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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 June 30, 1999
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: (858) 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 July 31,
1999, was 11,735,356.
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ENCAD, INC.
INDEX
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<CAPTION>
PAGE
<S> <C>
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets at
June 30, 1999 and December 31, 1998...................................................1
Consolidated Statements of Income for the
three and six months ended June 30, 1999 and 1998.....................................2
Consolidated Statements of Cash Flows for the
six months ended June 30, 1999 and 1998...............................................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 AND USE OF PROCEEDS..............................................13
ITEM 3. DEFAULTS UPON SENIOR SECURITIES........................................................13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................................14
ITEM 5. OTHER INFORMATION......................................................................14
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.......................................................14
SIGNATURES...............................................................................................15
</TABLE>
i
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PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
<TABLE>
<CAPTION>
JUNE 30, December 31,
1999 1998
-------------------- -------------------
(UNAUDITED) (Note)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,261 $ 586
Accounts receivable - net 26,235 29,063
Income taxes receivable - 2,403
Inventories 13,231 16,205
Deferred income taxes 4,720 6,025
Prepaid expenses 685 825
-------------------- -------------------
Total current assets 48,132 55,107
PROPERTY - NET 15,126 15,604
OTHER ASSETS 1,860 1,432
-------------------- -------------------
TOTAL ASSETS $ 65,118 $ 72,143
-------------------- -------------------
-------------------- -------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,450 $ 11,785
Accrued expenses and other liabilities 6,678 6,002
Borrowings under line of credit - 6,000
-------------------- -------------------
Total current liabilities 15,128 23,787
-------------------- -------------------
OTHER LIABILITIES 884 813
STOCKHOLDERS' EQUITY:
Preferred stock - $.001 par value, 5,000 shares authorized,
Series A Junior Participating Preferred Stock - no shares
issued and outstanding - -
Common stock - $.001 par value, 60,000 shares authorized,
11,732 and 11,636 shares issued and outstanding at
June 30, 1999 and December 31, 1998 12 12
Additional paid -in capital 19,111 18,704
Accumulated earnings 29,983 28,827
-------------------- -------------------
Total stockholders' equity 49,106 47,543
-------------------- -------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 65,118 $ 72,143
-------------------- -------------------
-------------------- -------------------
</TABLE>
Note: The balance sheet at December 31, 1998 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
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CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- -------------------------------
1999 1998 1999 1998
---------------- -------------- -------------- --------------
---------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
NET SALES $ 29,253 $ 34,695 $ 58,235 $ 58,212
COST OF SALES 16,448 20,586 33,027 35,205
---------------- -------------- -------------- --------------
GROSS PROFIT 12,805 14,109 25,208 23,007
---------------- -------------- -------------- --------------
MARKETING AND SELLING 5,653 6,773 11,375 12,541
RESEARCH AND DEVELOPMENT 3,328 2,669 6,260 5,276
GENERAL AND ADMINISTRATIVE 2,522 2,452 5,613 5,035
---------------- -------------- -------------- --------------
11,503 11,894 23,248 22,852
---------------- -------------- -------------- --------------
INCOME FROM OPERATIONS 1,302 2,215 1,960 155
OTHER INCOME - - - 999
INTEREST EXPENSE - NET (51) (114) (169) (214)
---------------- -------------- -------------- --------------
INCOME BEFORE INCOME TAXES 1,251 2,101 1,791 940
PROVISION FOR INCOME TAXES 444 727 635 292
---------------- -------------- -------------- --------------
NET INCOME $ 807 $ 1,374 $ 1,156 $ 648
---------------- -------------- -------------- --------------
---------------- -------------- -------------- --------------
EARNINGS PER SHARE - BASIC $ 0.07 $ 0.12 $ 0.10 $ 0.06
---------------- -------------- -------------- --------------
---------------- -------------- -------------- --------------
EARNINGS PER SHARE - DILUTED $ 0.07 $ 0.12 $ 0.10 $ 0.05
---------------- -------------- -------------- --------------
---------------- -------------- -------------- --------------
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING - BASIC 11,694 11,565 11,665 11,546
---------------- -------------- -------------- --------------
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING - DILUTED 11,954 11,764 11,811 11,918
---------------- -------------- -------------- --------------
</TABLE>
See Notes to Consolidated Financial Statements.
