ENCAD INC, 10-Q, 1998-11-13

ENCAD INC
10-Q, 1998-11-13
COMPUTER PERIPHERAL EQUIPMENT, NEC

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
(Mark One)

X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934

For the fiscal quarter ended September 30, 1998

- ----- 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: 0-23034

ENCAD-REGISTERED TRADEMARK-, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 95-3672088
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

6059 CORNERSTONE COURT WEST
SAN DIEGO, CA 92121
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (619) 452-0882

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
---- ----

The number of shares outstanding of the Registrant's Common Stock as of
September 30, 1998, was 11,609,089.

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ENCAD, INC.

INDEX

<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I - FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

Consolidated Balance Sheets at
September 30, 1998 and December 31, 1997. . . . . . . . . . . 1

Consolidated Statements of Income for the
three and nine months ended September 30, 1998 and 1997 . . . 2

Consolidated Statements of Cash Flows for the
nine months ended September 30, 1998 and 1997 . . . . . . . . 3

Notes to Consolidated Financial Statements . . . . . . . . . . . . 4

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.. . . . . . . . . . . . . 6

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK. .. . . . . . . . . . . . . . . . . . . . . . . .14

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . . . .14

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. . . . . . . . . . . . .14

ITEM 3. DEFAULTS UPON SENIOR SECURITIES. . . . . . . . . . . . . . . . . .15

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . . . . .15

ITEM 5. OTHER INFORMATION. . . . . . . . . . . . . . . . . . . . . . . . .15

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . . . . .15

SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

</TABLE>

<PAGE>

PART I. - FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

ENCAD, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)

September 30, December 31,
1998 1997
---------------------------
(Unaudited) (Note)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,474 $ 1,265
Accounts receivable - net 28,228 36,800
Inventories 24,701 29,155
Deferred income taxes 3,725 3,118
Prepaid expenses 2,038 1,780
--------- ---------
Total current assets 60,166 72,118

PROPERTY - NET 15,795 14,825
OTHER ASSETS 4,806 3,352
--------- ---------
TOTAL ASSETS $ 80,767 $ 90,295
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,867 $ 12,369
Accrued expenses and other liabilities 3,600 8,670
Borrowings under line of credit 4,144 3,261
--------- ---------
Total current liabilities 16,611 24,300
--------- ---------
OTHER LIABILITIES 1,642 1,273

STOCKHOLDERS' EQUITY:
Common stock, $.001 par value 12 12
Additional paid -in capital 18,639 17,577

Accumulated earnings 43,863 47,133
--------- ---------
Total stockholders' equity 62,514 64,722
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 80,767 $ 90,295
--------- ---------
--------- ---------

</TABLE>

Note:

The balance sheet at December 31, 1997 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.

See Notes to Consolidated Financial Statements.

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ENCAD, INC.
CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED
(in thousands, except per share data)

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
NET SALES $ 24,201 $ 38,509 $ 82,413 $ 107,745
COST OF SALES 18,485 20,409 53,690 56,574
--------- --------- --------- ----------
GROSS PROFIT 5,716 18,100 28,723 51,171
--------- --------- --------- ----------
MARKETING AND SELLING 5,983 6,874 18,524 18,088
RESEARCH AND DEVELOPMENT 2,701 2,487 7,977 8,052
GENERAL AND ADMINISTRATIVE 3,004 1,928 8,039 6,180
--------- --------- --------- ----------
11,688 11,289 34,540 32,320
--------- --------- --------- ----------
(LOSS) INCOME FROM OPERATIONS (5,972) 6,811 (5,817) 18,851
OTHER INCOME - - 999 -
INTEREST (EXPENSE) INCOME - NET (112) (39) (326) 103
--------- --------- --------- ----------
(LOSS) INCOME BEFORE INCOME TAXES (6,084) 6,772 (5,144) 18,954
PROVISION FOR INCOME TAXES (2,166) 2,329 (1,874) 6,594
--------- --------- --------- ----------
NET (LOSS) INCOME $ (3,918) $ 4,443 $ (3,270) $ 12,360
--------- --------- --------- ----------
--------- --------- --------- ----------
(LOSS) EARNINGS PER SHARE - BASIC $ (0.34) $ 0.39 $ (0.28) $ 1.09
--------- --------- --------- ----------
--------- --------- --------- ----------
(LOSS) EARNINGS PER SHARE - DILUTED $ (0.34) $ 0.37 $ (0.28) $ 1.03
--------- --------- --------- ----------
--------- --------- --------- ----------
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING - BASIC 11,584 11,400 11,556 11,365
--------- --------- --------- ----------
--------- --------- --------- ----------
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING - DILUTED 11,584 12,048 11,556 12,042
--------- --------- --------- ----------
--------- --------- --------- ----------

</TABLE>

See Notes to Consolidated Financial Statements.

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ENCAD, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(in thousands)

NINE MONTHS ENDED SEPTEMBER 30,
1998 1997
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (3,270) $ 12,360
Adjustments to reconcile net income to cash provided by (used in)
operating activities:
Depreciation and amortization 3,055 2,503
Tax benefit from exercise of stock options 295 1,495
Changes in assets and liabilities:
Accounts receivable 8,572 (15,273)
Inventories 4,454 (6,758)
Deferred income taxes (1,172) 279
Prepaid expenses and other assets (1,147) (1,260)
Accounts payable (3,502) 2,230
Accrued expenses and other liabilities (4,701) 1,822
-------- --------
Cash provided by (used in) operating activities 2,584 (2,602)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property (4,025) (6,141)
-------- --------
Cash used in investing activities (4,025) (6,141)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of Common Stock options and sale of stock under
employee stock purchase plan 767 1,046
Net borrowings under line of credit 883 2,000
-------- --------
Cash provided by financing activities 1,650 3,046
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 209 (5,697)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,265 6,949
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,474 $ 1,252
-------- --------
-------- --------

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for income taxes $ 2,082 $ 3,195
-------- --------
-------- --------
Cash paid during the period for interest $ 300 $ 66
-------- --------
-------- --------

</TABLE>

See Notes to Consolidated Financial Statements.

