other trade
restrictions, changes in tariffs and political instability.
Although most of the video monitors used in the Company's products are
available from more than one supplier, monitors used in some of its products
are currently available from a single source. The Company has, from time to
time, experienced delays in the receipt of monitors from certain of these
suppliers. In addition, the Company is required to place orders for some
monitors several months in advance of its anticipated requirements, and its
ability to react to short-term increases or decreases in customer demands of
these models is, therefore, limited. A number of other components and parts
used
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in the Company's products, including microprocessors, also are currently
available only from single sources. Prolonged or repeated delays in the
receipt of these components could have a material adverse effect on the
Company's operations.
The Company has no long-term purchase agreements or other guaranteed
supply arrangements with suppliers of these single or limited source
components and purchases such components, as well as its other parts and
components, pursuant to its standard form of purchase order. The Company has
generally been able to obtain adequate supplies of parts and components in a
timely manner from existing sources under purchase orders and endeavors to
maintain inventory levels adequate to guard against interruptions in
supplies. The Company's inability to develop alternative supply sources in
the future, or to obtain sufficient components from existing suppliers as
required, could adversely affect the Company's operating results.
The Company's products also incorporate memory components, such as DRAMs
and VRAMs, that are available from multiple sources but have been subject to
substantial fluctuations in availability and price. To date, these
fluctuations have not had a material effect on the Company's operating
results and the Company has been able to obtain an adequate supply of such
components. There can be no assurance, however, that the Company will be
able to obtain adequate supplies of these components in the future or that
price fluctuations will not adversely affect the Company's operating results.
Proprietary Rights and Licenses
The Company believes that its success will depend primarily on the
innovative skills, technical competence and marketing abilities of its
personnel rather than upon the ownership of patents or other intellectual
property protection methods. In addition, there can be no assurance that any
patents issued to the Company will not be challenged, invalidated or
circumvented, or that any rights granted thereunder will provide adequate
protection to the Company.
Certain technology used in the Company's products is licensed from third
parties on a royalty-bearing basis. Generally, such licenses grant to the
Company non-exclusive, worldwide rights with respect to the subject
technology and terminate only upon a material breach by the Company. The
Company has licensed technology in the current year from Spyglass, Inc. and
from Sun Microsystems, Inc. The Company is also a member of the X
Consortium, an industry standards setting organization. Software developed
by the X Consortium is in the public domain and once it is released can be
used, reproduced, distributed and sold by the Company and others on a non-
exclusive, royalty-free basis. In addition to these licensing agreements,
the Company holds a license agreement with the Open Software Foundation
(OSF), and various other licenses which it does not consider to be material.
Although the Company has not received any claims that its products
infringe on the proprietary rights of third parties, there can be no
assurance that third parties will not assert infringement claims against the
Company in the future with respect to current or future products or that any
such assertion may not require the Company to enter into royalty arrangements
or result in costly litigation.
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Employees
As of June 30, 1996, the Company had 67 employees.
ITEM 2. PROPERTIES.
The Company's principal administrative, marketing, manufacturing and
research and development operations are located in King of Prussia,
Pennsylvania. The facility consists of approximately 22,000 square feet with
an option for an additional 8,000 square feet under a lease which expires in
the year 2001. The annual gross rent for the facility currently approximates
$81,500. The Company believes that its facilities are adequate for its
present requirements, and that suitable additional space will be available as
needed.
ITEM 3. LEGAL PROCEEDINGS.
There are no material legal proceedings pending against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders of the Company
during the fourth quarter of fiscal 1996.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS.
Until March 2, 1995, the Company's Units, Common Stock and Warrants were
each quoted on the OTC Bulletin Board under the symbols ISACU, ISAC and
ISACW, respectively. Commencing on March 3, 1995, the Common Stock and the
Warrants began trading on the NASDAQ Small Cap Market under the symbols HDSX
and HDSXW, respectively. Commencing on October 3, 1995, the Common Stock and
the Warrants began trading on the NASDAQ National Market. The Units
discontinued trading on March 2, 1995. The following table sets forth the
high and low closing bid quotations for the periods indicated.
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Units Common Stock Warrants
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High Low High Low High Low
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1996
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First Quarter... N/A N/A $5 1/2 $4 5/8 $1 3/8 $7/8
Second Quarter.. N/A N/A $6 5/8 $4 3/4 $2 $1 3/16
Third Quarter... N/A N/A $7 3/8 $5 1/8 $2 1/2 $1 11/16
Fourth Quarter.. N/A N/A $9 1/4 $5 1/4 $4 $1 5/8
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Units Common Stock Warrants
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High Low High Low High Low
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1995
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First Quarter... $7 $6 1/2 $4 7/8 $4 1/4 $1 1/4 $5/8
Second Quarter.. $7 $6 1/2 $4 7/8 $4 1/8 $1 1/4 $9/16
Third Quarter... $9 $6 1/2 $7 $4 7/8 $2 1/16 $1
Fourth Quarter.. N/A N/A $5 1/2 $3 5/8 $1 3/8 $11/16
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The above quotations represent prices between dealers and do not include
retail markups or markdowns or commissions. They may not necessarily
represent actual transactions.
There were approximately 64 holders of record of Common Stock as of
September 17, 1996. The Company has never declared or paid any cash
dividends on its capital stock and does not intend to pay any cash dividends
in the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected financial data with respect to
the Company for the periods indicated. The data below has been derived from
the Company's consolidated financial statements which have been audited by
Arthur Andersen LLP, independent public accountants, for the years ended June
30, 1996, 1995 and 1994 and by William E. Howe & Co., independent public
accountants, for the two years ended June 30, 1993. The data set forth below
should be read in conjunction with the Financial Statements of the Company
together with the related notes thereto included elsewhere herein and Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
--------------------------------------------------------------------------
Operations. Upon the consummation of the Merger, the Company changed its
----------
fiscal year for accounting and reporting purposes to June 30.