2
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CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(in thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-----------------------------------
1999 1998
---------------- -----------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 1,156 $ 648
Adjustments to reconcile net income to cash provided by
(used in) operating activities:
Depreciation and amortization 1,649 1,992
Provision for losses on accounts receivable and inventories (144) 150
Tax benefit from exercise of stock options 16 295
Changes in assets and liabilities:
Accounts receivable 2,972 2,047
Income taxes receivable 2,403 -
Inventories 2,974 1,815
Deferred income taxes 1,305 (98)
Prepaid expenses and other assets (288) (1,627)
Accounts payable (3,335) (1,998)
Accrued expenses and other liabilities 747 (3,269)
---------------- -----------------
Cash provided by (used in) operating activities 9,455 (45)
---------------- -----------------
INVESTING ACTIVITIES:
Purchases of property (1,171) (2,864)
---------------- -----------------
Cash used in investing activities (1,171) (2,864)
---------------- -----------------
FINANCING ACTIVITIES:
Exercise of common stock options and sale of stock under
employee stock purchase plan 391 613
Net borrowings under line of credit (6,000) 1,739
---------------- -----------------
Cash (used in) provided by financing activities (5,609) 2,352
---------------- -----------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,675 (557)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 586 1,265
---------------- -----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,261 $ 708
---------------- -----------------
---------------- -----------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash (received) paid during the period for income taxes $ (3,416) $ 2,031
Cash paid during the period for interest $ 210 $ 189
</TABLE>
See Notes to Consolidated Financial Statements.
3
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ENCAD, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Unaudited (in thousands, except per
share data)
1) BASIS OF PRESENTATION -- The accompanying consolidated financial
statements as of June 30, 1999 and for the three and six month periods
ended June 30, 1999 and 1998 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, 1998 ("1998 Annual Report"). 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 and six month periods ended June 30, 1999.
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.
2) INVENTORIES:
<TABLE>
<CAPTION>
JUNE 30, December 31,
1999 1998
---------------- ----------------
<S> <C> <C>
Raw materials $ 4,918 $ 5,061
Work-in-process 86 269
Finished goods 8,227 10,875
================ ================
Total $ 13,231 $ 16,205
================ ================
</TABLE>
3) COMPREHENSIVE INCOME -- 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.
4) REVOLVING LINE OF CREDIT -- At June 30, 1999, the Company had available a
$15,000 revolving line of credit currently set to expire in January 2000.
No amounts were outstanding under the line of credit at June 30, 1999 and
$6,000 was outstanding under a prior agreement at December 31, 1998. The
line is secured by certain assets of the Company with a borrowing base
limited to eligible accounts receivable and inventory and is subject to
certain financial covenants.
4
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5) EARNINGS PER SHARE -- 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.
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,
1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ----------- ---------------
<S> <C> <C> <C> <C>
Net income $ 807 $ 1,374 $ 1,156 $ 648
============ ============ =========== ===============
Earnings per share - basic $ 0.07 $ 0.12 $ 0.10 $ 0.06
============ ============ =========== ===============
Basic weighted average common
shares outstanding 11,694 11,565 11,665 11,546
Effect of dilutive securities:
Stock options 260 199 146 372
------------ ------------ ----------- ---------------
Diluted weighted average common and
common equivalent shares outstanding 11,954 11,764 11,811 11,918
============ ============ =========== ===============
Earnings per share - diluted $ 0.07 $ 0.12 $ 0.10 $ 0.05
============ ============ =========== ===============
</TABLE>
6) SEGMENT INFORMATION -- For the years ended December 31, 1997 and 1998, and
during the first quarter of 1999 the Company's business was organized,
managed and internally reported as two segments: the Digital Imaging
Solutions business unit and the Textile business unit. Due to the
similarity of production processes, distribution methods, customers and
products, the segment information for the Digital Imaging Solutions and
Textile business units had been aggregated into one segment. On April 22,
1999, the Company consolidated its Digital Imaging Solutions and Textile
business units in order to further leverage the Company's resources in
support of its solutions-based, vertical market strategy. As a result, the
Company is managing and internally reporting the Company's business as one
reportable segment, principally, the design, development, manufacture and
sales of digital imaging solutions, including wide-format color inkjet
printers and related supplies, accessories, software and service for the
graphic arts and computer aided design markets.