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ENCAD, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Unaudited

1) BASIS OF PRESENTATION - The accompanying consolidated financial statements
as of September 30, 1998 and for the three-month and nine-month periods
ended September 30, 1998 and 1997 are unaudited and reflect all adjustments
(consisting only of normal recurring adjustments) which are, in the opinion
of management, necessary for a fair presentation of the financial position
and operating results for the interim period. These consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto, together with management's discussion and
analysis of financial condition and results of operations, contained in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997.
The results of operations for the interim periods are not necessarily
indicative of the results to be expected for any other interim period or
for the entire fiscal year.

The consolidated financial statements include the accounts of ENCAD, Inc.
and its wholly owned subsidiaries (collectively, the "Company"). All
intercompany transactions and balances are eliminated in consolidation.
Certain reclassifications have been made to amounts included in the prior
year's financial statements to conform to the financial statement
presentation for the three-month and nine-month periods ended September 30,
1998.

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect amounts reported in the consolidated financial
statements and related notes. Changes in those estimates may affect
amounts reported in future periods.

RECENT ACCOUNTING PRONOUNCEMENTS - In February 1998, the Financial
Accounting Standards Board issued Statement of Financial Accounting
Standards ("SFAS") No. 132, "Employers' Disclosures about Pensions and
Other Postretirement Benefits" ("SFAS No. 132"). SFAS No. 132 revises
employers' disclosure about pension and other postretirement benefit plans,
but does not change the measurement or recognition of those plans. SFAS
No. 132 is effective for fiscal years beginning after December 15, 1997.
The Company has adopted SFAS No. 132 for the year ended December 31, 1998.
The Company has determined that the adoption of SFAS No. 132 will not have
a material effect on the financial statements or disclosures of the
Company.

2) INVENTORIES:
(IN THOUSANDS)

SEPTEMBER 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Raw materials $ 10,330 $ 11,043
Work-in-process 154 629
Finished goods 14,217 17,483
--------- ---------
Total $ 24,701 $ 29,155
--------- ---------
--------- ---------

</TABLE>

3) EARNINGS PER SHARE - SFAS No. 128 "Earnings Per Share" was adopted by the
Company in the fourth quarter of 1997 and all earnings per share amounts
previously reported have been restated. Basic earnings per share is
computed by dividing net income by the weighted average common shares
outstanding. Diluted earnings per share is computed by dividing net income
by the weighted average number of common and common equivalent shares
outstanding.

<PAGE>

The following table is a reconciliation of the basic and diluted earnings per
share computations for the three- and nine-month periods ended September 30,
1998 and 1997: (IN THOUSANDS, EXCEPT PER SHARE DATA)

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
---------- --------- ---------- -----------
<S> <C> <C> <C> <C>
Net income $ (3,918) $ 4,443 $ (3,270) $ 12,360
--------- -------- --------- ---------
Earnings per share - basic $ (0.34) $ 0.39 $ (0.28) $ 1.09
--------- -------- --------- ---------
--------- -------- --------- ---------
Basic weighted average common
shares outstanding 11,584 11,400 11,556 11,365
Effect of dilutive securities:
Stock options 0 648 0 677
--------- -------- --------- ---------
Diluted weighted average common and
common equivalent shares outstanding 11,584 12,048 11,556 12,042
--------- -------- --------- ---------
--------- -------- --------- ---------
Earnings per share - diluted $ (0.34) $ 0.37 $ (0.28) $ 1.03
--------- -------- --------- ---------
--------- -------- --------- ---------

</TABLE>

4) COMPREHENSIVE INCOME - SFAS No. 130 "Reporting Comprehensive Income" was
adopted by the Company in the first quarter of 1998. There are no material
current differences between net income and comprehensive income, and
accordingly, no amounts have been reflected in the accompanying
consolidated financial statements.

5) STOCKHOLDER RIGHTS PLAN - In March 1998, the Company's Board of Directors
adopted a preferred stockholder rights plan which provides for a dividend
distribution of one preferred share purchase right (a "Right") on each
outstanding share of the Common Stock. On March 19, 1998, the Company's
Board of Directors declared a dividend of one Right for each outstanding
share of Common Stock, payable on April 2, 1998 to stockholders of record
on that date. Each Right entitles stockholders to buy 1/1000th of a share
of ENCAD Series A Junior Participating Preferred Stock at an exercise price
of $80, subject to adjustment. The Rights will become exercisable on the
close of business on the first day a person or group announces an
acquisition of 15% or more of the Common Stock or on the tenth day after a
person or a group commences or announces commencement of a tender offer,
the consummation of which would result in ownership by the person or group
of 15% or more of the Common Stock. The Company will be entitled to redeem
the Rights at $0.01 per Right at any time on or before the close of
business on the first date of a public announcement that a person has
acquired beneficial ownership of 15% or more of the Common Stock.