<TABLE>
<CAPTION>
Year Ended June 30
---------------------------------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS
DATA:
<S> <C> <C> <C> <C> <C>
Net revenues $20,819,444 $21,841,229 $19,495,642 $14,790,305 $8,882,174
=========== =========== =========== =========== ==========
Gross profit 5,115,850 4,990,123 3,596,141 2,865,098 2,183,121
Operating expenses 4,390,344 2,680,209 2,742,126 2,665,435 2,128,485
----------- ----------- ----------- ----------- ----------
Operating income 725,506 2,309,914 854,015 199,663 54,636
Interest income (expense), net 220,277 (23,239) (161,012) (163,514) (161,715)
Income (loss) before income taxes,
extraordinary item, and cumulative
effect of change in accounting for
income taxes 945,783 2,286,675 693,003 36,149 (107,079)
Income taxes 322,898 843,405 319,561 25,433 --
Extraordinary item (1) -- -- -- 23,517 2,620
Cumulative effect of change
in accounting for income taxes (2) -- -- 81,023 -- --
----------- ----------- ----------- ----------- ----------
Net income (loss) $ 622,885 $ 1,443,270 $ 454,465 $ 34,233 $ (104,459)
=========== =========== =========== =========== ==========
Earnings (loss) per share $.13 $.39 $.16 $.01 $(.04)
=========== =========== =========== =========== ==========
Weighted average number
of shares outstanding (3) 8,206,705 3,747,633 2,809,983 2,809,983 2,809,983
=========== =========== =========== =========== ==========
BALANCE SHEET DATA:
Current assets $11,165,185 $12,373,592 $ 6,474,654 $ 4,757,031 $3,266,237
Current liabilities 2,449,010 4,554,720 4,971,611 3,710,685 2,554,071
Working capital 8,716,175 7,818,872 1,503,043 1,046,346 712,166
Total assets 12,023,903 13,161,155 6,920,222 5,420,133 3,996,255
Long-term debt, excluding current
portion 3,733 9,293 388,119 602,827 754,540
Stockholders' equity 9,481,890 8,494,565 1,503,190 1,031,850 672,543
</TABLE>
- ------------------------
(1) Relates to the utilization of net operating loss and tax credit
carryforwards.
(2) Effective July 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," and
reported the cumulative effect of the change in accounting in fiscal
1994. Prior to fiscal 1994, the Company accounted for income taxes in
accordance with Accounting Principles Board Opinion No. 11.
(3) Weighted average number of shares reflects the number of equivalent
shares of Common Stock received by the shareholders of HDS in
connection with the Merger with the Company on March 2, 1995.
11
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Introduction
The Company provides network computers and related software that are
designed to integrate and deliver information to the desktop cost in network-
centric environments. The Company's @workStation network computers combine a
variety of windowed-display, graphical user interface ("GUI") and
communications industry standards to provide the user seamless and
transparent access to all information, including text, graphics, audio and
video data, on any type of network. The Company has licensed Sun
Microsystems, Inc.'s Java(TM) technology and Spyglass, Inc.'s Web browser
technologies that it has incorporated into its products to provide cost-
effective access to information and applications within the corporate
enterprise and on the Internet.
The Company's network computer product line was introduced in June 1996.
Prior to the introduction of the network computer, the Company manufactured
and marketed a family of desktop computing devices, including multimedia-
capable X Window terminals. The X terminal product line was designed around
industry standards and allowed users to access multiple forms of information
simultaneously, using the industry standard X protocol and industry standard
networking interfaces. The Company's new line of network computers utilize
many of the same open systems technologies which had been used in its X
terminal products. The Company believes that its new line of network
computers should have a broader market appeal than its X terminal products.
12
<PAGE>
The Company's current strategy is to become a leader in the emerging
market for network computers by focusing on expanding its operating system
software products and its network computer hardware. The Company also plans
to continue to seek to acquire strategic technologies, products or businesses
complementary to its current business. The Company sells its products in
North America directly to end users and through resellers, system integrators
and OEMs. International sales are generally made through distributors.
Results of Operations
The following table sets forth, for the periods indicated, certain items
from the Company's consolidated statements of operations as a percentage of
net revenues.
<TABLE>
<CAPTION>
Year Ended June 30
---------------------
1996 1995 1994
------ ------ -----
<S> <C> <C> <C>
Gross Profit 24.5% 22.8% 18.4%
Operating expenses:
Sales and Marketing 11.3 7.0 7.0
General and administrative 6.9 3.6 4.3
Research and development 2.9 2.2 2.8
Operating income 3.6 10.6 4.3
Interest income (expense), net 1.0 (.1) (.8)
Income before taxes
and changes in accounting
for income taxes 4.6 10.5 3.5
Income taxes 1.6 3.9 1.6
Cumulative effect of change in
accounting for income taxes -- -- .4
---- ---- ----
Net Income 3.0% 6.6% 2.3%
===== ===== =====
</TABLE>
Year Ended June 30, 1996 Compared to Year Ended June 30, 1995
For the year ended June 30, 1996, net revenues decreased by $1,021,785
or 4.6% to $20,819,444 from $21,841,229 for the prior year. The decrease in
revenue is attributable to a lack of growth in the Company's X terminal
business, as well as the timing of the introduction of the Company's new
network computer product line, which was too late in the fiscal year to
contribute significant revenue.
13
<PAGE>
Sales to the United States Government, through integration subcontracts
and through direct sales, have historically constituted a significant portion
of the Company's total net revenues. Sales under Government contracts are
subject to continued Government funding, as to which there is no assurance.
The Company is subject to significant variances in its periodic operating
results because of the fluctuations in the timing of the receipt of large
orders.
For the year ended June 30, 1996, net income was $622,885 as compared to
$1,443,270 for the prior year. The decrease in net income was due to
significant increases in the Company's investment in both sales and marketing
and research and development expenses, as well as decreased revenues during
the period. These investments, as well as increases in general and
administrative expenses, were partially offset by increased gross margins and
investment income and a lower effective income tax rate.
The Company's gross profit as a percentage of net revenues increased to
24.5% for the year ended June 30, 1996 from 22.8% for the prior fiscal year.
The increase in the Company's gross profit margins was primarily due to the
Company's ability to reduce the cost of acquiring components used in its
products, as well as to its mix of business, as its margins vary within the
Company's product line. The market in which the Company competes remains very
competitive, and although the Company intends to continue its efforts to
reduce the cost of its products, there can be no certainty that the Company
will not be required to reduce prices of its products without compensating
reductions in the cost to produce its products in order to increase its
market share or to meet competitors' price reductions.
Operating expenses for the year ended June 30, 1996 were $4,390,344
as compared to $2,680,209 in the prior year. Sales and marketing expenses
increased by $947,563 to $2,352,098 for the year ended June 30, 1996 as
compared to $1,404,535 for the prior year as a result of increased
expenditures for advertising and public relations as well as investments in
increasing the Company's sales and marketing staff, in the US, the United
Kingdom and Germany. Research and development expenses for the year ended
June 30, 1996 increased by $97,419 to $585,770 from $488,351 in the prior
year as the Company expanded its investment to develop, adapt or acquire
technologies complementary to its current business that will expand the
market for its current and future products. General and administrative
expenses increased to $1,452,476 for the year ended June 30, 1996 from
$787,323 in the prior year due to an increase in corporate staff, increased
expenditures relating to the compliance functions required of a public
company and the Company's purchase of directors' and officers' liability
insurance in the third quarter of the prior fiscal year.
