<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 September 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-R-, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-3672088
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6059 CORNERSTONE COURT WEST
SAN DIEGO, CA 92121
(Address of principal executive offices) (Zip Code)
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 October
31, 1999, was 11,760,219.
<PAGE>
ENCAD, INC.
INDEX
PAGE
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets at
September 30, 1999 and December 31, 1998.................. 1
Consolidated Statements of Income for the
three and nine months ended September 30, 1999 and 1998... 2
Consolidated Statements of Cash Flows for the
nine months ended September 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........ 13
ITEM 5. OTHER INFORMATION.......................................... 13
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K........................... 13
SIGNATURES.......................................................... 15
i
<PAGE>
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(in thousands, except per share data) SEPTEMBER 30, December 31,
1999 1998
--------------------------------
(UNAUDITED) (Note)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,012 $ 586
Accounts receivable - net 28,611 29,063
Inventories 12,740 16,205
Income taxes receivable - 2,403
Deferred income taxes 3,969 6,025
Prepaid expenses 1,112 825
------- -------
Total current assets 47,444 55,107
PROPERTY - NET 14,777 15,604
OTHER ASSETS 1,871 1,432
------- -------
TOTAL ASSETS $64,092 $72,143
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 7,465 $11,785
Accrued expenses and other liabilities 5,765 6,002
Borrowings under line of credit - 6,000
------- -------
Total current liabilities 13,230 23,787
------- -------
OTHER LIABILITIES 931 813
STOCKHOLDERS' EQUITY:
Preferred stock - $.001 par value; 5,000 shares authorized,
Series A Junior Participating Preferred Stock - no shares
issued and outstanding - -
Common stock, par value - $.001 per share, 60,000 shares
authorized, 11,759 and 11,636 shares issued and
outstanding at September 30, 1999 and December 31, 1998 12 12
Additional paid -in capital 19,246 18,704
Accumulated earnings 30,673 28,827
------- -------
Total stockholders' equity 49,931 47,543
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $64,092 $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
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
NET SALES $27,022 $24,201 $85,257 $82,413
COST OF SALES 15,102 18,485 48,129 53,690
------- ------- ------- -------
GROSS PROFIT 11,920 5,716 37,128 28,723
------- ------- ------- -------
MARKETING AND SELLING 5,963 5,983 17,338 18,524
RESEARCH AND DEVELOPMENT 2,614 2,701 8,874 7,977
GENERAL AND ADMINISTRATIVE 2,350 3,004 7,963 8,039
------- ------- ------- -------
10,927 11,688 34,175 34,540
------- ------- ------- -------
INCOME (LOSS) FROM OPERATIONS 993 (5,972) 2,953 (5,817)
OTHER INCOME - - - 999
INTEREST EXPENSE - NET (28) (112) (197) (326)
------- ------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES 965 (6,084) 2,756 (5,144)
PROVISION FOR INCOME TAXES 275 (2,166) 910 (1,874)
------- ------- ------- -------
NET INCOME (LOSS) $ 690 $(3,918) $ 1,846 $(3,270)
------- ------- ------- -------
------- ------- ------- -------
EARNINGS (LOSS) PER SHARE - BASIC $ 0.06 $ (0.34) $ 0.16 $ (0.28)
------- ------- ------- -------
------- ------- ------- -------
EARNINGS (LOSS) PER SHARE - DILUTED $ 0.06 $ (0.34) $ 0.16 $ (0.28)
------- ------- ------- -------
------- ------- ------- -------
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING - BASIC 11,736 11,584 11,689 11,556
------- ------- ------- -------
------- ------- ------- -------
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING - DILUTED 12,087 11,584 11,892 11,556
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
See Notes to Consolidated Financial Statements.
2
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
1999 1998
---- ----
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 1,846 $(3,270)
Adjustments to reconcile net income (loss) to cash provided by
operating activities:
Depreciation and amortization 2,456 3,055
Provision for losses on accounts receivable and inventories (688) 1,852
Tax benefit from exercise of stock options 22 295
Changes in assets and liabilities:
Accounts receivable 940 8,020
Inventories 3,665 3,154
Income taxes receivable 2,403 -
Deferred income taxes 2,056 (1,172)
Prepaid expenses and other assets (726) (1,147)
Accounts payable (4,320) (3,502)
Accrued expenses and other liabilities (119) (4,701)
------- -------
Cash provided by operating activities 7,535 2,584
------- -------
INVESTING ACTIVITIES:
Purchases of property (1,629) (4,025)
------- -------
Cash used in investing activities (1,629) (4,025)
------- -------
FINANCING ACTIVITIES:
Exercise of common stock options and sale of stock under
employee stock purchase plan 520 767
Net borrowings under line of credit (6,000) 883
------- -------
Cash (used in) provided by financing activities (5,480) 1,650
------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS 426 209
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 586 1,265
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,012 $ 1,474
------- -------
------- -------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash (received) paid during the period for income taxes $(3,416) $ 2,082
------- -------
------- -------
Cash paid during the period for interest $ 256 $ 300
------- -------
------- -------
</TABLE>
See Notes to Consolidated Financial Statements.