6) REVOLVING LINE OF CREDIT - At September 30, 1998, the Company had available
a $20,000 revolving line of credit currently set to expire in January 2000.
$4,144 was outstanding under the line of credit at September 30, 1998 and
$3,261 at December 31, 1997. The line requires the Company to maintain
certain financial ratios. At September 30, 1998, the Company was not in
compliance with one covenant of this line of credit. As a result, the bank
has the right to declare the outstanding balance due and payable, to cease
to extend any further credit, and to exercise other rights and remedies
specified in the credit agreement. To date, the bank has not exercised any
such remedies. The Company is currently renegotiating the terms of the
credit agreement with the bank, including amendments to address the non-
compliance issue; however, there can be no assurance that an amendment can
be negotiated on terms acceptable to the Company. During this process, the
bank has permitted the Company to continue to make withdrawals from the
line.

5
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(in thousands, except percentages)

This discussion may contain forward-looking statements that involve
risks and uncertainties. The Company's actual results may differ materially
from the results discussed in such forward-looking statements. Factors that
might cause such a difference include, but are not limited to, those
discussed in "Risks and Uncertainties" below. The Company undertakes no
obligation to release publicly the results of any revisions to these
forward-looking statements to reflect events or circumstances arising after
the date hereof.

During the nine months ended September 30, 1998, the Company announced that
weak industry sales worldwide, coupled with accelerated competitor-driven
pressure on gross profits for its flagship products, lower than expected sales
of its Digital Textile Printing-TM- system, and third quarter problems
associated with a supplier-provided ink and the implementation of the initial
phase of the enterprise-wide information system, would cause net income and
sales for the full-year 1998 to be lower than 1997 results.

The Company also announced plans to enhance its competitive position in the
marketplace and further align its cost and expense structure to be more
competitive. These plans include potential actions of exiting unprofitable
lines of business, increasing research and development spending in 1999 in
support of the core graphic arts business, as well as a limited number of new,
targeted markets, and lowering the cost structure, particularly
manufacturing material, overhead and logistics costs, as well as other
organizational streamlining to reduce expenses.

While the plans are not yet complete, some of these activities will likely
result in significant additional charges in the fourth quarter of 1998.

The following table sets forth, as a percentage of net sales, certain
consolidated statements of income data for the periods indicated.

CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------- -------------------------------
1998 1997 1998 1997
- ----------------------------------------------------------------------------- -------------------------------
<S> <C> <C> <C> <C>
NET SALES 100.0% 100.0% 100.0% 100.0%
COST OF SALES 76.4% 53.0% 65.1% 52.5%
- ----------------------------------------------------------------------------- -------------------------------
GROSS PROFIT 23.6% 47.0% 34.9% 47.5%
- ----------------------------------------------------------------------------- -------------------------------
MARKETING AND SELLING 24.7% 17.8% 22.5% 16.8%
RESEARCH AND DEVELOPMENT 11.2% 6.5% 9.7% 7.5%
GENERAL AND ADMINISTRATIVE 12.4% 5.0% 9.8% 5.7%
- ----------------------------------------------------------------------------- -------------------------------
(LOSS) INCOME FROM OPERATIONS (24.7%) 17.7% (7.1%) 17.5%
OTHER INCOME - - 1.2% -
INTEREST (EXPENSE) INCOME - NET (0.5%) (0.1%) (0.4%) 0.1%
- ----------------------------------------------------------------------------- -------------------------------
(LOSS) INCOME BEFORE INCOME TAXES (25.2%) 17.6% (6.3%) 17.6%
PROVISION FOR INCOME TAXES (9.0%) 6.1% (2.3%) 6.1%
- ----------------------------------------------------------------------------- -------------------------------
NET (LOSS) INCOME (16.2%) 11.5% (4.0%) 11.5%
- ----------------------------------------------------------------------------- -------------------------------
</TABLE>

RESULTS OF OPERATIONS

NET SALES - ENCAD's net sales for the three- and nine-month periods ended
September 30, 1998 decreased by 37% and 24%, respectively, from the same
periods in 1997. The decline in net sales related to lower sales of the
Company's older products, which were not offset by increased sales of its
newer products, in particular, its Digital Textile System, the impact of
weak economic conditions on industry sales worldwide, lower average selling
prices as the Company lowered prices and implemented incentive programs to
counter aggressive pricing and similar programs offered by competitors, and
the disruption to business caused by certain supplier quality problems and
the implementation of the Company's enterprise-wide information system.

During the three- and nine-month periods ended September 30, 1998,
supplies sales increased 17% and 28%, respectively, over the same periods in
1997, and accounted for 40% and 35% of net sales for the three- and nine-month
periods ended September 30, 1998, respectively, as compared to 21% and 20%
for the same periods of 1997. Original Equipment Manufacturers ("OEM") sales
for the three and nine months ended September 30, 1998 accounted for 20% and
17% of net sales, respectively, as compared to 25% and 24% for the same
periods of 1997. International sales accounted for approximately 61% and 64%
of the Company's net sales for the three- and nine-month periods ended
September 30, 1998, respectively, compared to 57% and 58% for the same
periods in 1997.

One customer, Tekgraf, Inc., a U.S. distributor, accounted for 10% of net
sales for the current quarter, but no one customer accounted for more than 10%
of net sales during the nine-month period ended September 30, 1998.

- --------------------------------
Digital Textile System is a trademark of ENCAD, Inc.
6
<PAGE>

In 1997 no one customer accounted for more than 10% of net sales during the
third quarter, but Xerox accounted for 12% of net sales during the nine-month
period ended September 30, 1997.

