<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________________
FORM 10-Q
_______________________
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- - -----
EXCHANGE ACT OF 1934
For the Quarter ended March 31, 1996
______ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to ________.
Commission File Number: 0-21240
________________________________
HDS NETWORK SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 23-2705700
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
400 Feheley Drive
King of Prussia, Pennsylvania 19406
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(610) 277-8300
(REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE)
_________________________________
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 _____
---
As of May 13, 1996, there were outstanding 5,607,850 shares of the Registrant's
Common Stock.
Page 1 of 13 pages
Exhibit Index is on page 12
<PAGE>
HDS NETWORK SYSTEMS, INC.
-------------------------
INDEX
-----
<TABLE>
<CAPTION>
Page
Number
------
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets:
March 31, 1996 and June 30, 1995 2
Consolidated Statements of Operations:
Three Months and Nine Months Ended March 31, 1996 and 1995 3
Consolidated Statements of Cash Flows:
Nine Months Ended March 31, 1996 and 1995 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 12
Item 6. Exhibits and Reports on Form 8-K 12
Signatures 13
</TABLE>
1
<PAGE>
HDS Network Systems, Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
March 31, 1996 June 30,1995
--------------- -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,591,625 $ 2,184,983
Short-term investments 1,000,000 1,959,324
Accounts receivable, net 2,099,166 5,764,676
Inventories 2,917,790 2,215,015
Prepaid expenses and other 615,227 166,677
Deferred income taxes 381,917 81,917
----------- -----------
Total current assets 10,605,725 12,373,592
PROPERTY AND EQUIPMENT, net 560,025 550,276
CAPITALIZED SOFTWARE, net 190,298 187,287
PREPAID ROYALTY, net - 50,000
----------- -----------
$11,356,048 $13,161,155
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ - $ 589,000
Current portion of long-term debt 4,095 3,915
Accounts payable 1,376,640 2,797,652
Accrued expenses 118,202 400,574
Deferred revenue 154,906 137,204
Income taxes payable - 626,375
----------- -----------
Total current liabilities 1,653,843 4,554,720
LONG-TERM DEBT 6,877 9,293
----------- -----------
DEFERRED INCOME TAXES 102,577 102,577
----------- -----------
COMMITMENTS
STOCKHOLDERS' EQUITY
Common stock 5,610 5,610
Additional paid-in capital 8,255,796 7,955,796
Retained earnings 1,465,946 706,837
Deferred compensation (134,601) (173,678)
----------- -----------
Total stockholders' equity 9,592,751 8,494,565
----------- -----------
$11,356,048 $13,161,155
=========== ===========
</TABLE>
2
<PAGE>
HDS Network Systems, Inc.
Consolidated Statements of Operations
Nine Months and Three Months Ended March 31, 1996 and 1995
(Unaudited)
<TABLE>
<CAPTION>
9 Months Ended March 31, 3 Months Ended March 31,
1996 1995 1996 1995
---------------------------- --------------------------
<S> <C> <C> <C> <C>
NET REVENUES $15,686,094 $15,214,360 $3,681,011 $3,358,063
COST OF REVENUES 11,855,927 11,491,463 2,647,720 2,569,022
----------- ----------- ---------- ----------
Gross profit 3,830,167 3,722,897 1,033,291 789,041
OPERATING EXPENSES:
Sales and marketing 1,441,542 1,082,826 591,991 339,600
General and administrative 887,558 667,914 297,373 196,394
Research and development 486,843 378,611 193,207 125,499
----------- ----------- ---------- ----------
Total operating expenses 2,815,943 2,129,351 1,082,571 661,493
----------- ----------- ---------- ----------
Operating income (loss) 1,014,224 1,593,546 (49,280) 127,548
INTEREST INCOME
(EXPENSE), net 178,672 (73,154) 57,182 (6,503)
----------- ----------- ---------- ----------
Income before taxes 1,192,896 1,520,392 7,902 121,045
INCOME TAXES 433,787 648,619 2,845 50,838
----------- ----------- ---------- ----------
NET INCOME $ 759,109 $ 871,773 $ 5,057 $ 70,207
=========== ============ ========== ==========
EARNINGS PER SHARE $ 0.13 $ 0.28 $ 0.02 $ 0.02
=========== =========== ========== ==========
WEIGHTED AVERAGE
SHARES 7,257,717 3,121,903 10,553,186 3,740,645
=========== =========== ========== =========
</TABLE>
3
<PAGE>
HDS Network Systems, Inc.
