<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 fiscal quarter ended June 30, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the transition period from __ to __
Commission File Number: 0-23034
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 92121
SAN DIEGO, CA (Zip Code)
(Address of principal executive offices)
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 June 30,
1998, was 11,582,500.
<PAGE>
ENCAD, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
----
PART I - FINANCIAL INFORMATION
<S> <C> <C>
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets at
June 30, 1998 and December 31, 1997.............................1
Consolidated Statements of Income for the
three and six months ended June 30, 1998 and 1997................2
Consolidated Statements of Cash Flows for the
six months ended June 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.....................................................13
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS..................................................13
ITEM 2. CHANGES IN SECURITIES..............................................13
ITEM 3. DEFAULTS UPON SENIOR SECURITIES....................................13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................13
ITEM 5. OTHER INFORMATION..................................................14
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................14
SIGNATURES...................................................................14
</TABLE>
i
<PAGE>
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
ENCAD, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
JUNE 30, December 31,
1998 1997
----------- ------------
(UNAUDITED) (Note)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 708 $ 1,265
Accounts receivable - net 34,703 36,800
Inventories 27,240 29,155
Deferred income taxes 2,713 3,118
Prepaid expenses 2,974 1,780
------- -------
Total current assets 68,338 72,118
PROPERTY - NET 15,697 14,825
OTHER ASSETS 4,288 3,352
------- -------
TOTAL ASSETS $88,323 $90,295
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $10,371 $12,369
Accrued expenses and other liabilities 4,885 8,670
Borrowings under line of credit 5,000 3,261
------- -------
Total current liabilities 20,256 24,300
------- -------
OTHER LIABILITIES 1,789 1,273
STOCKHOLDERS' EQUITY:
Common stock 12 12
Additional paid -in capital 18,485 17,577
Accumulated earnings 47,781 47,133
------- -------
Total stockholders' equity 66,278 64,722
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $88,323 $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.
1
<PAGE>
ENCAD, INC.
CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
NET SALES $34,695 $37,725 $58,212 $69,236
COST OF SALES 20,586 20,060 35,205 36,165
------- ------- ------- -------
GROSS PROFIT 14,109 17,665 23,007 33,071
------- ------- ------- -------
MARKETING AND SELLING 6,773 6,100 12,541 11,214
RESEARCH AND DEVELOPMENT 2,669 2,775 5,276 5,565
GENERAL AND ADMINISTRATIVE 2,452 2,392 5,035 4,252
------- ------- ------- -------
------- ------- ------- -------
11,894 11,267 22,852 21,031
------- ------- ------- -------
INCOME FROM OPERATIONS 2,215 6,398 155 12,040
OTHER INCOME - - 999 -
INTEREST (EXPENSE) INCOME - NET (114) 78 (214) 142
------- ------- ------- -------
INCOME BEFORE INCOME TAXES 2,101 6,476 940 12,182
PROVISION FOR INCOME TAXES 727 2,253 292 4,265
------- ------- ------- -------
NET INCOME $ 1,374 $ 4,223 $ 648 $ 7,917
------- ------- ------- -------
EARNINGS PER SHARE - BASIC $ 0.12 $ 0.37 $ 0.06 $ 0.70
------- ------- ------- -------
EARNINGS PER SHARE - DILUTED $ 0.12 $ 0.35 $ 0.05 $ 0.66
------- ------- ------- -------
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING - BASIC 11,565 11,364 11,546 11,348
------- ------- ------- -------
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING - DILUTED 11,764 12,046 11,918 12,038
------- ------- ------- -------
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
ENCAD, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(in thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
1998 1997
--------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 648 $ 7,917
Adjustments to reconcile net income to cash used in
operating activities:
Depreciation and amortization 1,992 1,465
Tax benefit from exercise of stock options 295 766
Changes in assets and liabilities:
Accounts receivable 2,097 (11,047)
Inventories 1,915 (3,306)
Deferred income taxes (98) (16)
Prepaid expenses and other assets (1,627) (677)
Accounts payable (1,998) 2,050
Accrued expenses and other liabilities (3,269) 2,699
------- --------
Cash used in operating activities (45) (149)
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property (2,864) (4,018)
------- --------
Cash used in investing activities (2,864) (4,018)
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of Common Stock options and sale of stock under
employee stock purchase plan 613 575
Net borrowings under line of credit 1,739 -
------- --------
Cash provided by financing activities 2,352 575
------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (557) (3,592)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,265 6,949
------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 708 $ 3,357
------- --------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for income taxes $ 2,031 $ 1,584
------- --------
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
ENCAD, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
1) BASIS OF PRESENTATION - The accompanying consolidated financial statements
as of June 30, 1998 and for the three month and six month periods ended
June 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 with the financial statement
presentation for the three month and six month periods ended June 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)
<TABLE>
<CAPTION>
JUNE 30, December 31,
1998 1997
-------- ------------
<S> <C> <C>
Raw materials $11,950 $11,043
Work-in-process 108 629
Finished goods 15,182 17,483
------- -------
Total $27,240 $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.