Operating income decreased to $725,506 for the year ended June 30, 1996
from $2,309,914 in the previous fiscal year. The decrease in operating income
is the result of increased investments in the Company's sales and marketing
and research and development expenses as well as increased general and
administrative expenses, which were partially offset by higher gross profit
margins.
Net interest income increased due to the use of the proceeds from the
Merger to repay debt and provide interest income.
The effective income tax rates were approximately 34.1% in the year
ended June 30, 1996 as compared to 36.9% in the prior fiscal year due to the
implementation of tax planning.
Year Ended June 30, 1995 Compared to Year Ended June 30, 1994
Net revenues increased $2,345,587 or 12.0% to $21,841,229 for the year
ended June 30, 1995
14
<PAGE>
from $19,495,642 for the year ended June 30, 1994. The increase was due
primarily to increased shipments of the Company's View Station Series under
two large system integration procurement contracts. Revenues derived from one
of these contracts, the Reserve Component Automation System project ("RCAS")
in which the Company was a principal contractor to The Boeing Company,
accounted for approximately 25% of the Company's net revenues in fiscal 1995
and 35% of net revenues in fiscal 1994. Sales to Boeing under this contract
have been insignificant since March 1995 and the Company anticipates that
they will continue to be insignificant in the future as a result of a
previously announced reduction in government appropriations related to the
Army's review of the RCAS project and its proposal to significantly change
the system's architecture.
During the fourth quarter of fiscal 1995, the Company commenced volume
shipments to IBM Government Systems under its contract to supply X terminals
to the USDA Forest Service. Shipments under government contracts, such as
the subcontract with IBM, are subject to continued government funding, as to
which there is no assurance. Product sales to other customers of the Company
also increased during fiscal 1995 as compared to fiscal 1994 due to
introductions of enhanced versions of existing product lines.
The Company's gross profit as a percentage of net revenues increased to
22.8% for fiscal 1995 as compared to 18.4% for fiscal 1994, primarily as a
result of cost reduction measures undertaken by the Company. Cost reductions
were a result of negotiating with suppliers of components to achieve lower
costs for items such as video monitors and integrated circuits, employing
additional materials management staff to oversee the cost and timing of
component acquisitions, buying out a software license and achieving operating
efficiencies associated with higher production volumes. The market in which
the Company competes remains very competitive, and although the Company
intends to continue its efforts to reduce the cost of its products, there can
be no certainty that the Company will not be required to reduce prices of its
products without compensating reductions in the cost to produce products in
order to increase its market share or to meet competitors' price reductions.
Operating expenses decreased $61,917 or 2.3% to $2,680,209 for the 1995
fiscal year from $2,742,126 for the 1994 fiscal year as a result of the
Company's efforts to control operating expenses despite the increase in
revenue levels. Sales and marketing expenses increased 2.1% to $1,404,535 in
fiscal 1995 from $1,375,068 in fiscal 1994, but decreased to 6.4% of net
revenues in fiscal 1995 from 7.0% of net revenues in the prior year. General
and administrative expenses decreased to $787,323 in fiscal 1995 from
$830,445, and as a percentage of net revenues decreased to 3.6% in fiscal
1995 from 4.3% in fiscal 1994. Research and development expenses also
decreased during the 1995 fiscal year, to $488,351 from $536,613, and as a
percentage of revenues decreased to 2.2% from 2.8%.
Operating income increased $1,455,899 or 170.5% to $2,309,914 for the
year ended June 30, 1995 from $854,105 for the year ended June 30, 1994.
Operating income as a percentage of revenues was 10.6% for fiscal 1995 as
compared to 4.3% for fiscal 1994. This increase was a result of higher net
revenues, higher gross profit margins and decreased operating expenses.
Net interest expense declined for the year ended June 30, 1995 due to
the use of the proceeds from the Merger to repay long-term debt and provide
interest income.
The effective income tax rate for the year ended June 30, 1995 was 36.9%
as compared to 46.1% for the year ended June 30, 1994, due to the decrease in
non-deductible expenses compared to
15
<PAGE>
pre-tax income as well as a decrease in the Company's effective state tax
rate. Effective July 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," and reported the
cumulative effect of the change in the method of accounting for income taxes
in fiscal 1994.
Liquidity and Capital Resources
At June 30, 1996, the Company had net working capital of $8,716,175
composed primarily of cash and cash equivalents, accounts receivable and
inventory. The Company's principal sources of liquidity included
approximately $2,700,298 of cash and cash equivalents and a $3,000,000 bank
line of credit facility, all of which was available as of June 30, 1996.
The Company used $433,070 in cash in operating activities in the 1996
fiscal year compared to generating cash of approximately $907,074 during the
1995 fiscal year. The decrease in cash generated from operations during the
1996 fiscal year is primarily due to decreases in accounts payable, accrued
expenses and income taxes payable, which were partially offset by net income
and decreases in accounts receivable. Cash flow from operations can vary
significantly from quarter to quarter depending on the timing of payments
from, and shipments to, large customers.
Net cash of $1,530,291 was generated from investing activities in the
1996 fiscal year from the redemption of approximately $1,959,000 of short-
term investments, which was partially offset by purchases of equipment and
capitalized software. Net cash of $581,906 was used in financing activities
in the 1996 fiscal year due to the repayment of the Company's line of credit
borrowings.
The Company believes that there will be sufficient funds from current
cash, operations and available financing to fund operations and cash
expenditures for the next 12 months.
Inflation
The Company believes that inflation has not had a material effect on its
sales and net revenues during the past three years.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements of the Company are filed under this Item 8,
beginning on page F-2 of this Report.
16
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information with respect to directors required by this Item is
incorporated by reference to the Section entitled "Election of Directors" in
the Company's defintive Proxy Statement for its 1995 Annual Meeting of
Stockholders.
The following individuals are the current executive officers of the
Company:
Name Age Position
---- --- --------
Arthur R. Spector 55 Chairman of the Board, President and
Chief Executive Officer
Michael G.
Kantrowitz 36 Executive Vice President and Director
Steven B. Ahlbom 46 Vice President of Operations
Edward M. Parks 44 Vice President of Engineering
Scott Holland 35 Vice President of Finance and
Administration
Mr. Spector has been Chairman of the Board of the Company since its
inception. He served as President and Chief Executive Officer from inception
until March 2, 1995 and reassumed these roles in May 1996. Mr. Spector is
also Chairman of the Board of USDATA Corporation, a developer of software
tools for real-time data collection and control, and FormMaker Software, a
developer of document automation software He has been affiliated with
Safeguard Scientifics since January 1993
17
<PAGE>
and currently serves as its Director of Acquisitions. From July 1992 until
May 1995, he was Vice Chairman of Casino and Credit Services, Inc., a company
which operated nationwide debt collection and credit database businesses.