3
<PAGE>
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 September 30, 1999 and for the three and nine month periods ended
September 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 nine month periods ended September 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>
SEPTEMBER 30, December 31,
1999 1998
---------------- ----------------
<S> <C> <C>
Raw materials $ 5,061 $ 5,061
Work-in-process 102 269
Finished goods 7,577 10,875
---------------- ----------------
Total $ 12,740 $ 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 September 30, 1999, the Company had
available a $15,000 revolving line of credit currently set to expire in
January 2000. We are currently in discussions with the bank regarding a
similar line of credit. No amounts were outstanding under the line of
credit at September 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
<PAGE>
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 nine month periods ended September
30, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ----------- -------------
<S> <C> <C> <C> <C>
Net income $ 690 $ (3,918) $ 1,846 $ (3,270)
------------ ------------ ----------- -------------
Earnings per share - basic $ 0.06 $ (0.34) $ 0.16 $ (0.28)
------------ ------------ ----------- -------------
------------ ------------ ----------- -------------
Basic weighted average common
shares outstanding 11,736 11,584 11,689 11,556
Effect of dilutive securities:
Stock options 351 0 203 0
------------ ------------ ----------- -------------
Diluted weighted average common and
common equivalent shares outstanding 12,087 11,584 11,892 11,556
------------ ------------ ----------- -------------
Earnings per share - diluted $ 0.06 $ (0.34) $ 0.16 $ (0.28)
------------ ------------ ----------- -------------
------------ ------------ ----------- -------------
</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
<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. 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ------------------------------
1999 1998 1999 1998
--------------------------------- ------------------------------
<S> <C> <C> <C> <C>
NET SALES 100.0% 100.0% 100.0% 100.0%
COST OF SALES 55.9% 76.4% 56.5% 65.1%
- ------------------------------------------------------------------- ------------------------------
GROSS PROFIT 44.1% 23.6% 43.5% 34.9%
- ------------------------------------------------------------------- ------------------------------
MARKETING AND SELLING 22.1% 24.7% 20.4% 22.5%
RESEARCH AND DEVELOPMENT 9.7% 11.2% 10.4% 9.7%
GENERAL AND ADMINISTRATIVE 8.7% 12.4% 9.3% 9.7%
- ------------------------------------------------------------------- ------------------------------
INCOME FROM OPERATIONS 3.6% (24.7%) 3.4% (7.0%)
OTHER INCOME - - - 1.2%
INTEREST EXPENSE - NET (0.1%) (0.5%) (0.2%) (0.4%)
- ------------------------------------------------------------------- ------------------------------
INCOME BEFORE INCOME TAXES 3.5% (25.2%) 3.2% (6.2%)
PROVISION FOR INCOME TAXES 1.0% (9.0%) 1.0% (2.2%)
- ------------------------------------------------------------------- ------------------------------
NET INCOME 2.5% (16.2%) 2.2% (4.0%)
- ------------------------------------------------------------------- ------------------------------
- ------------------------------------------------------------------- ------------------------------
</TABLE>
RESULTS OF OPERATIONS
NET SALES - Our net sales for the three and nine month periods ended
September 30, 1999 increased approximately 12% and 3%, respectively, from the
same periods of 1998. These increases were due to strong sales generally
throughout our printer product line. During the three and nine month periods
ended September 30, 1999, supplies sales decreased by 13% and 8%, respectively,
from the same periods of 1998, and accounted for approximately 31% of net sales
during both the three and nine month periods ended September 30, 1999,
respectively, as compared to 40% and 35% during the same periods of 1998. The
decrease in supplies sales was due primarily to decreased demand and lower
pricing for media products. We plan to continue to focus our supplies selling
efforts on higher margin ink products while de-emphasizing lower margin media
products. Net sales to OEM customers for both the three and nine month periods
ended September 30, 1999 accounted for 14% and 18% of net sales for each of
these periods as compared to 20% and 17%, respectively, for the same periods of
1998. The percentage decrease in sales to OEM customers as compared to the same
periods in 1998 was due to limited availability of our newly introduced products
to these OEM customers until late in the quarter.