4
<PAGE>
The following table is a reconciliation of the basic and diluted earnings
per share computations for the three and six month periods ended June 30,
1998 and 1997: (IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net Income $1,374 $4,223 $ 648 $7,917
------ ------ ------- ------
Earnings per share - basic $ 0.12 $ 0.37 $ 0.06 $ 0.70
------ ------ ------- ------
------ ------ ------- ------
Basic weighted average common
shares outstanding 11,565 11,364 11,546 11,348
Effect of dilutive securities:
Stock options 199 682 372 690
------ ------ ------- ------
Diluted weighted average common and
common equivalent shares outstanding 11,764 12,046 11,918 12,038
------ ------ ------- ------
Earnings per share - diluted $ 0.12 $ 0.35 $ 0.05 $ 0.66
------ ------ ------- ------
</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.
5
<PAGE>
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.
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 JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET SALES 100.0% 100.0% 100.0% 100.0%
COST OF SALES 59.3% 53.2% 60.5% 52.2%
----- ----- ----- -----
GROSS PROFIT 40.7% 46.8% 39.5% 47.8%
----- ----- ----- -----
MARKETING AND SELLING 19.5% 16.2% 21.5% 16.2%
RESEARCH AND DEVELOPMENT 7.7% 7.4% 9.1% 8.1%
GENERAL AND ADMINISTRATIVE 7.1% 6.2% 8.6% 6.1%
----- ----- ----- -----
INCOME FROM OPERATIONS 6.4% 17.0% 0.3% 17.4%
OTHER INCOME - - 1.7% -
INTEREST (EXPENSE) INCOME - NET (0.3%) 0.2% (0.4%) 0.2%
----- ----- ----- -----
INCOME BEFORE INCOME TAXES 6.1% 17.2% 1.6% 17.6%
PROVISION FOR INCOME TAXES 2.1% 6.0% 0.5% 6.2%
----- ----- ----- -----
NET INCOME 4.0% 11.2% 1.1% 11.4%
----- ----- ----- -----
</TABLE>
RESULTS OF OPERATIONS
NET SALES - ENCAD's net sales for the three and six month periods ended
June 30, 1998 decreased by 8% and 16%, respectively, from the same periods in
1997. The decline in revenues related to lower sales of older products, lower
sales in Asia, and lower average selling prices as the Company lowered prices
and implemented incentive programs to counter aggressive pricing and similar
programs offered by competitors. During the three and six month periods ended
June 30, 1998, supplies sales increased 27% and 34%, respectively, over the same
periods in 1997, and accounted for 29% and 32% of net sales for the three and
six month periods ended June 30, 1998, respectively, as compared to 21% and 20%
for the same periods of 1997. Sales to the Company's numerous original equipment
manufacturers ("OEM") for the three and six months ended June 30, 1998 accounted
for 11% and 16% of net sales, respectively, as compared to 21% and 20% for the
same periods of 1997.
No one customer accounted for more than 10% of net sales during the three
and six month periods ended June 30, 1998, whereas, one customer accounted for
10% and 13% of net sales during the three and six month periods ended June 30,
1997, respectively. International sales accounted for approximately 65% of the
Company's net sales for the three and six month periods ended June 30, 1998,
compared to 61% and 59% for the same periods in 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 59% and 60% for
the three and six month periods ended June 30, 1998, respectively, as compared
to 53% and 52% for the three and six month periods ended June 30, 1997. The
Company experienced lower gross profit margin percentages during the three and
six month periods ended June 30, 1998 compared to the same periods of 1997 due
to lower average selling prices, as the Company lowered prices and implemented
incentive programs to counter aggressive pricing and similar programs offered by
6
<PAGE>
competitors, and increased sales of supplies, which, in general, have lower
gross margins than the printer products. 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 20% and 22%,
respectively, of net sales during the three and six month periods ended June 30,
1998 compared to 16% during the same periods of 1997, which represents an
increase in absolute dollars of 11% and 12%. This increase was due to increased
staffing and related expenses to support the Company's entry into the textile
printing market and the expansion of international support for the supplies
product line, and increased spending related to the introduction and promotion
of new products. Marketing and selling expenses are expected to continue to
increase over prior periods as the Company promotes its products and supports
its marketing and selling activities.