Since October 1991, Mr. Spector has been Chief Executive Officer and a
director of Perpetual Capital Corporation, a merchant banking organization.
Mr. Kantrowitz has been Executive Vice President of the Company since
March 2, 1995. Prior to that, he was an employee of HDS from 1983, holding
the positions of Executive Vice President from 1991 until March 1995 and Vice
President of Marketing and Sales from 1987 until 1991. Prior to joining HDS,
Mr. Kantrowitz held positions with Raytheon Company and Adage Corporation.
Mr. Ahlbom has been Vice President of Operations of the Company since
March 2, 1995. Prior to that, he held the positions of Vice President of
Operations and Manager of Operations of HDS from 1988. Prior to joining HDS,
Mr. Ahlbom was World-Wide Quality Assurance Manager for Commodore
International from 1987 until 1988, and served as Quality Assurance Manager
of Burroughs Corporation.
Mr. Parks has been Vice President of Engineering of the Company since
March 2, 1995. Prior to that, he held the position of Vice President of
Engineering of HDS from 1987. Prior to joining HDS, Mr. Parks was Corporate
Director for Product and Market Development and Director of Engineering for
Commodore Business Machines from 1984 until 1987, and was employed by Eastman
Kodak in engineering management positions from 1974 to 1984.
Mr. Holland has served as Vice President-Finance and Administration
since May 30, 1995. Prior to joining the Company, he served as the New
Jersey Area Manager for Lawyers Title Insurance Corporation from 1993 until
1995. From 1988 until 1993, Mr. Holland held financial and operations
management positions with IVT Group, Inc. and Fidelity Bond and Mortgage
Company. Prior to that, Mr. Holland was employed by Laventhol & Horwath from
1982 through 1988 in various positions, with the latest position being
Manager, Accounting and Auditing.
All officers of the Company are appointed annually by the Company's
Board and serve at its discretion.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to
the section entitled "Executive Compensation" in the Company's definitive
proxy statement for its 1996 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference to
the section entitled "Beneficial Ownership of Common Stock" in the Company's
definitive proxy statement for its 1996 Annual Meeting of Stockholders.
18
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference to
the section entitled "Certain Transactions" in the Company's definitive proxy
statement for its 1996 Annual Meeting of Stockholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
Financial Statements
--------------------
See Index to Financial Statements at page F-1.
Financial Statement Schedules
-----------------------------
All schedules have been omitted because they are not applicable, or not
required, or the information is shown in the financial statements or notes
thereto.
Exhibits
--------
The following is a list of exhibits filed as part of this annual report
on Form 10-K. Where so indicated by footnote, exhibits which were previously
filed are incorporated by reference.
Exhibit Sequential Sequential
Numbers Description Page Number
------- ----------- -----------
2.1 Agreement of Merger dated as of December 2, 1994
among the Company, ISAC Acquisition Co. and HDS
(Exhibit 2.1)(3)
3.1 Certificate of Incorporation (Exhibit 3.1(1)
3.2 Amendment to Certificate of Incorporation (Exhibit 3.2)(2)
3.3 By-laws (Exhibit 3.2)(1)
3.4 Amendment to By-laws, dated July 20, 1995 (Exhibit 3.4)(6)
4.2 Form of Warrant Certificate (Exhibit 4.2)(2)
19
<PAGE>
4.3 Unit Purchase Option Granted to GKN Securities Corp.
(Exhibit 4.4)(2)
4.4 Warrant Agreement between Continental Stock
Transfer & Trust Company and Registrant (Exhibit 4.4)(3)
4.5 Warrant Agreement, dated March 2, 1995, between Continental
Stock Transfer & Trust Company and the Registrant
(Exhibit 4.5)(2)
4.6 Loan Agreement between Meridian Bank and the Registrant,
dated as of December 20, 1990, Security Agreement between
Meridian Bank and the Registrant, and Notes, as amended.
(Exhibit 4.6)(2)
10.3 Letter Agreement between GKN Securities Corp. and each
of the Initial Stockholders (Exhibit 10.4(1)
10.4 Letter Agreement between Safeguard Scientifics, Inc.
and Registrant (Exhibit 10.5)(3)
10.8 Lease between the Registrant and GBF Partners, as
amended (Exhibit 10.9)(4)
10.9+ 1995 Stock Option Plan (Exhibit 10.9)(2)
10.10+ Employment Agreement, dated March 2, 1995, between
the Registrant and Mark A. Gelberg (Exhibit 99.1)(5)
10.11+ Employment Agreement, dated March 2, 1995, between
the Registrant and Michael G. Kantrowitz
(Exhibit 99.2)(5)
11.* Statement re: computation of per share earnings
21.* Subsidiaries
23.* Consent of Arthur Andersen LLP
27.* Financial Data Schedule
- -------------------------------
* Filed herewith.
+ Management contract or arrangement.
(1) Filed as an Exhibit to the Company's Registration Statement on Form S-1
(File No. 33-56834) filed with the SEC on January 7, 1993.
(2) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1994.
(3) Filed as an Exhibit to Amendment No. 1 to the Company's Registration
Statement on Form S-1 (No. 33-56834) filed with the SEC on February
11, 1993.
(4) Filed as an Exhibit to the Company's Registration Statement on Form S-4
(File No. 33-87036) filed with the SEC on December 6, 1994.
(5) Filed as an Exhibit to the Company's Current Report on Form 8-K dated
March 2, 1995.
(6) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
year ended June 30, 1995.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
HDS NETWORK SYSTEMS, INC.
Date: 9/25/96 By: /s/ Arthur R. Spector
------------------- --------------------------------------------
Arthur R. Spector
Chairman, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated.
Each person in so signing also makes, constitutes and appoints
Michael G. Kantrowitz, Executive Vice President and Scott Holland, Vice
President of Finance and Administration, and each of them severally, his or
her true and lawful attorney-in-fact, in his or her name, place and stead to
execute and cause to be filed with the Securities and Exchange Commission any
or all amendments to this report.