COST OF SALES - Cost of sales includes costs related to product shipments,
including materials, labor, overhead and other direct or allocated costs
involved in the manufacture, warehousing, delivery, support and maintenance
of products. Cost of sales as a percentage of net sales stood at 76% and 65%
for the three- and nine-month periods ended September 30, 1998, respectively,
as compared to 53% for both the three- and nine-month periods ended September
30, 1997. The Company experienced lower gross profit margin percentages
during the three- and nine-month periods ended September 30, 1998 compared to
the same periods of 1997 due to a number of factors. These factors include
lower average selling prices, as the Company lowered prices and implemented
incentive programs to counter aggressive pricing and similar programs offered
by competitors, increased sales of supplies, which, in general, have lower
gross margins than its printer products. In addition, during the current
quarter, the Company incurred the following additional charges: a $1,250
writedown of Croma24-TM- inventories to estimated net realizable value and an
increase in inventory reserves of $1,200 for excess and obsolete inventory.
The Company's future success will depend, in part, on its ability to develop
and manufacture competitive products and achieve cost reductions for its
existing products.

MARKETING AND SELLING - Marketing and selling expenses were 25% and 22%,
respectively, of net sales during the three- and nine-month periods ended
September 30, 1998 compared to 18% and 17% during the same periods of 1997. In
absolute dollars, third quarter 1998 marketing and selling expenses decreased by
13%, when compared to the same quarter of 1997, due to an overall decrease in
marketing and selling spending. For the nine months ended September 30, 1998,
marketing and selling expenses increased by 2% over the same period of 1997, due
to increased staffing and related expenses to support the Company's entry into
the textile printing market, offset by an overall decrease in marketing and
selling spending.

RESEARCH AND DEVELOPMENT - Research and development expenses, which can vary
depending upon product development cycles, were 11% and 10% of net sales during
the three- and nine-month periods ended September 30, 1998, respectively,
compared to 6% and 7% during the same periods of 1997, respectively. In absolute
dollars, third quarter 1998 research and development expenses increased by 9%
over the same period of 1997 due primarily to increased spending on prototypes
related to new products currently under development and an overall increase in
labor and related expenses. For the nine-month period ended September 30, 1998,
research and development expenses in absolute dollars were basically flat when
compared to the same period of 1997. The Company expects to continue to invest
significant resources in its strategic programs and enhancements to existing
products. As a result, the Company expects that research and development
expenses will continue to increase in absolute dollars and as a percentage of
sales as compared to prior periods.

GENERAL AND ADMINISTRATIVE - General and administrative expenses were 12% and
10% of net sales during the three- and nine-month periods ended September 30,
1998 compared to 5% and 6% during the same periods of 1997 and increased by 56%
and 30% in absolute dollars over the three- and nine-month periods ended
September 30, 1997, respectively. These increases were primarily due to
increases in the bad debt reserve, severance costs and legal expenses.

- --------------------------------
Croma24 is a trademark of ENCAD, Inc.

<PAGE>

OTHER INCOME - Other income for the nine months ended September 30, 1998
included payments received under a new product development and manufacturing
license agreement signed during the first quarter of 1998. Under this
agreement, the Company is assisting in the development of a wide-format color
inkjet product targeted for markets outside of the Company's mainstream graphics
and textiles focus. The Company will receive additional reimbursements for
engineering expenses during the remainder of 1998 and royalties on future
product sales, if any.

INTEREST (EXPENSE) INCOME - NET - An increase in interest expense caused net
interest expense to increase to $112 and $326 during the three- and nine-month
periods ended September 30, 1998, respectively, from $39 expense and $103 income
during the comparable periods of 1997 due to less cash available for external
investment and increased borrowings under the bank line of credit.

PROVISION FOR INCOME TAXES - The Company's effective income tax rate was 36%
for both the three- and nine-month periods ended September 30, 1998, compared to
34% and 35% during the comparable periods of 1997.

NET (LOSS) INCOME - Net loss was 16% and 4% of net sales for the three- and
nine-month periods ended September 30, 1998 as compared to net income of 12% and
11% for the same periods of 1997.

LIQUIDITY AND CAPITAL RESOURCES

The Company has historically funded its operations primarily through cash
flow provided from operations; however, recently the Company also utilized cash
provided through its line of credit. At September 30, 1998, the Company had
cash and cash equivalents totaling $1,474, and working capital of $43,555. In
comparison, the Company had cash and cash equivalents totaling $1,265, and
working capital of $47,818 as of December 31, 1997.

The Company has received, and anticipates it will continue to receive, the
majority of its cash from collections of accounts receivable from its
distributors and OEMs. These groups have a history of timely payments; however,
an increasing amount of international sales can increase accounts receivable
balances due to traditionally slower payments by international customers. At
September 30, 1998, net accounts receivable decreased by $8,572 from $36,800 at
December 31, 1997. The decrease was primarily related to a lower sales volume
in the nine months ended September 30, 1998 and the successful collection of
existing balances.

Inventory levels decreased by $4,454 at September 30, 1998 from $29,155 at
December 31, 1997. This decrease was due primarily to increased inventory
reserves and a $1,250 writedown of Croma24 inventories to net realizable value
as a result of a substantial reduction in selling prices.