RESEARCH AND DEVELOPMENT - Research and development expenses, which can
vary depending upon product development cycles, were 8% and 9% of net sales
during the three and six month periods ended June 30, 1998, respectively,
compared to 7% and 8% during the same periods of 1997, respectively. In absolute
dollars, 1998 research and development spending decreased by 4% and 5% over the
three and six month periods ended June 30, 1997, respectively. Spending in the
three and six month periods ended June 30 of both years reflects costs for
products launched in the second quarter; however, spending was slightly lower in
the three and six month periods ended June 30, 1998 due primarily to lower
spending on prototype and testing expenses. The Company expects to continue to
invest significant resources in its strategic programs and enhancements to
existing products and, as a result, that research and development expenses will
continue to increase in absolute dollars as compared to prior periods.
GENERAL AND ADMINISTRATIVE - General and administrative expenses were 7%
and 9% of net sales during the three and six month periods ended June 30, 1998
compared to 6% during the same periods of 1997 and increased by 3% and 18% in
absolute dollars over the three and six month periods ended June 30, 1997,
respectively. This increase was primarily due to higher staffing expenses and
increased spending related to business development. The Company expects general
and administrative expenses will continue to increase in absolute dollars over
prior periods.
NET INTEREST - Net interest decreased to $114 and $214 expense during the
three and six month periods ended June 30, 1998, respectively, from $78 and $142
income during the comparable periods of 1997 due to less cash available for
external investment and increased borrowings under the bank line of credit.
OTHER INCOME - Other income for the three and six months ended June 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.
PROVISION FOR INCOME TAXES - The Company's effective income tax rate during
the three and six month periods ended June 30, 1998 was approximately 35% and
31%, respectively, compared to 35% during the comparable periods of 1997. The
tax rate difference of 4% for the six months ended June 30, 1998, when applied
against income before income taxes for the same period, represents approximately
$30. The Company expects the effective income tax rate for the twelve months
ending December 31, 1998 to be at or near historical levels.
NET INCOME - Net income was 4% and 1% of net sales for the three and six
month periods ended June 30, 1998 as compared to net income of 11% for the same
periods of 1997 and decreased by $2,849 and $7,269, respectively, from the same
periods of 1997 for the reasons previously described.
7
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically funded its operations primarily through cash
flow provided from operations; however during the first half of 1998, the
Company also utilized cash provided through its line of credit. At June 30,
1998, the Company had cash and cash equivalents totaling $708, and working
capital of $48,082. In comparison, the Company had cash and cash equivalents
totaling $1,265, and working capital of $47,818 as of December 31, 1997. The
decrease in cash and cash equivalents was due primarily to a decreases in
payables and accrued expenses and other liabilities, offset by decreases in
accounts receivable and inventories.
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
June 30, 1998, net accounts receivable decreased by $2,097 from $36,800 at
December 31, 1997. The decrease was directly related to a lower sales volume in
the six months ended June 30, 1998 and the successful collection of existing
balances.
Inventory levels decreased by $1,915 at June 30, 1998 from $29,155 at
December 31, 1997. This decrease was due primarily to a reduction in finished
good inventory, however, this decrease was offset somewhat by increases in raw
materials required to support the demand for the Company's new products.
During the six month periods ended June 30, 1998 and 1997, the Company had
capital expenditures of $2,864 and $4,018, respectively. In the first six months
of 1998 the Company primarily incurred costs related to the implementation of an
enterprise-wide information system. During the remainder of 1998, the Company
plans to continue its capital expenditures at a somewhat reduced rate, primarily
in continuing the implementation of the enterprise-wide information system.
At June 30, 1998, the Company had available a $20,000 revolving line of
credit. The line requires the Company to maintain certain financial ratios.
$5,000 was outstanding under the line at June 30, 1998 and $3,261 at December
31, 1997. The line expires on January 2, 2000.
The Company's overall level of operating expense is expected to increase
for the remainder of 1998 due to the development and marketing of new products
for existing and new markets. Management believes that its existing cash and
cash equivalents, cash generated from operations, and funds available under the
bank line of credit 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.