One customer, Tekgraf, Inc., a U.S. distributor, accounted for
approximately 13% and 14% of net sales during the three and nine month periods
ended September 30, 1999. Tekgraf, Inc. accounted for 10% of net sales during
the three month period ended September 30, 1998, and no single customer
accounted for more than 10% of sales during the nine month period ended
September 30, 1998. International sales accounted for approximately 69% and 64%
for the three and nine month periods ended September 30, 1999, compared to 61%
and 64% during the same periods of 1998.
6
<PAGE>
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 approximately 56% and 57% for the three and
nine month periods September 30, 1999, respectively, as compared to
approximately 76% and 65% for the three and nine month periods ended September
30, 1998. The Company achieved higher gross profit margin percentages during the
three- and nine-month periods ended September 30, 1999 compared to the same
periods of 1998. This improvement reflects the result of our efforts to reduce
production costs, as well as the higher gross margins we are realizing on newly
introduced products. During the three and nine month period ended September 30,
1998, we incurred total charges of $2,450 related to a writedown of Croma24(TM)
inventories and an increase in inventory reserves for excess and obsolete
inventory. We incurred no charges of a similar nature during the same periods in
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 approximately
22% and 20%, respectively, of net sales during the three and nine month periods
ended September 30, 1999 compared to approximately 25% and 23% during the same
periods of 1998. This represents a decrease in absolute dollars of less than 1%
and 6%, 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, supplies and textile business units into one business unit, marketing
and selling expenses during the remainder of 1999 are expected to remain at
levels consistent with prior periods. We may, however, need to increase costs
related to marketing programs required to support our distribution channel or in
connection with the introduction of new products.
RESEARCH AND DEVELOPMENT - Research and development spending was
approximately 10% of net sales for both the three and nine month periods ended
September 30, 1999 compared to approximately 11% and 10% during the same periods
of 1998, respectively. In absolute dollars, 1999 research and development
spending decreased 3% and increased 11% over the three and nine month periods
ended September 30, 1998, respectively. The increase in year to date spending
reflects the addition of several engineers and consultants, as well as expenses
related to the recently introduced NovaJet 500, 630 and 700 products. We expect
to continue to invest significant resources in our strategic programs and
enhancements to existing products.
GENERAL AND ADMINISTRATIVE - General and administrative expenses were
approximately 9% of net sales during both the three and nine month periods ended
September 30, 1999, respectively, compared to approximately 12% and 10% during
the same periods of 1998 and decreased in absolute dollars by 22% and 1% over
the three and nine month periods ended September 30, 1998, respectively.
Expenses decreased over comparable periods in 1998 due primarily to a decrease
in bad debt reserve and lower staffing offset somewhat by higher than normal
legal expenses associated with litigation, which is more fully described in the
legal proceedings sections of our previously filed Form 10-K and Form 10-Qs. It
is likely that these legal expenses will remain high in future quarters as
litigation continues.
INTEREST EXPENSE - NET - Interest expense net of interest income
decreased to $28 and $197 during the three and nine month periods ended
September 30, 1999, respectively, from $112 and $326 during the comparable
periods of 1998. Decreased average amounts outstanding under our line of credit
caused the decrease in interest expense.
OTHER INCOME - Other income for the nine month period ended September 30,
1998 included payments received under a product development and license
agreement signed during the first quarter of 1998 and which terminated in July
1999.
PROVISION FOR INCOME TAXES - The effective income tax rate during the
three and nine month periods ended September 30, 1999 were 28% and 33%
respectively compared to 36% during each of the same periods in 1998.
- -------------------------------------
Croma24 is a trademark of ENCAD, Inc.
7
<PAGE>
The low rate for the third quarter reflects adjustments made to our current
tax provision to reflect revised estimates of prior provisions. As a result,
the year-to-date effective tax rate was 33%.
NET INCOME - The previously described elements caused net income during
the three and nine months periods ended September 30, 1999 to stand at 3% and 2%
of net sales, respectively, as compared to a net loss of 16% and 4% for the same
periods of 1998.
LIQUIDITY AND CAPITAL RESOURCES
We have historically funded our operations primarily through cash flow
provided from operations. As of September 30, 1999, we had cash and cash
equivalents totaling $1,012 and working capital of $34,214. 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 nine 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 September 30, 1999, net accounts receivable decreased by $452 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 nine
months of 1999, offset somewhat by a "back loaded" quarter for sales and
seasonally slow payments from Europe during the current quarter. In addition, we
have received slower payments from our Latin American customers recently due to
the weak economic conditions those countries are currently experiencing.