During the nine-month periods ended September 30, 1998 and 1997, the Company
made capital expenditures of $4,025 and $6,141, respectively. In the first nine
months of 1998 these expenditures related primarily to the costs associated
with the implementation of an enterprise-wide information system. During the
remainder of 1998, the Company will continue its capital expenditures at a
somewhat reduced rate, primarily in continuing the implementation of the
enterprise-wide information system.

<PAGE>

Company is currently renegotiating the terms of the credit agreement with the
bank, including amendments to address the non-compliance issue; however,
there can be no assurance that an amendment can be negotiated on terms
acceptable to the Company. During this process, the bank has permitted the
Company to continue to make withdrawals from the line.

Management believes that its existing cash and cash equivalents, cash
generated from operations, funds available under the bank line of credit, or
potential funds available through a sale-leaseback of or borrowings against the
Company's headquarter facility will be sufficient to satisfy its currently
anticipated working capital needs. Actual cash requirements may vary from
planned amounts, depending on the timing of the launch and extent of acceptance
of new products. There can be no assurances that future cash requirements to
fund operations will not require the Company to seek additional capital, or that
such additional capital will be available when required on terms acceptable to
the Company. To date, inflation has not had a significant effect on the
Company's operating results.

YEAR 2000 COMPLIANCE The Company utilizes computer technologies throughout
its business to conduct its day-to-day operations. Computer technologies include
both information technology in the form of hardware and software, as well as
embedded technology in the Company's facilities systems and equipment. The
Company must determine whether its products and systems are capable of
recognizing and processing date sensitive information properly as the year 2000
approaches. To do so, the Company is using a multi-phased concurrent approach.
Specific project phases include: awareness, assessment, remediation, validation
and implementation. The Company has completed the awareness phase of this
project. Furthermore, the Company has nearly completed the assessment phase and
is well into the remediation phase.

All of the Company's current products are year 2000 compliant. The Company's
recent enterprise-wide information system implementation, the initial phase of
which is substantially complete, should mitigate most internal problems as the
system vendors have represented that these systems are year 2000 compliant. The
Company is actively correcting and replacing those other systems which are not
year 2000 ready. The Company currently intends to substantially complete the
remediation, validation and implementation phases of the year 2000 project prior
to June 30, 1999. This process includes the testing of critical systems to
ensure that year 2000 readiness has been accomplished. If the Company determines
that it may be unable to remediate and properly test affected systems on a
timely basis, the Company intends to develop appropriate contingency plans for
any such mission-critical systems at the time such determination is made. While
the Company is not presently aware of any significant exposure that its systems
will not be properly remediated on a timely basis, there can be no assurances
that all year 2000 remediation processes will be completed and properly tested
before the year 2000, or that contingency plans will sufficiently mitigate the
risk of a year 2000 readiness problem. An interruption of the Company's ability
to conduct its business due to a year 2000 readiness problem could have a
material adverse effect on the Company.

Due to the recent implementation of the enterprise-wide information system,
the Company estimates that the additional aggregate costs of its year 2000
project will not be material. A portion of these costs, primarily those not
related to the implementation of the enterprise-wide information system, is not
likely to be incremental costs, but rather will represent the redeployment of
existing resources. This reallocation of resources is not expected to have a
significant impact on the day-to-day operations of the Company. The anticipated
impact and costs of the project, as well as the date, on which the Company
expects to complete the project, are based on management's best estimates using
information currently available and numerous assumptions about future events.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ materially from those plans. Based on its current
estimates and information currently available, the Company does not anticipate
that the costs associated with this project will have a material adverse effect
on the Company's consolidated financial position, results of operations or cash
flows in future periods.

<PAGE>

The Company will develop appropriate contingency plans in the event that a
significant exposure is identified relative to the dependencies on
third-party systems. While the Company is not presently aware of any such
significant exposure, there can be no guarantee that the systems of
third-parties on which the Company relies will be converted in a timely
manner, or that a failure to properly convert by another company would not
have a material adverse effect on the Company.

RISKS AND UNCERTAINTIES

POTENTIAL FLUCTUATION IN QUARTERLY PERFORMANCE - The Company's quarterly
operating results can fluctuate significantly depending on factors such as the
timing of product announcements and subsequent introductions of products by the
Company and its competitors, availability and cost of components, timing of
shipments of the Company's products, mix of product families shipped, market
acceptance of new products, seasonality, currency fluctuations, changes in
prices by the Company and its competitors, and price protection for selling
price reductions offered to distributors and OEMs. In addition, the timing of
expenditures for staffing and related support costs, advertising, trade show
attendance, promotion, research and development expenditures, and, of course,
changes in general economic conditions can impact quarterly performance. Any
one of these factors could have a material adverse effect on the Company's
results of operations. The Company may experience significant quarterly
fluctuations in net sales as well as operating expenses with respect to future
new product introductions. In addition, the Company's component purchases,
production and spending levels are based upon forecast demand for the Company's
products. Accordingly, any inaccuracy in forecasting could adversely affect the
Company's financial condition and results of operations. Demand for the
Company's products could be adversely affected by a slowdown in the overall
demand for computer systems, printer products or digitally printed images. The
Company's failure to complete shipments during a quarter could have a material
adverse effect on the Company's results of operations. Quarterly results are
not necessarily indicative of future performance for any particular period, and
there can be no assurance that the Company can maintain the levels of sales and
profitability experienced over the past several years on a quarterly or annual
basis.