The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. The "year 2000 problem"
is pervasive and complex as virtually every computer operation will be affected
in some way by the rollover of the two digit year value to 00. The issue is
whether computer systems will properly recognize date sensitive information when
the year changes to 2000. Systems that do not properly recognize such
information could generate erroneous data or cause a system to fail. The
Company's recent enterprise-wide information system implementation, the initial
phase of which is expected to be completed in 1998, should mitigate most
internal problems as the system vendors have represented that these systems are
already year 2000 compliant. In addition, the Company is in the process of
communicating with others with whom it does significant business to determine
their year 2000 compliance readiness and the extent to which the Company is
vulnerable to any third party year 2000 issues. Management does not anticipate
that the Company will incur significant operating expenses or be required to
invest heavily in other computer systems improvements to be year 2000 compliant.
The Company plans to devote the necessary resources to resolve significant year
2000 issues in a timely manner; however, if the Company, its customers, vendors
or others with whom it does significant business are unable to resolve external
processing issues in a timely manner, it could result in material adverse effect
on certain of the Company's operations.
8
<PAGE>
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
total revenues 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 revenue and profitability
experienced over the past several years on a quarterly or annual basis.
On March 16, 1998, the Company announced that lower than anticipated
product sales, coupled with accelerated competitor-driven pressure on gross
profits for its flagship products, could generate operating results ranging from
break even to a loss for the first quarter of 1998 on sales significantly lower
than the same quarter last year. Due to the results for the first quarter, the
likelihood of continued sales weakness in Asia, lower gross profit in its core
business over the course of 1998, and increased marketing and selling expenses
required to respond to competitive pressures, the Company also announced that it
expects net income for the year will fall well below comparable 1997 results,
and that sales for full-year 1998 could be lower than 1997 sales.
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. There can be no assurance
that the Company's products will continue to be competitively priced. 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
9
<PAGE>
maintain the Company's market position. The Company's financial condition and
results of operations could be 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 - The
markets for wide-format, color inkjet printers and related supplies are
relatively new and are still developing. The Company believes that there has
been growing market acceptance for inkjet printers and related supplies. There
can be no assurance that the markets and applications for wide-format printers
and related supplies will continue to grow. Other technologies are constantly
evolving and improving. There can be no assurance that products based on these
other technologies will not have a material adverse effect on the demand for the
Company's products.
FUTURE CAPITAL NEEDS - Although the Company has had only one unprofitable
quarter (quarter ended March 31, 1998) since its public offering in December
1993, there can be no assurance that future profitability or revenue growth, if
any, will 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. Adequate funds for these
purposes, whether through financial markets or from other sources, may not be
available when needed or, if available, not 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. The Company
uses a material requirements planning system that is intended to aid in making
"Just-in-Time" decisions; however, 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
financial condition and results of operations.
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
10
<PAGE>
rights. There can be no assurance, however, that the measures adopted by the
Company for the protection of its intellectual property will be adequate to
protect its interests, or that the Company's competitors will not
independently develop technologies that are substantially equivalent or
superior to the Company's technologies.
DEPENDENCE ON EXPORT SALES - For the quarters ended June 30, 1998 and
1997, sales outside the United States represented approximately 65% and 61% 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 expand its international business, there
can be no assurance that these factors will not have an adverse effect on
the Company's sales and, consequently, on the Company's financial condition
and results of operations.
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 financial condition and results of
operations. 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 financial condition and results of operations.
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 six month
periods ended June 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 has 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. There can be no
assurance that any new personnel hired by the Company will be successfully
integrated into the business or that changes to the Company's systems will be
effective. The Company's inability to manage growth effectively could have a
material adverse effect on the Company's results of operations.
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 revenue 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
11
<PAGE>
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. There can be no assurance
that the market price of the Company's Common Stock will not experience
significant fluctuations that are unrelated to the Company's operating
performance.
ENTERPRISE-WIDE INFORMATION SYSTEM - The Company is in the process of
replacing its current management information system with a comprehensive
enterprise-wide information system and is devoting significant resources to
system and process design and system testing. 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 transition to the new system is not effected smoothly or if the system
does not perform as expected.
YEAR 2000 COMPLIANCE - The Company is aware of the issues associated with
the programming code in existing computer systems as the year 2000 approaches.