Signature Title Date
--------- ----- ----
/s/ Arthur R. Spector Chairman, President and 9/25 , 1996
------------------------- Chief Executive Officer (Principal --------
Arthur R. Spector Executive Officer)
/s/ Michael G. Kantrowitz Executive Vice President and 9/25 , 1996
------------------------- Director --------
Michael G. Kantrowitz
/s/ Scott Holland Vice President-Finance and 9/25 , 1996
------------------------- Administration (Principal Financial--------
Scott Holland Officer and Principal Accounting
Officer)
/s/ Howard L. Morgan Director 9/25 , 1996
------------------------- --------
Howard L. Morgan
/s/ John M. Ryan Director 9/25 , 1996
------------------------- --------
John M. Ryan
/s/ Samuel A. Plum Director 9/25 , 1996
------------------------- --------
Samuel A. Plum
/s/ Carl G. Sempier Director 9/25 , 1996
------------------------- --------
Carl G. Sempier
/s/ James W. Dixon Director 9/25 , 1996
------------------------- --------
James W. Dixon
<PAGE>
INDEX TO FINANCIAL STATEMENTS
-----------------------------
<TABLE>
<CAPTION>
Page
----
HDS Network Systems, Inc.
Report of Independent Public Accountants F-2
<S> <C>
Consolidated Financial Statements--
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of F-5
Stockholders' Equity
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial F-7
Statements
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To HDS Network Systems, Inc.:
We have audited the accompanying consolidated balance sheets of HDS Network
Systems, Inc. (a Delaware corporation) and subsidiaries as of June 30, 1996 and
1995, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended June 30,
1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of HDS Network Systems, Inc. and
subsidiaries as of June 30, 1996 and 1995, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
1996 in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Philadelphia, Pa.,
August 21, 1996
F-2
<PAGE>
HDS NETWORK SYSTEMS, INC.
-------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
<TABLE>
<CAPTION>
June 30
---------------------------
ASSETS 1996 1995
- ---------------------------------------- ------------- -------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,700,298 $ 2,184,983
Short term investments - 1,959,324
Accounts receivable, net
of allowance for doubtful 4,914,007 5,764,676
accounts of $36,762 and $66,762
Inventories 2,354,254 2,216,015
Prepaid expenses and other 761,156 166,677
Deferred income taxes 435,470 81,917
----------- -----------
Total current assets 11,165,185 12,373,592
PROPERTY AND EQUIPMENT, net 668,420 550,276
CAPITALIZED SOFTWARE, net 190,298 187,287
PREPAID ROYALTY, net - 50,000
----------- -----------
$12,023,903 $13,161,155
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Line of credit $ - $ 589,000
Current portion of long-term debt 4,232 3,915
Accounts payable 1,927,897 2,797,652
Accrued expenses 316,937 400,574
Deferred revenue 199,944 137,204
Income taxes payable - 626,375
---------- -----------
Total current liabilities 2,449,010 4,554,720
----------- -----------
LONG-TERM DEBT 3,733 9,293
----------- -----------
DEFERRED INCOME TAXES 89,270 102,577
----------- -----------
COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, -- --
1,000,000 shares authorized and
none issued and outstanding
Common stock, $.001 par value,
50,000,000 shares authorized, 5,620 5,610
5,619,595 and 5,609,983 shares
issued and outstanding
Additional paid-in capital 8,268,123 7,955,796
Retained earnings 1,329,722 706,837
Deferred compensation (121,575) (173,678)
----------- -----------
Total stockholders' equity 9,481,890 8,494,565
----------- -----------
$12,023,903 $13,161,155
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
HDS NETWORK SYSTEMS, INC.
-------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
<TABLE>
<CAPTION>
Year Ended June 30
-----------------------------------------------
1996 1995 1994
-------------- --------------- ---------------
<S> <C> <C> <C>
NET REVENUES $20,819,444 $21,841,229 $19,495,642
COST OF REVENUES 15,703,594 16,851,106 15,899,501
----------- ----------- -----------
Gross profit 5,115,850 4,990,123 3,596,141
----------- ----------- -----------
OPERATING EXPENSES:
Sales and marketing 2,352,098 1,404,535 1,375,068
General and administrative 1,452,476 787,323 830,445
Research and development 585,770 488,351 536,613
----------- ----------- -----------
Total operating expenses 4,390,344 2,680,209 2,742,126
----------- ----------- -----------
Operating income 725,506 2,309,914 854,015
INTEREST INCOME (EXPENSE), net 220,277 (23,239) (161,012)
----------- ----------- -----------
Income before income taxes
and cumulative effect of
change in accounting
for income taxes 945,783 2,286,675 693,003
INCOME TAXES 322,898 843,405 319,561
----------- ----------- -----------
Income before cumulative
effect of change in
accounting for income
taxes 622,885 1,443,270 373,442
CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING FOR INCOME -- -- 81,023
TAXES
----------- ----------- -----------
NET INCOME $ 622,885 $ 1,443,270 $ 454,465
=========== =========== ===========
EARNINGS PER SHARE $.13 $.39 $.16
=========== =========== ===========
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 8,206,705 3,747,633 2,809,983
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
HDS NETWORK SYSTEMS, INC.
-------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
<TABLE>
<CAPTION>
Common Stock Common Additional
--------------------- Stock Paid-in Retained Treasury Deferred
Shares Amount Warrants Capital Earnings Stock Compensation Total
--------- --------- ----------- ---------- ---------- ---------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT JUNE 30, 1993 2,319,175 $ 2,319 $ 78,750 $ 693,059 $ 357,722 $(100,000) -- $ 1,031,850
Exercise of Common stock
warrants 160,023 160 (59,063) 75,778 -- -- -- 16,875
Net income -- -- -- -- 454,465 -- -- 454,465
--------- --------- ----------- ---------- ---------- --------- ------------ ------------
BALANCE AT JUNE 30, 1994 2,479,198 2,479 19,687 768,837 812,187 (100,000) -- 1,503,190
Exercise of stock options 309,378 310 -- 228,534 -- -- -- 228,844
Tax benefit on options -- -- -- 163,556 -- -- -- 163,556
exercised
Exercise of Common stock 53,341 53 (19,687) 25,259 -- -- -- 5,625
warrants
Retirement of treasury (31,934) (32) -- (99,968) -- 100,000 -- --
stock
Dividend -- -- -- (3,951,380) (1,548,620) -- -- (5,500,000)
Reverse merger with
Information Systems
Acquisition Corporation
(Note 1) 2,800,000 2,800 -- 10,629,912 -- -- -- 10,632,712
Deferred compensation
(Note 8) -- -- -- 191,046 -- -- (191,046) --
Amortization of deferred
compensation -- -- -- -- -- -- 17,368 17,368
Net income -- -- -- -- 1,443,270 -- -- 1,443,270
--------- --------- ----------- ---------- ---------- --------- ------------ ------------
BALANCE AT JUNE 30, 1995 5,609,983 5,610 -- 7,955,796 706,837 -- (173,678) 8,494,565
Tax benefit of acquired
net operating loss
carryforward -- -- -- 300,000 -- -- -- 300,000
Exercise of stock options 9,612 10 -- 12,327 -- -- -- 12,337
Amortization of deferred
compensation -- -- -- -- -- -- 52,103 52,103
Net income -- -- -- -- 622,885 -- -- 622,885
--------- --------- ----------- ---------- ---------- --------- ------------ ------------
BALANCE AT JUNE 30, 1996 5,619,595 $ 5,620 $ -- $8,268,123 $1,329,722 $ -- $ (121,575) $ 9,481,890
========= ========= =========== ========== ========== ========= ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
HDS NETWORK SYSTEMS, INC.