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. Our 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. We undertake 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, consolidated
statements of income data for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------------- -------------------------------
1999 1998 1999 1998
- ------------------------------------------------------------------- -------------------------------
<S> <C> <C> <C> <C>
NET SALES 100.0% 100.0% 100.0% 100.0%
COST OF SALES 56.2% 59.3% 56.7% 60.5%
- ------------------------------------------------------------------- -------------------------------
GROSS PROFIT 43.8% 40.7% 43.3% 39.5%
- ------------------------------------------------------------------- -------------------------------
MARKETING AND SELLING 19.3% 19.5% 19.5% 21.5%
RESEARCH AND DEVELOPMENT 11.4% 7.7% 10.8% 9.1%
GENERAL AND ADMINISTRATIVE 8.6% 7.1% 9.6% 8.6%
- ------------------------------------------------------------------- -------------------------------
INCOME FROM OPERATIONS 4.5% 6.4% 3.4% 0.3%
OTHER INCOME - - - 1.7%
INTEREST EXPENSE - NET (0.2%) (0.3%) (0.3%) (0.4%)
- ------------------------------------------------------------------- -------------------------------
INCOME BEFORE INCOME TAXES 4.3% 6.1% 3.1% 1.6%
PROVISION FOR INCOME TAXES 1.5% 2.1% 1.1% 0.5%
- ------------------------------------------------------------------- -------------------------------
NET INCOME 2.8% 4.0% 2.0% 1.1%
- ------------------------------------------------------------------- -------------------------------
- ------------------------------------------------------------------- -------------------------------
</TABLE>
RESULTS OF OPERATIONS
NET SALES -- Our net sales for the three and six month periods ended June
30, 1999 decreased 16% and remained flat, respectively, from the same periods of
1998. This decrease was due to strong sales during the second quarter of 1998,
which had been positively impacted by the first quarter pre-announcement by us
and our competitors of new products which then shipped in the second quarter of
1998. During the three and six month periods ended June 30, 1999, supply sales
decreased 14% and 5%, respectively, from the same periods of 1998, and accounted
for approximately 29% and 30% of net sales during the three and six month
periods ended June 30, 1999, respectively, as compared to 29% and 32% during the
same periods of 1998. The decrease of supply sales was due primarily to
decreased demand and lower pricing on media products. We plan to continue to
focus our supply selling efforts on higher margin ink products while
de-emphasizing lower margin media products. Net sales to OEM customers for
both the three and six month periods ended June 30, 1999 accounted for 20% of
net sales for each of these periods as compared to 11% and 16%, respectively,
for the same periods of 1998.
One customer, Tekgraf, Inc., a U.S. distributor, accounted for 14% and 13%
of net sales during the three and six month periods ended June 30, 1999, whereas
no one customer accounted for more than 10% of net sales during the same periods
of 1998. International sales accounted for approximately 56% and 62% for the
three and six month periods ended June 30, 1999, compared to 65% of net sales
for each of the same periods of 1998.
COST OF SALES -- Cost of sales includes costs related to product
shipments, including materials, labor, overhead, inventory reserves,
manufacturing variances, 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 56% and 57% for the three and
six month periods June 30, 1999, respectively, as compared to 59%
6
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and 60% for the three and six month periods ended June 30, 1998. The decrease
during the three months ended June 30, 1999 was due to a reduction in product
costs and higher margins on the newly introduced NovaJet family of printers.
The decrease during the six months ended June 30, 1999 also included an
increase in average selling prices due to the cessation of rebate programs
during the first quarter of 1999. Our future success will depend, in part, on
our ability to develop and manufacture competitive higher margin products and
continue to achieve cost reductions for our existing products.
MARKETING AND SELLING -- Marketing and selling expenses were 19% and 20%,
respectively, of net sales during the three and six month periods ended June 30,
1999 compared to 20% and 22% during the same periods of 1998, which represents a
decrease in absolute dollars of 17% and 19%, respectively. This decrease was due
to decreased spending for advertising and trade shows and an overall decrease in
expenditures related to the supplies and textile business. As a result of the
consolidation of our printer and supplies business units, and most recently our
textile business unit, into one business unit, marketing and selling expenses
during the remainder of 1999 are expected to remain at levels below prior
periods as we intend to continue to promote our products and support our
marketing and selling activities in a more cost effective manner. We may,
however, need to increase costs related to marketing programs required to
support our distribution channel or on connection with the introduction of new
products.
RESEARCH AND DEVELOPMENT -- Research and development spending was 11% of
net sales for both the three and six month periods ended June 30, 1999
compared to 8% and 9% during the same periods of 1998, respectively. In
absolute dollars, 1999 research and development spending increased by 25% and
19% over the three and six month periods ended June 30, 1998, respectively.
The increase in spending reflects the addition of several engineers and
consultants, as well as expenses related to the recently introduced NovaJet
products. We expect to continue to invest significant resources in our
strategic programs and enhancements to existing products and consequently
expect that 1999 research and development expenses will continue to increase
in absolute dollars over 1998.
GENERAL AND ADMINISTRATIVE -- General and administrative expenses were
9% and 10% of net sales during the three and six month periods ended June 30,
1999, respectively, compared to 7% and 9% during the same periods of 1998 and
increased by 3% and 11% over the three and six month periods ended June 30,
1998, respectively. This slight increase was due largely to increased legal
fees related primarily to the numerous lawsuits in which we are currently
engaged.