The "year 2000 problem" is pervasive and complex as virtually every computer
operation will be affected in some way by the rollover of the two digit year
value to 00. The issue is whether computer systems will properly recognize date
sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Company's recent enterprise-wide information system
implementation, the initial phase of which is expected to be completed in 1998,
should mitigate most internal problems as the system vendors have represented
that these systems are already year 2000 compliant. In addition, the Company is
in the process of communicating with others with whom it does significant
business to determine their year 2000 compliance readiness and the extent to
which the Company is vulnerable to any third party year 2000 issues. Management
does not anticipate that the Company will incur significant operating expenses
or be required to invest heavily in other computer systems improvements to be
year 2000 compliant. The Company plans to devote the necessary resources to
resolve significant year 2000 issues in a timely manner; however, if the
Company, its customers, vendors or others with whom it does significant business
are unable to resolve external processing issues in a timely manner, it could
result in material adverse effect on certain of the Company's operations.
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.
12
<PAGE>
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 June 1998, Hewlett Packard served the Company with a lawsuit alleging that
one of the Company's products infringes another Hewlett Packard patent. The
lawsuit was filed in the U.S. District Court for the District of Idaho. The
outcome of this lawsuit cannot be determined, however, management believes it is
without merit, and the Company intends to vigorously defend the allegations. No
amounts had 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
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's 1998 Annual Meeting of Stockholders was held on June 9, 1998, in
Del Mar, California, for the following purposes:
1. The following seven directors were elected to serve a one-year term that
will expire at the Company's 1999 Annual Meeting of Stockholders:
<TABLE>
<CAPTION>
FOR WITHHELD
--- --------
<S> <C> <C>
Robert V. Adams 10,579,918 57,874
Craig S. Andrews 10,581,118 56,674
Ronald J. Hall 10,581,618 56,174
Howard L. Jenkins 10,581,918 55,874
Richard A. Plante 10,550,755 87,037
David A. Purcell 10,581,223 56,569
Charles E. Volpe 10,576,118 61,674
</TABLE>
2. The stockholders ratified and approved the 1998 Stock Option Plan and the
reservation of 575,000 shares for issuance thereunder. The total number of
votes cast for and against were 8,581,767, and 2,004,920, respectively, and
51,105 votes were withheld.
3. The stockholders ratified the appointment of Deloitte & Touche LLP as the
Company's independent public accountants for the fiscal year ending
December 31, 1998. The total number of votes cast for and against were
10,588,971, and 26,045, respectively, and 22,776 votes were withheld.
13
<PAGE>
ITEM 5. OTHER INFORMATION
None
(a) Exhibits
<TABLE>
<CAPTION>
<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)
4.1 Rights Agreement, dated as of March 19, 1998, between the
Company and Harris Trust Company of California, which
includes the Form of Certificate of Designation for the
Series A Preferred Stock as Exhibit A, the form of Rights
Certificate as Exhibit B and the Summary of Rights to
Purchase Shares as Exhibit C. (2)
10.1 1998 Stock Option Plan (filed as Exhibit 99.1) (3)
10.2 Form of Notice of Grant of Stock Option (filed as Exhibit
99.2). (3)
10.3 Form of Stock Option Agreement (filed as Exhibit 99.3). (3)
10.4 1997 Supplemental Stock Option Agreement (filed as Exhibit
99.4). (3)
+ 10.5 Form of Non-Statutory Stock Option Agreement (filed as
Exhibit 99.5). (3)
27 Summary Financial Data
(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.
(3) Filed as an exhibit to the Registrant's Registration Statement on
Form S-8 (No. 333-59779) and incorporated herein by reference.
+ Management Compensatory Plan
</TABLE>
(b) Reports on Form 8-K - No reports on Form 8-K were filed during the quarter
ended June 30, 1998.
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: August 14, 1998
ENCAD, Inc.
(Registrant)
/s/ Todd W. Schmidt
-----------------------------------------------
(Todd W. Schmidt)
Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)
14
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ENCAD,
INC. JUNE 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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 708
<SECURITIES> 0
<RECEIVABLES> 34,703
<ALLOWANCES> 0
<INVENTORY> 27,240
<CURRENT-ASSETS> 68,338
<PP&E> 26,111
<DEPRECIATION> 10,414
<TOTAL-ASSETS> 88,323
<CURRENT-LIABILITIES> 20,256
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 66,266
<TOTAL-LIABILITY-AND-EQUITY> 88,323
<SALES> 58,212
<TOTAL-REVENUES> 58,212
<CGS> 35,205
<TOTAL-COSTS> 35,205
<OTHER-EXPENSES> 22,852
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 214
<INCOME-PRETAX> 940
<INCOME-TAX> 292
<INCOME-CONTINUING> 648
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 648
<EPS-PRIMARY> .06
<EPS-DILUTED> .05
</TABLE>