-------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
<TABLE>
<CAPTION>
For the Year Ended June 30
---------------------------------------
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 622,885 $ 1,443,270 $ 454,465
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities-
Depreciation and amortization 357,878 356,347 391,413
Amortization of deferred compensation 52,103 17,368 --
Amortization of debt discount -- -- 28,125
Deferred income taxes (66,860) 82,101 (18,892)
Cumulative effect in change in accounting
for income taxes -- -- (81,023)
Changes in operating assets and liabilities-
(Increase) decrease in:
Accounts receivable 850,669 (2,173,044) (1,087,031)
Inventories (138,239) 418,802 (629,721)
Prepaid expenses and other (594,479) (67,247) 10,674
Increase (decrease) in:
Accounts payable (869,755) 474,218 412,336
Accrued expenses (83,637) 3,623 125,674
Deferred revenue 62,740 21,078 (8,727)
Income taxes payable (626,375) 330,558 270,525
---------- ----------- -----------
Net cash provided by (used in)
operating activities (433,070) 907,074 (132,182)
---------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (291,227) (421,864) (30,565)
Prepaid royalty -- (150,000) --
Purchase/redemption of short-term 1,959,324 (1,959,324) --
investments
Capitalized software (137,806) (126,478) (126,864)
---------- ----------- -----------
Net cash provided by
(used in) investing activities 1,530,291 (2,657,666) (157,429)
---------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (repayment of) line of credit (589,000) (991,000) 360,000
Principal payments on long-term debt (5,243) (634,194) (79,838)
Exercise of stock options 12,337 228,844 --
Tax benefits on options exercised -- 163,556 --
Exercise of warrants -- 5,625 --
Payment of dividend -- (5,500,000) --
Proceeds from reverse merger (Note 1) -- 10,632,712 16,875
---------- ----------- -----------
Net cash provided by (used in)
financing activities (581,906) 3,905,543 297,037
---------- ----------- -----------
INCREASE IN CASH AND CASH EQUIVALENTS 515,315 2,154,951 7,426
CASH AND CASH EQUIVALENTS, BEGINNING
OF YEAR 2,184,983 30,032 22,606
---------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $2,700,298 $ 2,184,983 $ 30,032
========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF NONCASH
OPERATING ACTIVITIES:
Cash paid for income taxes $1,026,500 $ 267,190 $ 50,433
Cash paid for interest 10,069 124,706 129,227
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
HDS NETWORK SYSTEMS, INC.
-------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. COMPANY BACKGROUND:
-------------------
HDS Network Systems, Inc. (the Company) is a leading international supplier of
network computers which are cost-effective solutions for the integration and
delivery of information and applications to the desktop. The Company's network
computers are based on an open architecture, incorporating industry standards to
enable seamless access to multiple forms of information, including text,
graphics, audio and video data, on any type of network.
On March 2, 1995, Human Designed Systems, Inc. (HDS) merged with and into ISAC
Acquisition Co., a wholly owned subsidiary of Information Systems Acquisition
Corporation (ISAC). ISAC issued 2,810,000 shares of Common stock, cash of
$5,500,000 and warrants to purchase 618,200 shares of ISAC Common stock at $5.50
per share to the shareholders of HDS. ISAC then changed its name to HDS Network
Systems, Inc.
The merger resulted in HDS's stockholders having majority ownership of the
merged entity. The merger was treated as an issuance of shares by HDS for the
net assets of ISAC, which is primarily cash. The consolidated financial
statements as of and for the year ended June 30, 1995 contain the assets and
liabilities of both companies at their book values, and the historical earnings
of HDS are presented as the historical earnings of the merged entity. The
historical stockholders equity of HDS prior to the merger has been retroactively
restated for the equivalent number of shares received in the merger after giving
effect to the difference in par value of ISAC's and HDS's stock with an offset
to paid-in capital. Pro forma information is not presented since the
combination is not considered a business combination for financial reporting
purposes.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
-------------------------------------------
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany profits, accounts
and transactions have been eliminated in consolidation.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
F-7
<PAGE>
Cash Equivalents
- ----------------
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents for the purpose of
determining cash flows. Cash equivalents at June 30, 1996 consist of money
market funds of approximately $700,000 and a $2,000,000 one-month certificate of
deposit.
Short-term Investments
- ----------------------
Investments are recorded in accordance Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." Management determines the appropriate classification of debt and
equity securities at the time of purchase and reevaluates such designation as of
each balance sheet date. The Company's investment at June 30, 1995, consists of
a $2,000,000 face value, six-month United States Treasury Bill and is considered
to be "held to maturity," as defined in SFAS No. 115. As such, it is recorded
in the accompanying balance sheet at amortized cost, which approximates the fair
market value of the security.
Inventories
- -----------
Inventories are stated at the lower of cost or market. Cost is determined by
the first-in, first-out method.
Property and Equipment
- ----------------------
Property and equipment are stated at cost. Additions and improvements that
significantly extend the useful life of an asset are capitalized. Expenditures
for repairs and maintenance are charged to operations as incurred. Depreciation
and amortization are provided using the straight-line and accelerated methods
over the estimated useful lives of the assets as follows:
Computer equipment 3-5 years
Office furniture and equipment 5-7 years
Leasehold improvements Lease term
Other 3-5 years
Prepaid Royalty
- ---------------
In August 1994, the Company modified an existing royalty agreement and paid
$150,000 on November 30, 1994 for the right to continue to use certain software
without paying a per unit royalty charge. The cost of modifying the royalty
agreement was capitalized and was amortized over eighteen months.
Revenue Recognition
- -------------------
Product revenue is recognized at the time of title transfer, which ordinarily
occurs at the time of shipment. From time to time, customers request delayed
shipment, usually because of customer scheduling for systems integration. If
the company's substantial performance obligations otherwise have been fulfilled,
revenue on such delayed shipment transactions generally is recognized. Service
contract revenue is recognized ratably over the contract
F-8
<PAGE>
period. Product warranty costs and an allowance for sales returns are accrued at
the time revenues are recognized.