INTEREST EXPENSE - NET -- Interest expense - net of interest income
decreased to $51 and $169 during the three and six month periods ended June
30, 1999, respectively, from $114 and $214 during the comparable periods of
1998. Decreased average amounts outstanding on our line of credit during the
three and six month periods ended June 30, 1999 caused the decrease in
interest expense.
OTHER INCOME -- Other income for the six month period ended June 30,
1998 included payments received under a product development and license
agreement signed during the first quarter of 1998. Under this agreement, we
assisted in the development of a wide-format color inkjet product targeted
for markets outside of our focus. We received additional reimbursements for
engineering expenses in 1998 and in 1999.
PROVISION FOR INCOME TAXES -- The effective income tax rate during both
the three and six month periods ended June 30, 1999 was approximately 35%
compared to 35% and 31% during the same periods of 1998, respectively. 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 of 1999,
represents approximately $80. We expect the effective rate for the year
ending December 31, 1999 to be at or near the current levels.
NET INCOME -- The previously described elements caused net income during
the three and six months periods ended June 30, 1999 to stand at 3% and 2% of
net sales, respectively, as compared to net income of 4% and 1% for the same
periods of 1998.
7
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LIQUIDITY AND CAPITAL RESOURCES
We have historically funded our operations primarily through cash flow
provided from operations. As of June 30, 1999, we had cash and cash
equivalents totaling $3,261 and working capital of $33,004. In comparison, we
had cash and cash equivalents totaling $586, and working capital of $31,320
as of December 31, 1998. The increase in cash and cash equivalents was due
primarily to collections of accounts receivable, the receipt of an income tax
refund and operating income during the first six months of 1999.
We have received, and anticipate we will continue to receive, the
majority of our cash from collections of accounts receivable from our
distributors and OEMs. These groups in general have a history of timely
payments; however, an increasing amount of international sales can increase
accounts receivable balances due to traditionally slower payments by our
international customers.
At June 30, 1999, net accounts receivable decreased by $2,828 from
1998's year end balance of $29,063. This decrease was due primarily to
increased collections as a result of increased collection efforts during the
first six months of 1999.
We invest our excess cash in money market accounts and have established
guidelines relative to diversification and maturities to maintain safety and
liquidity. These guidelines are periodically reviewed and modified to take
advantage of trends in yields and interest rates. We have not experienced, to
date, any losses on our short-term investments.
Inventory levels decreased by $2,974 at June 30, 1999 from $16,205 at
the end of 1998. This decrease was primarily attributable to a more focused
effort to reduce finished good inventories while maintaining required
availability to meet demand.
During the six months ended June 30, 1999 and 1998, we made capital
expenditures of $1,171 and $2,864, respectively. In the first six months of
1998, we incurred costs related primarily to the implementation of a new
enterprise-wide information system, whereas 1999's amounts were related
primarily to computer and related systems and building improvements. During
the remainder of 1999, we anticipate that we will incur similar types of
capital expenditures.
REVOLVING LINE OF CREDIT -- At June 30, 1999, we had available a $15,000
revolving line of credit currently set to expire in January 2000. No amounts
were outstanding under the line of credit at June 30, 1999 and $6,000 was
outstanding under a prior agreement at December 31, 1998. The line is secured
by specified assets with a borrowing base limited to eligible accounts
receivable and inventory. In addition, the availability of the line is
subject to our maintaining financial covenants.
We believe that our existing cash and cash equivalents, cash generated
from operations, funds available from various financing alternatives
involving our owned headquarter facilities, and funds available under the
bank line of credit will be sufficient to satisfy our 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, as well as the selling price and costs of these products.
Future cash requirements to fund operations may require us to seek additional
capital which may not be available when required on terms acceptable to us.
To date, inflation has not had a significant effect on our operating results.
YEAR 2000 COMPLIANCE -- We utilize computer technologies throughout our
business to conduct our day-to-day operations. Computer technologies include
both information technology in the form of hardware and software, as well as
embedded technology in our facilities systems and equipment. We must
determine whether our products and systems are capable of recognizing and
processing date sensitive information properly as the year 2000 approaches.
To do so, we are using a multi-phased concurrent approach. Specific project
phases include: awareness, assessment, remediation, validation and
implementation. We have completed the awareness and assessment phases of this
project. Furthermore, we have nearly completed the remediation phase and are
well into the validation and implementation phases.