HIGHLY COMPETITIVE INDUSTRY - The markets for the Company's products, both
printers and supplies, is highly competitive and rapidly changing. Several new
competitors have entered the market. The Company's principal competitor is
Hewlett-Packard Company ("Hewlett-Packard"), which dominates the Computer Aided
Design ("CAD") segment of the wide-format inkjet markets and is the Company's
principal competition in the Graphic Arts ("GA") segment. In addition to direct
competition in inkjet printers and related supplies, the Company's products also
face competition from other technologies in the wide-format market. Such
technologies include pen, electrostatic and thermal methods. The competition to
sell ink, media and software products to the customer is also intense. Some of
the Company's current and prospective competitors, particularly Hewlett-Packard,
have significantly greater financial, technical, manufacturing and marketing
resources than the Company. The Company's ability to compete in the wide-format
inkjet market depends on a number of factors within and outside its control,
including the success and timing of product introductions by the Company and its
competitors, selling prices, product performance, product distribution,
marketing ability and customer support. A key element of the Company's strategy
is to provide competitively priced, quality products. The Company may not be
able to continue to provide competitively-priced products. The Company has
reduced prices on many of its products in 1998 and will likely continue to do so
in the future. Price reductions, while partially offset by similar reductions
in product costs, have affected gross margins and likely will continue to affect
gross margins and may adversely affect the Company's financial condition and
results of operations. See "Short Product Lives and Technological Change."

SHORT PRODUCT LIVES AND TECHNOLOGICAL CHANGE - The markets for wide-format
printers and related supplies are characterized by rapidly evolving technology,
frequent new product introductions and significant price competition.
Consequently, short product life cycles and reductions in unit selling prices
due to competitive pressures over the life of a product are common. The
Company's future success will depend on its ability to continue to develop and
manufacture competitive products and achieve cost reductions for its existing
products. In addition, the Company monitors new technology developments and
coordinates with suppliers, distributors and dealers to enhance existing
products and lower costs. Advances in technology will require increased
investment to maintain the Company's market position. The Company's financial
condition and results of operations could be

<PAGE>

adversely affected if the Company is unable to develop and manufacture new,
competitive products in a timely manner.

DEVELOPING WIDE-FORMAT INKJET AND SUPPLIES MARKETS AND APPLICATIONS - While
the markets for wide-format, color inkjet printers and related supplies are
relatively new and are still developing, there has been growing market
acceptance for inkjet printers and related supplies. Markets and applications
for wide-format printers and related supplies may not continue to grow. Other
competitive technologies are constantly evolving and improving. Products based
on these other technologies may have a material adverse effect on the demand for
the Company's products.

FUTURE CAPITAL NEEDS - Future profitability or sales growth, if any, may be
difficult to achieve and, if achieved, may be difficult to continue on a
quarterly or annual basis. Losses may occur on a quarterly or annual basis for
a number of reasons outside the Company's control. See "Potential Fluctuation
in Quarterly Performance." The growth of the Company's business will require
the commitment of substantial capital resources. If funds are not available
from operations, the Company will need additional funds. The Company may seek
such additional funding through public and private financing, including debt or
equity financing. Future cash requirements to fund operations may require the
Company to seek additional capital. Such additional capital may not be
available when required on terms acceptable to the Company. Insufficient funds
may require the Company to delay, reduce or eliminate some or all of its planned
activities.

DEPENDENCE ON KEY PERSONNEL - The success of the Company is dependent, in
part, on its ability to attract and retain qualified management and technical
personnel. Competition for such personnel is intense, and the inability to
attract additional key employees or the loss of one or more key employees could
adversely affect the Company. Although the Company does not have employment
agreements with or life insurance on members of senior management, it does have
severance agreements with members of this group. There can be no assurance that
the Company will retain its key personnel. The Company relies heavily on
industry consultants and other specialists to assist and influence decisions,
keep abreast of technological and industry advances, and assist in other Company
processes. A delay in product introduction is possible to the extent key
consultants become unavailable.

COMPONENT AVAILABILITY AND COST; DEPENDENCE ON SINGLE SOURCES - While most
components are available locally from multiple vendors, certain components used
in the Company's products are only available from single sources. Although the
Company generally buys components under purchase orders and does not have long-
term agreements with its suppliers, it expects that its suppliers will be able
to continue to satisfy its requirements. The Company has developed strategic
relationships with single suppliers of several of its components. Although
alternate suppliers are readily available for many of these components, for some
components the process of qualifying replacement suppliers, replacing tooling or
ordering and receiving replacement components could take several months and
cause substantial disruption to the Company's operations. In addition, if a
supplier is unable to meet the Company's needs or supplies parts which the
Company finds unacceptable, the Company may not be able to meet production
demands. Certain key components of the Company's products are supplied
indirectly by its principal competitor, Hewlett-Packard. The Company believes
that Hewlett-Packard supplies these components to many other customers. Any
significant increase in component prices or decrease in component availability
could have a material adverse effect on the Company's business.

POSSIBILITY OF CHALLENGE TO COMPANY'S PRODUCTS OR INTELLECTUAL PROPERTY
RIGHTS - From time to time, certain competitors, including Hewlett-Packard, have
asserted patent rights relevant to the Company's business. The Company expects
that this will continue. The Company carefully evaluates each assertion
relating to its products. If the Company is not successful in establishing that
asserted rights have not been violated, the Company could be prohibited from
marketing the products that incorporate such technology. The Company could also
incur substantial costs to redesign its products or to defend any legal action
taken against the Company. If the Company's products should be found to
infringe upon the intellectual property rights of others, the Company could be
enjoined from further infringement and be liable for any damages. The Company
relies on a combination of trade secret, copyright, trademark and patent
protection and non-disclosure agreements to protect its proprietary rights.
Measures adopted by the Company for the protection of its intellectual property
may not be adequate to protect its interests. In addition, the Company's
competitors may independently develop technologies that are substantially
equivalent or superior to the Company's technologies.