Research and Development
- ------------------------
Costs incurred in the development of new software products and enhancements to
existing software products are charged to expense as incurred until the
technological feasibility of the product has been established. After
technological feasibility has been established, any additional costs are
capitalized in accordance with SFAS No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed". Capitalized
software costs are amortized to cost of revenues over the expected life of the
product, not to exceed three years. The Company capitalized $137,806, $126,478
and $126,864 of software development cost and amortized $134,795, $118,292 and
$108,323 in fiscal 1996, 1995 and 1994, respectively. Accumulated amortization
was $605,303 and $470,508 at June 30, 1996 and 1995, respectively. The Company
continually evaluates whether events and circumstances have occurred that
indicate that unamortized product development costs may not be recoverable or
that the amortization period should be revised.
Earnings Per Share
- ------------------
The Company utilized the modified treasury stock method for the year ended June
30, 1996 to compute earnings per share since common share equivalents at the end
of the year exceeded 20 percent of the number of common shares outstanding.
Earnings per common and common equivalent share (primary earnings per share) is
computed using the weighted average number of common shares and common share
equivalents (stock options and warrants, using the treasury stock method)
outstanding. If the inclusion of common stock equivalents has an anti-dilutive
effect in the aggregate, it is excluded from the earnings per share calculation.
Fully diluted earnings per share is not materially different from the primary
earnings per share indicated.
All share and per share amounts have been adjusted retroactively to give effect
to the equivalent number of shares received by the HDS stockholders in the
merger discussed in Note 1.
Income Taxes
- ------------
The Company adopted SFAS No. 109, "Accounting for Income Taxes," effective July
1, 1993, and has reported the cumulative effect of the change in the method of
accounting for income taxes in fiscal 1994.
Under the asset-and-liability method of SFAS No. 109, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.
F-9
<PAGE>
New Accounting Pronouncements
- -----------------------------
The Financial Accounting Standards Board has issued SFAS No. 123, "Accounting
for Stock-Based Compensation." The Company is required to adopt this standard
for the year ending June 30, 1997. The Company has elected to adopt the
disclosure requirement of this pronouncement only. The adoption of this
pronouncement, therefore, will have no impact on the Company's financial
position or results of operations.
3. MAJOR CUSTOMERS AND FOREIGN REVENUES:
-------------------------------------
Net revenues from two customers represented 27% and 16% of total net revenues in
fiscal 1996, while net revenues from three customers represented 25%, 12% and
11% of total net revenues in fiscal 1995 and net revenues from one customer
represented 35% of total net revenues in fiscal 1994. Revenues from one of the
significant customers in fiscal 1996, two of the significant customers in fiscal
1995 and the significant customer in 1994 were under subcontracts for systems
integration contracts for major US government procurements. The procurement
projects are subject to funding by the US government and there are no assurances
that such funding will continue. At June 30, 1996 and 1995, the Company had
receivables from these customers of approximately $1,923,000 and $3,374,000,
respectively.
The Company's products are used in a broad range of industries for a variety of
applications. Sales are made to both domestic and international customers. Net
foreign revenues in fiscal 1996, 1995 and 1994 were approximately 3%, 6% and
10%, respectively, and were transacted in US dollars.
4. CONSOLIDATED BALANCE SHEET COMPONENTS:
--------------------------------------
<TABLE>
<CAPTION>
Inventories consisted of the following:
June 30
-----------------------
1996 1995
----------- -----------
<S> <C> <C>
Purchased components and subassemblies $ 942,210 $1,014,982
Work-in-process 173,792 197,859
Finished goods 1,238,252 1,003,174
---------- ----------
$2,354,254 $2,216,015
========== ==========
</TABLE>
F-10
<PAGE>
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
June 30
-----------------------
1996 1995
----------- -----------
<S> <C> <C>
Computer equipment $ 695,200 $ 506,079
Office furniture and equipment 216,462 177,001
Leasehold improvements 344,039 319,067
Other 95,156 57,483
---------- ----------
1,350,857 1,059,630
Less- Accumulated depreciation and (682,437) (509,354)
amortization ---------- ----------
$ 668,420 $ 550,276
========== ==========
</TABLE>
5. LINE OF CREDIT:
---------------
The Company has a $3,000,000 revolving line of credit with a bank which expires
on December 31, 1996, subject to annual renewal. Borrowings under the line bear
interest at the bank's prime rate (8.25% at June 30, 1996). There were no
outstanding borrowings at June 30, 1996. Under the line, the Company is required
to maintain specified ratios of working capital and debt to net worth, as
defined. The maximum amount borrowed under the line of credit was $1,206,000 in
fiscal 1996, $2,046,000 in fiscal 1995 and $2,000,000 in fiscal 1994. The
average amounts outstanding were $247,917, $1,085,000 and $1,096,083 in fiscal
1996, 1995 and 1994, respectively, and the weighted average interest rate during
such years was 8.69%, 9% and 7.12%, respectively.
6. LONG-TERM DEBT:
---------------
The Company has a term loan payable with an outstanding balance of $7,965 and
$13,208 at June 30, 1996 and 1995, respectively, with a current portion of
$4,232 and $3,915, respectively. The loan is payable in monthly installments of
approximately $400, including interest at 7.8%, with final payment due in July
1998.
7. INCOME TAXES:
-------------
<TABLE>
<CAPTION>
The components of income taxes are as follows:
For the Year Ended June 30
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Current-
Federal $377,528 $606,313 $246,533
State 12,230 154,991 91,920
-------- -------- --------
389,758 761,304 338,453
-------- -------- --------
Deferred-
Federal (57,551) 71,014 (13,552)
State ( 9,309) 11,087 (5,340)
-------- -------- --------
(66,860) 82,101 (18,892)
-------- -------- --------
$322,898 $843,405 $319,561
======== ======== ========
</TABLE>
F-11
<PAGE>
The federal statutory income tax rate is reconciled to the effective tax rate as
follows:
<TABLE>
<CAPTION>
For the Year Ended June 30
--------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Federal statutory rate 34.0% 34.0% 34.0%
State income taxes, net 0.8 5.5 7.8
Expenses not deductible
for tax 0.4 -- 2.4
Other (1.1) (2.6) 1.9
------- ------- -------
34.1% 36.9% 46.1%
------- ------- -------
</TABLE>
Income tax expense differs from the amount currently payable as certain
transactions are reported in different periods for financial reporting and tax
purposes. The principal differences relate to depreciation and amortization,
the capitalization of software development costs, service contract revenue and
accrued expenses.