8
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All of our current products are year 2000 compliant. The system vendors
have represented that the enterprise-wide information systems which we
implemented in the third quarter of 1998 are year 2000 compliant. We are
actively correcting and replacing those other systems which are not year 2000
ready. We have verified this compliance with our own testing. We are in the
final upgrade and testing stages for our network servers and we have one
engineering design system that we intend to upgrade in the third quarter of
1999. All year 2000 remediation processes may not be completed and properly
tested before the year 2000; and contingency plans may not sufficiently
mitigate the risk of a year 2000 readiness problem. An interruption of our
ability to conduct our business due to a year 2000 readiness problem could
have a material adverse effect on us.
We estimate that the additional aggregate costs of our year 2000
project will not be material. A portion of these costs, primarily those not
related to the implementation of our primary enterprise-wide information
system, are 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 our day-to-day operations. The
anticipated impact and costs of the project, as well as the date on which we
expect to complete the project, are based on our 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 our current
estimates and information currently available, we do not anticipate that the
costs associated with this project will have a material adverse effect on our
consolidated financial position, results of operations or cash flows in
future periods.
We continue the process of communicating with our significant
suppliers, customers and critical business partners to determine the extent
to which we may be vulnerable in the event that those parties fail to
properly remediate their own year 2000 issues. We are monitoring the progress
made by those parties, and to the extent possible, plan to test critical
system interfaces. We will develop appropriate contingency plans in the event
that a significant exposure is identified relative to the dependencies on
third-party systems. While we are not presently aware of any such significant
exposure, the systems of third-parties on which we rely may not be converted
in a timely manner, or that a failure to properly convert by another company
may have a material adverse effect on us.
RISKS AND UNCERTAINTIES
OUR QUARTERLY OPERATING RESULTS CAN FLUCTUATE SIGNIFICANTLY.
Our quarterly operating results can fluctuate significantly depending on a
number of factors. Any one of these factors could have a material adverse effect
on our financial condition or results of operations. These factors include:
- timing of product announcements and subsequent introductions of
products by us and our competitors;
- timing of shipments of our products, including the mix of product
families shipped;
- changes in prices by us and our competitors;
- market acceptance of new products;
- availability and cost of components;
- price protection for selling price reductions offered to customers.
- currency fluctuations; and
- seasonality.
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. We may experience significant quarterly fluctuations in
net sales as well as operating expenses with respect to future new product
introductions. In addition, our component purchases, production and spending
levels are based upon forecast demand for our products. Accordingly, any
inaccuracy in forecasting could adversely affect our financial condition and
results of operations in any financial period. Demand for our products could be
adversely affected by a slowdown in the overall demand for computer systems,
printer products or digitally printed images. Failure to complete shipments
during a quarter also could have a material adverse effect on our financial
condition or results of operations. Quarterly results are not necessarily
indicative of future performance for any particular period. We may not be able
to maintain the levels of sales and profitability experienced over the past
several years on a quarterly or annual basis.
9
<PAGE>
THE MARKETS FOR OUR PRODUCTS ARE HIGHLY COMPETITIVE AND RAPIDLY CHANGING
AND WE MAY NOT BE SUCCESSFUL IN COMPETING IN THIS MARKET.
The markets for our printers and supplies are highly competitive and
rapidly changing. Several new competitors, including Seiko Epson Corporation,
have entered the market. Our principal competitor is Hewlett-Packard Company,
which dominates the CAD category of the wide-format inkjet markets and is our
principal competition in the graphic arts category. In addition to direct
competition in inkjet printers and related supplies, our products also face
competition from other technologies in the wide-format market. The competition
to sell ink, media and software products to the customer is also intense. Some
of our current and prospective competitors, particularly Hewlett-Packard and
Epson, have significantly greater financial, technical, manufacturing and
marketing resources than us. Our ability to compete in the wide-format inkjet
market depends on a number of factors within and outside our control, including:
- the success and timing of product introductions by us and our
competitors;
- selling prices;
- product performance;
- product distribution;
- marketing ability; and
- customer support.
A key element of our strategy is to provide competitively priced,
quality products, yet we may not be able to do so. We reduced prices on many
of our 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 our financial condition and results of
operations in the future.
THE MARKETS IN WHICH WE COMPETE ARE CHARACTERIZED BY SHORT PRODUCT LIFE
CYCLES AND REDUCTIONS IN UNIT SELLING PRICES WHICH MAY HAVE AN ADVERSE
EFFECT ON OUR BUSINESS.
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. Our future success will depend on our ability to develop
and manufacture competitive products and achieve cost reductions for our
existing products. Advances in technology will require increased investment to
maintain our market position. Our financial condition and results of operations
could be adversely affected if we are unable to develop and manufacture new,
competitive products in a timely manner.