11
<PAGE>
DEPENDENCE ON EXPORT SALES - For the quarters ended September 30, 1998 and
1997, sales outside the United States represented approximately 61% and 57% of
the Company's net sales, respectively. Even with the recent decline in the
Company's business in Asia, the Company expects export sales to continue to
represent a significant portion of its sales. All of the Company's products sold
in the international markets are denominated in U.S. dollars. An increase in
the value of the U.S. dollar relative to foreign currencies could make the
Company's products less competitive in foreign markets. International sales and
operations may also be subject to risks such as the imposition of governmental
controls, export license requirements, restrictions on the export of critical
technology, currency exchange fluctuations, political instability, trade
restrictions, changes in tariffs, difficulties in staffing and managing
international operations and collecting accounts receivable. In addition, the
laws of certain countries do not protect the Company's products and intellectual
property rights to the same extent as the laws of the United States. As the
Company continues to pursue its international business, these factors may have
an adverse effect on the Company's sales and, consequently, on the Company's
business.

RELIANCE ON INDIRECT DISTRIBUTION - The Company markets and sells its
products domestically and internationally primarily through specialty
distributors, dealers, VARs and OEMs. The Company's sales are principally made
through distributors, which may carry competing product lines. Such
distributors could reduce or discontinue sales of the Company's products, which
could have a material adverse effect on the Company's business. There can be no
assurance that these independent distributors will devote the resources
necessary to provide effective sales and marketing support of the Company's
products. In addition, the Company is dependent upon the continued viability
and financial stability of these distributors, many of which are small
organizations with limited capital. These distributors, in turn, are
substantially dependent on general economic conditions and other unique factors
affecting the wide-format printer market. The Company believes that its future
growth and success will continue to depend in large part upon its distribution
channels. Although the Company believes that it provides adequate allowances
for bad debts which may arise from sales to these customers, and, to date, has
not experienced significant amounts of bad debts, there can be no assurance that
actual bad debts will not exceed recorded allowances resulting in a material
adverse effect on the Company's business. To expand its distribution channels,
the Company has entered into select OEM and private label arrangements that
allow it to address specific market segments or geographic areas. In order to
prevent inventory write-downs, to the extent that OEM and private label
customers do not purchase products as anticipated, the Company may need to
convert such products to make them salable to other customers.

MANAGEMENT OF GROWTH - Although net sales for the three- and nine-month
periods ended September 30, 1998 have declined when compared to the comparable
periods of 1997, the Company had previously experienced significant growth as
net sales had increased to $149.0 million in 1997 compared to $107.4 million in
1996 and $65.5 million in 1995. Such growth placed, and, if continued, will
continue to place, a significant strain on the Company's management, employees,
systems and operations. The Company's future operating results will depend on
its ability to continue to broaden the Company's senior management group,
attract, hire and retain skilled employees, and implement new and enhance
existing operational information and financial control systems. In so doing,
the Company may encounter difficulties successfully integrating new personnel
into the organization, and changes to the Company's information and financial
control systems may not be effective. The Company's inability to manage growth
effectively could have a material adverse effect on the Company's business.

VOLATILITY OF STOCK PRICE - The market price of the Company's Common Stock
has fluctuated significantly since the Company's initial public offering in
December 1993. The Company believes that factors such as general stock market
trends, announcements of developments related to the Company's business,
fluctuations in the Company's operating results, general conditions in the
computer peripheral market and the markets served by the Company or in the
worldwide economy, a shortfall in net sales or earnings from securities
analysts' expectations, announcements of technological innovations or new inkjet
products or enhancements by the Company or its competitors, developments in
patents or other intellectual property rights and developments in the Company's
relationships with its customers and suppliers could cause a further significant
fluctuation in the price of the Company's Common Stock. In addition, in recent
years the stock market in general, and the market for shares of technology
stocks in particular, have experienced extreme price fluctuations, which have
often been unrelated to the operating performance of affected companies. The
market price of the Company's Common Stock may continue to experience
significant fluctuations that are unrelated to the Company's operating
performance.
12
<PAGE>

ENTERPRISE-WIDE INFORMATION SYSTEM - The Company has substantially completed
the initial phase of replacing its management information system with a
comprehensive enterprise-wide information system and will devote significant
resources to system and process design and system testing for the remainder of
1998. The Company expects that this system will allow it to realize significant
operational efficiencies and facilitate future growth. The Company's operations
could be disrupted, however, if the final transition to the new system as
functionally designed is not effected smoothly or if the system does not perform
as expected.

The Company is in the process of communicating with its significant
suppliers, customers, and critical business partners to determine the extent to
which the Company may be vulnerable in the event that those parties fail to
properly remediate their own year 2000 issues. The Company has taken steps to
monitor the progress made by those parties, and to the extent possible, plans to
test critical system interfaces, as the year 2000 approaches. The Company will
develop appropriate contingency plans in the event that a significant exposure
is identified relative to the dependencies on third-party systems. While the
Company is not presently aware of any such significant exposure, there can be no
guarantee that the systems of third-parties on which the Company relies will be
converted in a timely manner, or that a failure to properly convert by another
company would not have a material adverse effect on the Company.

<PAGE>

ABSENCE OF DIVIDENDS - No cash dividends have been paid on the Company's
Common Stock to date and the Company does not anticipate paying cash dividends
in the foreseeable future.