The tax effect of temporary differences that gave rise to the deferred tax
assets and liabilities are as follows:
<TABLE>
<CAPTION>
June 30
---------------------
1996 1995
---------- ----------
<S> <C> <C>
Net deferred tax asset-
Accruals, allowances and reserves $ 109,487 $ 106,493
Operating loss carryforward 300,200 --
Deferred revenue 78,978 54,196
Capitalized inventory costs (53,195) (78,772)
---------- ----------
$ 435,470 $ 81,917
========== ==========
Net deferred tax liability-
Capitalized software costs $ 75,164 $ 73,978
Differences in book/tax depreciation 14,106 28,599
---------- ----------
$ 89,270 $ 102,577
========== ==========
</TABLE>
The Company has recorded no valuation allowances against deferred tax assets at
June 30, 1996 and 1995.
The Company recognized a $300,000 income tax benefit from a net operating loss
carryforward of ISAC (see Note 1) and recorded this benefit as a deferred tax
asset and an increase in additional paid-in capital.
8. STOCK OPTIONS AND WARRANTS:
---------------------------
The Company has an incentive stock option plan (the "Plan") for employees and
directors. The Company is authorized to issue options for the purchase of up to
1,000,000 shares of Common stock. Under the terms of the Plan, the exercise
price of options granted cannot be less than fair market value on the date of
grant. Employee options generally vest and become exercisable ratably over four
years. Director options vest and become exercisable ratably six months and one
year from the date of grant. All options expire five years from the grant date.
As of June 30, 1996, the Company had options outstanding under the Plan
F-12
<PAGE>
for the purchase of 665,188 shares of Common stock at prices ranging from $5.125
to $6.38 per share. Options to purchase 370,563 shares of Common stock were
vested at June 30, 1996.
In November 1994, a stock option to purchase 20,000 shares of Common stock of
HDS at $2.50 per share was granted, which has been exchanged in connection with
the merger into an option to purchase 28,448 shares of Common stock of the
Company at $1.76 per share. Deferred compensation of $191,046 was recorded for
the difference between the exercise price and merger consideration, and is being
amortized over the option vesting period. As of June 30, 1996, the options
outstanding under this grant were for 21,336 shares, none of which were vested.
HDS issued other stock options and warrants in earlier years and all such
outstanding options and warrants were exercised prior to the merger (see Note
1).
After giving effect to the merger of ISAC and HDS discussed in Note 1, there are
5,718,200 warrants outstanding to purchase Common stock at $5.50 per share. The
warrants are exercisable over seven years and expire in March 2000 through March
2002. The warrants will be redeemable at a price of $.01 per warrant upon 30
days notice at any time, only in the event that the last price of the Common
stock is at least $10 per share for 20 consecutive trading days ending on the
third day prior to the one on which notice of redemption is given.
9. COMMITMENTS AND CONTINGENCIES:
------------------------------
The Company leases its principal facility and an automobile under noncancelable
operating leases. The facility lease expires in 2001 and the auto lease expires
in fiscal 2000. Rent expense under these leases was $72,929, 142,039 and
$119,737 in fiscal 1996, 1995 and 1994, respectively. Minimum required lease
payments are $101,487 in 1997, $112,324 in 1998, $112,324 in 1999, $100,527 in
2000 and $15,350 in 2001.
The Company sponsors a profit sharing/401(k) plan (the "Plan") for all of its
employees who meet certain age and years of employment requirements.
Participants may make voluntary contributions to the Plan and the Company makes
a matching contribution of 50% of the first $1,000 of such contributions. The
Company's contributions were $20,139, $18,901 and $23,182 in fiscal 1996, 1995
and 1994, respectively.
Upon consummation of the merger transaction discussed in Note 1, an employment
agreement with an officer was executed. The agreement is for a three-year term
and provides for base compensation of $125,000 per year.
The Company has entered into various licensing agreements which required upfront
cash payments of $400,000 and royalties based on unit sales.
The Company is from time to time involved in certain legal actions arising in
the ordinary course of business. In the Company's opinion, the outcome of any
such actions will not have a material adverse effect on the Company's financial
position or results of operations.
F-13
<PAGE>
EXHIBIT 11
HDS NETWORK SYSTEMS, INC.
EARNINGS PER SHARE CALCULATION
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JUNE 30, 1996
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Earnings per common and common
equivalent share:
Net income $ 622,885 $ 1,443,270 $ 454,465
========== =========== ==========
Weighted average number of shares
issued and outstanding 5,612,386 3,747,633 2,809,983
Dilutive effect (excess number of shares
issuable over number of shares assumed
to be repurchased with the proceeds,
using the average market price during
the period) of outstanding options
and warrants 2,594,319 --- ---
---------- ----------- ----------
Adjusted weighted average number of
shares outstanding 8,206,705 3,747,633 2,809,983
========== =========== ==========
Earnings per common and common
equivalent share $.13 $.39 $.16
==== ==== ====
</TABLE>
<PAGE>
EXHIBIT 21
<TABLE>
<CAPTION>
Subsidiaries
------------
Name State of Incorporation
- ---------------------- ----------------------
<S> <C>
HDS Network Systems Investments, Inc. Delaware
Human Designed Systems Licensing, Inc. Delaware
Information Technology Consulting, Inc. Delaware
</TABLE>
<PAGE>
Exhibit 23
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in the Company's 1996 Form 10-K, into the Company's previously
filed Registration Statement File No. 33-93942 and No. 33-87036.
/s/ Arthur Andersen LLP
Philadelphia, Pa.,
September 20, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM JUNE
30, 1996 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> JUN-30-1996 JUN-30-1995
<PERIOD-START> JUL-01-1995 JUL-01-1994
<PERIOD-END> JUN-30-1996 JUN-30-1995
<CASH> 2,700,298 2,184,983
<SECURITIES> 0 1,959,324
<RECEIVABLES> 4,950,769 5,831,438
<ALLOWANCES> 36,762 66,762
<INVENTORY> 2,354,254 2,216,015
<CURRENT-ASSETS> 11,165,185 12,373,592
<PP&E> 1,350,857 1,059,630
<DEPRECIATION> 682,437 509,354
<TOTAL-ASSETS> 12,023,903 13,161,155
<CURRENT-LIABILITIES> 2,449,010 4,554,720
<BONDS> 0 0
0 0
0 0
<COMMON> 5,620 5,610
<OTHER-SE> 9,476,270 8,488,955
<TOTAL-LIABILITY-AND-EQUITY> 12,023,903 13,161,155
<SALES> 20,819,444 21,841,229
<TOTAL-REVENUES> 20,819,444 21,841,229
<CGS> 15,703,594 16,851,106
<TOTAL-COSTS> 4,390,344 2,680,209
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 21,889 124,706
<INCOME-PRETAX> 945,783 2,286,675
<INCOME-TAX> 322,898 843,405
<INCOME-CONTINUING> 622,885 1,443,270
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 622,885 1,443,270
<EPS-PRIMARY> 0.13 0.39
<EPS-DILUTED> 0.13 0.39
</TABLE>