THE GROWTH OF OUR BUSINESS WILL REQUIRE SUBSTANTIAL CAPITAL RESOURCES THAT
MAY NOT BE AVAILABLE WHEN NEEDED.
The growth of our business will require the commitment of substantial
capital resources. If funds are not available from operations we will need
additional funds. Such additional funds may not be available when required on
terms acceptable to us. Insufficient funds may require us to delay, reduce or
eliminate some or all of our planned activities.
OUR SUCCESS IS DEPENDENT ON OUR ABILITY TO ATTRACT AND RETAIN QUALIFIED
EMPLOYEES AND CONSULTANTS.
Our success is dependent, in part, on our ability to attract and retain
qualified management and technical employees. Competition for such personnel is
intense. The inability to attract additional key employees or the loss of one or
more key employees could adversely affect us. We do not have employment
agreements with or life insurance on members of senior management. We may not be
able to retain our key personnel. We rely heavily on industry consultants and
other specialists to assist and influence decisions, keep abreast of
technological and industry advances, and assist in other processes. A delay in
product introduction is possible to the extent key consultants are not
available.
10
<PAGE>
MANY OF OUR COMPONENTS ARE SUPPLIED BY SINGLE-SOURCE SUPPLIERS THAT MAY
NOT BE ABLE TO BE REPLACED WITHOUT DISRUPTING OUR OPERATIONS.
Certain components used in our products are only available from single
sources. We generally do not have long-term agreements with our suppliers. For
some of these sole-source components, the process of qualifying replacement
suppliers, replacing tooling or ordering and receiving replacement components
could take several months and cause substantial disruption to our operations. If
a supplier is unable to meet our needs or supplies parts which we find
unacceptable, we may not be able to meet production demands. Certain key
components of our products are supplied indirectly by our principal competitor,
Hewlett-Packard. Any significant increase in component prices or decrease in
component availability could have a material adverse effect on our business.
IF OUR COMPETITORS ARE SUCCESSFUL IN ESTABLISHING THAT THEIR INTELLECTUAL
PROPERTY RIGHTS ARE VIOLATED BY OUR PRODUCTS, WE COULD BE PROHIBITED FROM
MARKETING THE PRODUCTS THAT INCORPORATE SUCH RIGHTS.
From time to time, certain competitors, including Hewlett-Packard, have
asserted patent rights relevant to our business. We expect that this will
continue. We carefully evaluate each assertion relating to our products. If our
competitors are successful in establishing that asserted rights have been
violated, we could be prohibited from marketing the products that incorporate
such rights. We could also incur substantial costs to redesign our products or
to defend any legal action taken against us. If our products should be found to
infringe upon the intellectual property rights of others, we could be enjoined
from further infringement and be liable for any damages. The measures adopted by
us for the protection of our intellectual property may not be adequate to
protect our interests. In addition, our competitors may independently develop
technologies that are substantially equivalent or superior to our technologies.
A SIGNIFICANT PORTION OF OUR NET SALES IS DERIVED FROM SALES TO COUNTRIES
OUTSIDE THE UNITED STATES AND FACTORS OUTSIDE OUR CONTROL COULD ADVERSELY
AFFECT OUR SALES IN THOSE COUNTRIES.
For the six month periods ended June 30, 1999 and 1998, sales outside the
United States represented approximately 62% and 65% of our net sales,
respectively. We expect export sales to continue to represent a significant
portion of our sales. All of our products sold in international markets are
denominated in U.S. dollars. An increase in the value of the U.S. dollar
relative to foreign currencies could make our products less competitive in these
markets. International sales and operations may also be subject to risks such
as:
- 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 our products and
intellectual property rights to the same extent as the laws of the United
States. As we continue to pursue our international business, these factors may
have an adverse effect on our sales and, consequently, on our business.
WE ARE DEPENDENT ON OUR DISTRIBUTORS AND OEMS TO SELL AND MARKET OUR
PRODUCTS AND THEY MAY NOT DEVOTE SUFFICIENT RESOURCES TO THIS TASK TO
ENSURE OUR SUCCESS.
Our sales are principally made through independent distributors, which may
carry competing product lines. Such distributors could reduce or discontinue
sales of our products, which could have a material adverse effect on our
business. These distributors may not devote the resources necessary to provide
effective sales, service and marketing support of our products. In addition, we
are dependent upon the continued viability and financial stability of these
distributors, many of which are organizations with limited capital. These
distributors, in turn, are substantially dependent upon their dealers, general
economic conditions and other unique factors affecting the wide-format printer
11
<PAGE>
market. We believe that our future growth and success will continue to depend
in large part upon our distribution channels. Actual bad debts may in the
future exceed recorded allowances resulting in a material adverse effect on
our business. In order to prevent inventory write-downs, to the extent that
OEM and private label customers do not purchase products as anticipated, we
may need to convert such products to make them salable to other customers.