Consolidated Statements of Cash Flows
Nine Months Ended March 31, 1996 and 1995
(Unaudited)
<TABLE>
<CAPTION>
9 Months Ended March 31,
1996 1995
------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 759,109 $ 871,773
Adjustment to reconcile net income to net cash
provided by operating activities-
Depreciation and amortization 305,821 196,865
Changes in operating assets and liabilities-
(Increase) decrease in-
Accounts receivable 3,665,510 1,350,873
Inventories (701,775) (57,375)
Prepaid expenses and other (448,550) (183,002)
Increase (decrease) in-
Accounts payable (1,421,012) (1,169,429)
Accrued expenses (282,372) (108,041)
Deferred revenue 17,702 16,030
Income taxes payable (626,375) 361,129
---------- -----------
Net cash provided by operating activities 1,268,058 1,278,823
---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (136,982) (339,709)
Reduction in short-term investments 959,324 -
Capitalized software (92,512) (28,817)
---------- -----------
Net cash provided by (used in) investing activities 729,830 (368,526)
---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Merger with ISAC (net cash received) - 11,081,509
Dividend to shareholders - 5,500,000
Repayment of line of credit (589,000) (1,580,000)
Principal payments on long-term debt (2,246) (633,267)
Proceeds from the issuance of Common Stock - 6,750
---------- -----------
Net cash provided by (used in) investing activities (591,246) 3,374,992
---------- -----------
INCREASE IN CASH 1,406,642 4,285,289
CASH, BEGINNING OF PERIOD 2,184,983 30,032
---------- -----------
CASH, END OF PERIOD $3,591,625 $ 4,315,321
========== ===========
SUPPLEMENTAL DISCLOSURE OF NONCASH
OPERATING ACTIVITIES:
Cash paid for income taxes $1,001,000 $ 287,490
========== ===========
Cash paid for interest $ 10,475 $ 123,828
========== ===========
</TABLE>
4
<PAGE>
HDS NETWORK SYSTEMS, INC.
-------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. BASIS OF PRESENTATION:
----------------------
The accompanying unaudited consolidated financial statements have been prepared
in conformity with generally accepted accounting principles. The interim
financial information, while unaudited, reflects all normal recurring
adjustments which are, in the opinion of management, necessary to present a fair
statement of financial position and operating results for the interim periods
presented. The results of the three and nine month periods ended March 31,
1996 are not necessarily indicative of results expected for the full year.
These financial statements should be read in conjunction with the audited
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K filed with the Securities and Exchange Commission.
2. MERGER TRANSACTION:
-------------------
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 2,807,867 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 was 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.
3. MAJOR CUSTOMERS:
----------------
Net revenues from one customer represented 20% of total net revenues for the
three months ended March 31, 1996 and 19% of total net revenues for the nine
month period then ended, while net revenues from another customer represented
25% of total net revenues for the nine months ended March 31, 1996. Net revenues
from one customer represented 30% of total net revenues for the three months
ended March 31, 1995 and 34% of total net revenues for the nine months ended
March 31, 1995. At March 31, 1996 and 1995, the Company had receivables from
these customers of approximately $378,000 and $562,000 respectively.
5
<PAGE>
4. INVENTORIES:
------------
Inventories are stated at the lower of cost or market (first-in, first-out
method) and consisted of the following:
<TABLE>
<CAPTION>
March 31, June 30,
-------------------------
1996 1995
----------- -----------
<S> <C> <C>
Purchased components and subassemblies $ 1,388,783 $ 1,014,982
Work-in-process 203,837 197,859
Finished goods 1,325,170 1,003,174
----------- -----------
$ 2,917,790 $ 2,216,015
=========== ===========
</TABLE>
5. LINE OF CREDIT:
---------------
The Company has a $3,000,000 revolving line of credit (none outstanding at March
31, 1996) with a bank which expires on December 31, 1996 subject to annual
renewal. Borrowings under the line are at the bank's prime rate. Under the
line, the Company is required to maintain specified ratios of working capital
and debt to net worth, as defined.
6. LONG-TERM DEBT:
---------------
The Company has a term loan payable in monthly installments of approximately
$400, including interest at 7.8%, with final payment due in July 1998.