ANTI-TAKEOVER EFFECT OF STOCKHOLDER RIGHTS PLAN AND CHARTER DOCUMENTS - In
March 1998, the Company's Board of Directors adopted a preferred stockholder
rights plan (the "Stockholder Rights Plan") which provides for a dividend
distribution of one preferred share purchase right (a "Right") on each
outstanding share of the Common Stock. On March 19, 1998, the Company's Board
of Directors declared a dividend of one Right for each outstanding share of
Common Stock, payable on April 2, 1998 to stockholders of record on that date.
Each Right entitles stockholders to buy 1/1000th of a share of ENCAD Series A
Junior Participating Preferred Stock at an exercise price of $80, subject to
adjustment. The Rights will become exercisable on the close of business on the
first day a person or group announces an acquisition of 15% or more of the
Common Stock or on the tenth day after a person or a group commences or
announces commencement of a tender offer, the consummation of which would result
in ownership by the person or group of 15% or more of the Common Stock. The
Company will be entitled to redeem the Rights at $0.01 per Right at any time on
or before the close of business on the first date of a public announcement that
a person has acquired beneficial ownership of 15% or more of the Common Stock.

ENCAD's Certificate of Incorporation requires that any action required or
permitted to be taken by the stockholders of ENCAD must be effected at a duly
called annual meeting or special meeting of stockholders and may not be effected
by any consent in writing. In addition, special meetings of stockholders of
ENCAD may only be called by the Board of Directors, the Chairman of the Board or
the President of ENCAD or by any person or persons holding shares representing
at least 10% of the outstanding Common Stock. The Stockholder Rights Plan and
other charter provisions may discourage certain types of transactions involving
an actual or potential change in control of ENCAD, including transactions in
which the stockholders might otherwise receive a premium for their shares over
then-current market prices, and may limit the ability of stockholders to approve
transactions that they may deem to be in their best interests. In addition, the
Board of Directors has the authority to fix the rights and preferences of and
issue shares of preferred stock, which may have the effect of delaying or
preventing a change in control of ENCAD without action by the stockholders.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

None

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, the Company may be involved in litigation relating to
claims arising out of its operations in the normal course of business.

In September 1998 a class-action lawsuit was filed in the Chancery
Court of Delaware against ENCAD and the members of its Board of Directors. The
plaintiffs allege that the Stockholder Rights Plan adopted by the Board of
Directors in March 1998 is unlawful and seek to have it rescinded. In addition,
the plaintiffs seek a permanent injunction prohibiting the Company from
exercising the Plan. The Complaint also seeks damages. The Company is of the
opinion that this action has no merit, and intends to vigorously defend the
allegations. No amounts have been reported in the financial statements for any
losses which may result from this lawsuit.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None

<PAGE>

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

At September 30, 1998, the Company had available a $20,000 revolving line
of credit currently set to expire in January 2000. $4,144 was outstanding
under the line of credit at September 30, 1998 and $3,261 at December 31,
1997. The line requires the Company to maintain certain financial ratios.
At September 30, 1998, the Company was not in compliance with one covenant of
this line of credit. As a result, the bank has the right to declare the
outstanding balance due and payable, to cease to extend any further credit,
and to exercise other rights and remedies specified in the credit agreement.
To date, the bank has not exercised any such remedies. The Company is
currently renegotiating the terms of the credit agreement with the bank,
including amendments to address the non-compliance issue; however, there can
be no assurance that an amendment can be negotiated on terms acceptable to
the Company. During this process, the bank has permitted the Company to
continue to make withdrawals from the line.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<S> <C>
3.1 Certificate of Incorporation of the Company (filed as Exhibit 3.1). (1)

3.2 Bylaws of the Company (filed as Exhibit 3.2). (1)

3.3 Certificate of Designation for Series A Junior Participating Preferred
Stock (filed as Exhibit 3.1). (2)

27 Summary Financial Data

</TABLE>

(1) Filed as an exhibit to Registrant's Current Report on Form 8-K dated
January 5, 1998 and incorporated herein by reference.

(2) Filed as an exhibit to Registrant's Current Report on Form 8-K dated
March 20, 1998 and incorporated herein by reference.

(b) Reports on Form 8-K - No reports on Form 8-K were filed during the quarter
ended September 30, 1998.

<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 thereunto duly authorized.

Dated: November 13, 1998

ENCAD, Inc.
(Registrant)

/s/ Todd W. Schmidt
---------------------------------------
(Todd W. Schmidt)
Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)

<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ENCAD,
INC. SEPTEMBER 30, 1998 FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,474
<SECURITIES> 0
<RECEIVABLES> 28,228
<ALLOWANCES> 0
<INVENTORY> 24,701
<CURRENT-ASSETS> 60,166
<PP&E> 27,288
<DEPRECIATION> 11,493
<TOTAL-ASSETS> 80,767
<CURRENT-LIABILITIES> 16,611
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 62,502
<TOTAL-LIABILITY-AND-EQUITY> 62,514
<SALES> 82,413
<TOTAL-REVENUES> 82,413
<CGS> 53,690
<TOTAL-COSTS> 53,690
<OTHER-EXPENSES> 34,540
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 326
<INCOME-PRETAX> (5,144)
<INCOME-TAX> (1,874)
<INCOME-CONTINUING> (3,270)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,270)
<EPS-PRIMARY> (0.28)
<EPS-DILUTED> (0.28)

</TABLE>