Such a conversion would increase product costs and would likely result in a
delay in selling such products.
MANAGEMENT OF THE GROWTH OF OUR BUSINESS MAY PLACE STRAINS ON OUR
OPERATIONS.
We have experienced growth in the past that placed, and, if continued,
will continue to place, a significant strain on our management, employees,
systems and operations. Our future operating results will depend on our ability
to continue to broaden our senior management group, attract, hire and retain
skilled employees and enhance or replace existing operational information and
financial control systems. We may encounter difficulties in successfully
integrating new personnel into the organization, and changes to our information
and financial control systems may not be effective. Our inability to manage
growth effectively could have a material adverse effect on our business.
AS THE MARKET PRICE OF OUR COMMON STOCK HAS BEEN VOLATILE IN THE PAST AND
MAY CONTINUE TO BE SO IN THE FUTURE, AN INVESTMENT IN OUR COMMON STOCK MAY
YIELD UNCERTAIN RESULTS.
The market price of our common stock has fluctuated significantly since
our initial public offering in December 1993. We believe factors such as the
following could cause further significant volatility in the price of the common
stock:
- general stock market trends;
- announcements of developments related to our business;
- fluctuations in our operating results;
- general conditions in the computer peripheral market and the markets
we serve or in the worldwide economy;
- shortfalls in sales or earnings from securities analysts'
expectations;
- announcements of technological innovations or new inkjet products
or enhancements by us or our competitors;
- developments in patents or other intellectual property rights; and
- developments in our relationships with our customers or suppliers.
In addition, in recent years the stock market in general, and the market
for shares of technology stocks in particular, have experienced extreme
volatility, which has often been unrelated to the operating performance of
affected companies. The market price of our common stock may continue to
experience significant fluctuations that are unrelated to our operating
performance.
WE HAVE NOT COMPLETED OUR SURVEY OF OUR VENDORS OR CUSTOMERS OR OUR
TESTING OF THE SYSTEMS USED IN OUR BUSINESS TO DETERMINE IF THEY ARE YEAR
2000 COMPLIANT; FAILURE TO BE YEAR 2000 COMPLIANT COULD HAVE AN ADVERSE
EFFECT ON OUR BUSINESS.
All year 2000 remediation processes may not be completed and properly
tested before the year 2000. Any contingency plans we develop may not
sufficiently mitigate the risk of a year 2000 readiness problem. An interruption
of our ability to conduct our business due to a year 2000 readiness problem
could have a material adverse effect on us. For a discussion of our year 2000
initiatives, please see "Year 2000 Compliance" above.
WE DO NOT PAY DIVIDENDS ON OUR COMMON STOCK AND YOU WILL HAVE TO RELY ON
INCREASES IN ITS PRICE TO GET A RETURN ON YOUR INVESTMENT.
We have not paid dividends on our common stock. We currently intend to
continue this policy to retain earnings, if any, for use in our business. In
addition, our line of credit arrangement prohibits the payment of cash dividends
without prior bank approval if amounts are outstanding under such line of
credit.
OUR CHARTER DOCUMENTS AND RIGHTS PLAN MAY PREVENT A CHANGE OF CONTROL
WHICH IS IN YOUR BEST INTERESTS.
The stockholder rights plan and our charter documents may discourage some
types of transactions involving an actual or potential change in control of your
company, including transactions in which you might otherwise receive a
12
<PAGE>
premium for your shares over then-current market prices. Provisions in the
charter documents may limit your ability to approve transactions that you
deem to be in your best interests.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (in
thousands, except percentages)
Our only current financial instruments with market risk exposure are our
revolving line of credit borrowings, of which no amounts were outstanding at
June 30, 1999. The amount of variable rate debt fluctuates during the year based
upon our cash requirements. Maximum borrowings at any time during the second
quarter of 1999 were $4,000. Based on the outstanding balance at June 30, 1999,
an adverse 10% change in the interest rate underlying these borrowings would
result in no annual change in our pre-tax earnings and cash flow.
These instruments are non-trading in nature and carry interest at the
bank's prime rate (7.75% at June 30, 1999) or at our option, a rate based on the
London Interbank Overnight Rate (5.37% at June 30, 1999 plus 2.25%). Our
objective in maintaining these variable rate borrowings is the flexibility
obtained regarding early repayment without penalties and lower overall cost as
compared with fixed rate borrowings.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Reference is made to the disclosures in Part I, Item 3, "Legal
Proceedings," in the 1998 Form 10-K and to Part II, Item 1, "Legal Proceedings,"
in the Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
1999.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On April 25, 1999 we issued 4,000 shares of common stock to Michael J.T.