6
<PAGE>
7. STOCK OPTIONS:
--------------
The Company has a stock option plan for employees and directors which provides
for the grant of incentive and non-qualified stock options. 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. Except for options
issued to non-employee directors, options generally vest and become exercisable
ratably over four years, and expire five years from the grant date. Options
granted to non-employee directors are made automatically upon the date they are
first elected and on an annual basis pursuant to a formula set forth in the
plan. Initial options granted to non-employee directors become fully vested
nine months after the date of grant, and annual options become fully vested one
year after the date of grant. As of March 31, 1996, the Company had options
outstanding for the purchase of 900,000 shares of Common stock at prices ranging
from $5.13 to $6.38 per share. Options to purchase 205,750 shares of Common
stock were vested at March 31, 1996.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
INTRODUCTION
The Company provides a variety of hardware, software and service products
designed to integrate and deliver networked information to the desktop cost
effectively. The Company's desktop display stations 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's netVideo multimedia 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 has licensed Sun Microsystems, Inc.'s
Java/TM/ technology and Spyglass, Inc.'s Enhanced Mosaic Web browser
technologies that it intends to incorporate into a new line of Network Computer
products designed to provide cost-effective access to information and
applications within the corporate enterprise and on the Internet.
The Company's current strategy is to become a provider of broader solutions
in networked client/network technology by focusing on expanding its software
products and technical services to take advantage of the opportunities provided
by the growing convergence of communications, media and networking technologies
and applications in a single integrated market. 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>
Three Months Ended Nine Months Ended
March 31, March 31,
--------------- ------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross Profit 28.1% 23.5% 24.4% 24.5%
Operating expenses:
Sales and marketing 16.1 10.1 9.2 7.1
General and administrative 8.1 5.8 5.7 4.4
Research and development 5.2 3.7 3.1 2.5
Operating income (1.3) 3.8 6.4 10.5
Interest income (expense), net 1.5 (0.2) 1.1 (0.5)
Income before taxes 0.2 3.6 7.5 10.0
</TABLE>
8
<PAGE>
<TABLE>
<S> <C> <C> <C> <C>
Income taxes 0.1 1.5 2.8 4.3
--- --- --- ---
Net Income 0.1% 2.1% 4.7% 5.7%
===== ==== ======= ======
</TABLE>
For the three months ended March 31, 1996, net revenues increased by
$322,948 or 9.6% to $3,681,011 from $3,358,063 for the comparable period in the
prior fiscal year. Net revenues increased $471,734 or 3.1% to $15,686,094 for
the nine months ended March 31, 1996 as compared to $15,214,360 for the
comparable period in fiscal 1995. The increase in revenue is attributable to
increased shipments of the Company's ViewStation Series of display stations.
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's
revenues for the three months ended March 31, 1996 reflected the lack of
significant orders from its largest customer, to whom it supplies products under
a government subcontract. The Company is subject to significant variances in its
quarterly operating results because of the fluctuations in the timing of the
receipt of large orders.
For the three months ended March 31, 1996, net income was $5,057 as
compared to $70,207 for the comparable period in the prior year. Net income for
the nine months ended March 31, 1996 was $759,109 as compared to $871,773 for
the comparable period in fiscal 1995. The decrease in net income for both
periods was due to significant increases in the Company's investment in both
sales and marketing and research and development expenses during the periods.
These investments, as well as increases in general and administrative expenses,
were partially offset by higher revenues, increased investment income and a
lower effective income tax rate.
The Company's gross profit as a percentage of net revenues increased to
28.1% for the three months ended March 31, 1996 from 23.5% for the comparable
three-month period of the prior fiscal year. For the nine-month period ended
March 31, 1996, the Company's profit margin decreased to 24.4% from 24.5% in the
prior period. The fluctuation in the Company's gross profit margins was
primarily due to its mix of business, as its margins vary within the Company's
product line. The gross profit margin also varies in response to competitive
market conditions as well as periodic fluctuations in the cost of memory and
other significant components. 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 three and nine months ended March 31, 1996 were
$1,082,571 and $2,815,943, respectively. Operating expenses for the three-month
period increased by $421,078 as compared to the three months ended March 31,
1995. For the nine-month period, operating expenses increased by $686,592
compared to the prior fiscal year. Sales and marketing expenses increased by
$252,331 to $591,991 for the three months ended March 31, 1996 as compared to
$339,600 for the prior year. During the nine-month period, sales and marketing
expenses increased by $358,716 to $1,441,542 as
9
<PAGE>
compared to $1,082,826 in the prior period as a result of increased expenditures
for advertising as well as investments in increasing the Company's sales and
marketing staff. Research and development expenses for the three months ended
March 31, 1996 increased by $67,708 to $193,207 from $125,499 in the prior year.
For the nine-month period, research and development expenses increased to
$486,843 from $378,611 in the prior fiscal 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 $297,373 for the
three months ended March 31, 1996 from $196,394 in the prior year and to
$887,558 for the nine months ended March 31, 1996 from $667,914 in the previous
period 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 (loss) decreased to ($49,280) and $1,014,224 for the
three- and nine-month periods ended March 31, 1996 from $127,548 and $1,593,546
for the comparable periods in the previous fiscal year. The decrease in
operating income for both periods 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 revenues and, in the three-month period ended March 31, 1996, by higher
gross profit margins.
Net interest income (expense) increased in the three- and nine- month
periods ended March 31, 1996 due to the use of the proceeds from the merger
consummated in March 1995 to repay debt and provide interest income.
The effective income tax rates were approximately 36.0% and 36.4% in the
three and nine month periods ended March 31, 1996 as compared to 42.0% and
42.7% in the comparable periods of the prior fiscal year due to the
implementation of tax planning strategies to reduce state taxable income.
FORWARD-LOOKING STATEMENTS
The foregoing "Management's Discussion and Analysis of Financial Condition
and Results of Operations" contains 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, the mix of distribution channels
through which the Company's products are sold, increased competition, 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, increased
competition in the desktop computer market and the Company's ability to complete
strategic acquisitions.
10
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1996, the Company had net working capital of approximately
$8,950,000 composed primarily of cash and cash equivalents, short-term
investments, accounts receivable and inventory. The Company's principal sources
of liquidity included approximately $4,592,000 of cash and cash equivalents and
short-term investments and a $3,000,000 bank line of credit facility, which was
fully available as of March 31, 1996.
Cash and cash equivalents and short-term investments increased by
approximately $964,000 during the nine-month period ended March 31, 1996,
primarily as a result of reduction of its accounts receivable, which was offset
by a decrease in accounts payable and income taxes payable, and an increase in
inventory.
The Company generated approximately $1,268,000 in cash from operating
activities in the nine months ended March 31, 1996 compared to $1,279,000
during the comparable period of fiscal 1995.
Net cash provided by investing activities increased to approximately
$730,000 in the nine months ended March 31, 1996 as compared to cash used in
investing activities of approximately $369,000 in the comparable period of
fiscal 1995 due to reductions in short-term investments. Net cash used in
financing activities decreased in the nine months ended March 31, 1996 as
compared to the comparable period in fiscal 1995 due to the repayment of line of
credit borrowings during the current fiscal year and the merger of ISAC and HDS.
The Company expects to fund current operations and other cash expenditures,
as well as any acquisitions, through the use of available cash, cash from
operations, funds available under its credit facility, possible new sources of
debt financing, and its securities. The Company has no current plans,
arrangements or understandings with respect to any such acquisition, and there
is no assurance that it will be successful in completing any acquisitions.
11
<PAGE>
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
None
(b) Reports on Form 8-K:
None
12
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunder duly authorized.
HDS NETWORK SYSTEMS, INC.
Date: May 14, 1996 By: /S/ MARK A. GELBERG
--------------------------------
Mark A. Gelberg, President and Chief
Executive Officer
Date: May 14, 1996 By: /S/ SCOTT HOLLAND
--------------------------------
Scott Holland, Vice President of
Finance and Administration (Principal
Financial Officer and Principal
Accounting Officer)
13
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 9-MOS
<FISCAL-YEAR-END> JUN-30-1996 JUN-30-1995
<PERIOD-START> JAN-01-1996 JAN-01-1995
<PERIOD-END> MAR-31-1996 MAR-31-1995
<CASH> 3,591,625 2,184,983
<SECURITIES> 0 0
<RECEIVABLES> 2,135,778 5,831,438
<ALLOWANCES> 36,612 66,762
<INVENTORY> 2,917,790 2,216,015
<CURRENT-ASSETS> 10,605,725 12,373,592
<PP&E> 1,197,288 1,052,583
<DEPRECIATION> 637,263 502,307
<TOTAL-ASSETS> 11,356,048 13,161,155
<CURRENT-LIABILITIES> 1,653,843 4,554,720
<BONDS> 0 0
0 0
0 0
<COMMON> 5,610 5,610
<OTHER-SE> 9,592,751 8,494,565
<TOTAL-LIABILITY-AND-EQUITY> 11,356,048 13,161,155
<SALES> 3,681,011 3,358,063
<TOTAL-REVENUES> 3,681,011 3,358,063
<CGS> 2,647,720 2,569,022
<TOTAL-COSTS> 1,082,571 661,493
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> 7,902 121,045
<INCOME-TAX> 2,845 50,838
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 5,057 70,207
<EPS-PRIMARY> 0.02 0.02
<EPS-DILUTED> 0 0
</TABLE>