Steep, Executive Vice President and Chief Operating Officer, as consideration
for services rendered pursuant to his offer of employment letter. The issuance
of such shares were exempt from registration under the Securities Act of 1933,
as amended, pursuant to Section 4(2) as a transaction not part of a public
offering.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES (in thousands)
None
13
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's 1999 Annual Meeting of Stockholders was held on May 19, 1999,
in Del Mar, California, for the following purposes:
1. The following six directors were elected to serve a one-year term that
will expire at the Company's 2000 Annual Meeting of Stockholders:
<TABLE>
<CAPTION>
FOR WITHHELD
--- --------
<S> <C> <C>
Robert V. Adams 10,631,233 108,009
Craig S. Andrews 10,506,233 233,009
Ronald J. Hall 10,631,233 108,009
Howard L. Jenkins 10,631,233 108,009
David A. Purcell 10,631,233 108,009
Charles E. Volpe 10,631,233 108,009
</TABLE>
2. The stockholders ratified and approved the 1999 Stock Option Plan and the
reservation of 580,000 shares for issuance thereunder. The total number of
votes cast for and against were 9,632,887, and 884,865, respectively, with
51,883 abstentions and 169,607 broker non-votes.
3. The stockholders ratified the appointment of Deloitte & Touche LLP as the
Company's independent public accountants for the fiscal year ending
December 31, 1999. The total number of votes cast for and against were
10,630,480, and 71,629, respectively, with 37,133 abstentions.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
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 3.2).(2)
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)
4.2 First Amendment to the Company's Rights Plan.(3)
+ 10.1 ENCAD, Inc. 1999 Stock Option/Stock Issuance Plan (filed as
Exhibit 99.1).(4)
+ 10.2 Form of Notice of Grant of Stock Option (filed as
Exhibit 99.2).(4)
+ 10.3 Form of Stock Option Agreement (filed as Exhibit 99.3).(4)
+ 10.4 Form of Addendum to Stock Option Agreement - Involuntary
Termination Following Corporate Transaction/Change in Control
(filed as Exhibit 99.4).(4)
+ 10.5 Form of Addendum to Stock Option Agreement - Limited Stock
Appreciation Right (filed as Exhibit 99.5).(4)
+ 10.6 Form of Stock Issuance Agreement (filed as Exhibit 99.6).(4)
14
<PAGE>
+ 10.7 Form of Addendum to Stock Issuance Agreement - Involuntary
Termination Following Corporate Transaction/Change in Control
(filed as Exhibit 99.7).(4)
+ 10.8 Form of Notice of Grant of Non-Employee Director - Initial
(filed as Exhibit 99.8).(4)
+ 10.9 Form of Notice of Grant of Non-Employee Director - Annual
(filed as Exhibit 99.9).(4)
+ 10.10 Form of Automatic Stock Option Agreement (filed as
Exhibit 99.10).(4)
27.1 Financial Data Schedule.
-----------------------
(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 exhibit to the Registrant's Registration Statement on
Form 8-A12G/A (No. 000-23034) and incorporated herein by reference.
(4) Filed as exhibit to the Registrant's Registration Statement on Form S-8
(No. 333-85143) and incorporated herein by reference.
+ Management compensatory plan.
(b) Reports on Form 8-K - No reports on Form 8-K were filed during the quarter
ended June 30, 1999.
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 16, 1999
ENCAD, Inc.
(Registrant)
/s/ Todd W. Schmidt
---------------------------------------------
(Todd W. Schmidt)
Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)
15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ENCAD,
INC. JUNE 30, 1999 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-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 3,261
<SECURITIES> 0
<RECEIVABLES> 26,235
<ALLOWANCES> 0
<INVENTORY> 13,231
<CURRENT-ASSETS> 48,132
<PP&E> 28,364
<DEPRECIATION> 13,238
<TOTAL-ASSETS> 65,118
<CURRENT-LIABILITIES> 15,128
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 49,094
<TOTAL-LIABILITY-AND-EQUITY> 65,118
<SALES> 58,235
<TOTAL-REVENUES> 58,235
<CGS> 33,027
<TOTAL-COSTS> 33,027
<OTHER-EXPENSES> 23,248
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 169
<INCOME-PRETAX> 1,791
<INCOME-TAX> 635
<INCOME-CONTINUING> 1,156
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,156
<EPS-BASIC> 0.10
<EPS-DILUTED> 0.10
</TABLE>