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.
Net inventory levels decreased by $3,465 at September 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 nine months ended September 30, 1999 and 1998, we made capital
expenditures of $1,629 and $4,025, respectively. In the first nine 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.
At September 30, 1999, we had available a $15,000 revolving line of credit
currently set to expire in January 2000. We are currently in discussions with
the bank regarding a similar line of credit. No amounts were outstanding under
the line of credit at September 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.
8
<PAGE>
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
essentially completed all phases of the project. Furthermore, we continue to
review newly received information and retest any systems as required.
All of our printer products are year 2000 compliant. The system vendor for
the enterprise wide information systems which we implemented in the third
quarter of 1998 states that this system is year 2000 compliant. Our own internal
testing of this system validated that it is year 2000 compliant for our current
business practices. We have corrected and replaced those other critical systems
which are not year 2000 ready. We continue to verify this compliance with our
own testing. We upgraded and tested our network servers and engineering design
systems. 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 in the event that a significant exposure is
identified we will develop appropriate contingency plans. 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. Such
failure to properly convert by another company may have a material adverse
effect on us. Our contingency plans do address critical operations and
include such items as: inventory buffers, alternative freight carriers, case
by case reviews of credit for shipments to customers in "at risk" countries,
and systems hardware and database back-up support. We are, however,
vulnerable to external forces that might generally affect industry and
commerce, such as utility or transportation company year 2000 compliance
failures and related service interruptions.
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.
9
<PAGE>
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 recently on a
quarterly or annual basis.
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 and
Canon Inc., 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, Epson and Canon, 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 1999 and will likely continue to do so in the future. Price
reductions, while partially offset by similar reductions in product costs,
historically 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.
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 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.
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.
10
<PAGE>
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. One distributor, Tekgraf, Inc., accounted for greater than ten percent
of our sales during the three and nine month periods just ended. 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 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. Such bad
debts would increase our general and administrative expenses and reduce net
income. 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.
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.
MANY OF OUR COMPONENTS ARE SUPPLIED BY SINGLE-SOURCE SUPPLIERS THAT MAY
NOT BE ABLE TO BE REPLACED WITHOUT DISRUPTING OUR OPERATIONS.
Any significant increase in component prices or decrease in component
availability could have a material adverse effect on our business. Some of the
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. Some of the key components of our
products are supplied indirectly by our principal competitor, Hewlett-Packard.
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, 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 both the nine month periods ended September 30, 1999 and 1998, sales
outside the United States represented approximately 64% of our net sales. 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
11
<PAGE>
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.
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.
12
<PAGE>
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 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
September 30, 1999. The amount of variable rate debt fluctuates during the year
based upon our cash requirements. Maximum borrowings at any time during the
third quarter of 1999 were $1,000. Based on the outstanding balance at September
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 (8.25% at September 30, 1999) or at our option, a rate based
on the London Interbank Overnight Rate (5.47% at September 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
From time to time, we may be involved in litigation relating to claims
arising out of our operations in the usual course of business.
In January 1999, we filed a lawsuit against Hewlett Packard in the
California Superior Court for the County of San Francisco, alleging sales of
competitive products below cost and as loss leaders, in violation of the
California Unfair Trade Practices Act. We are seeking injunctive relief
enjoining Hewlett Packard from offering to sell or selling any article or
product below cost and monetary damages. ENCAD's motion for a preliminary
injunction to enjoin Hewlett Packard's further below cost sales under their
trade-in programs was granted on September 17, 1999. A trial date is set for
on March 27, 2000.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES (in thousands)
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None
13
<PAGE>
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)
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.
(b) Reports on Form 8-K - No reports on Form 8-K were filed during the
quarter ended September 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: November 12, 1999
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. SEPTEMBER 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> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 1,012
<SECURITIES> 0
<RECEIVABLES> 28,611
<ALLOWANCES> 0
<INVENTORY> 12,740
<CURRENT-ASSETS> 47,444
<PP&E> 28,457
<DEPRECIATION> 13,680
<TOTAL-ASSETS> 64,092
<CURRENT-LIABILITIES> 13,230
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 49,931
<TOTAL-LIABILITY-AND-EQUITY> 64,092
<SALES> 85,257
<TOTAL-REVENUES> 85,257
<CGS> 48,129
<TOTAL-COSTS> 48,129
<OTHER-EXPENSES> 34,175
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<INTEREST-EXPENSE> 197
<INCOME-PRETAX> 2,756
<INCOME-TAX> 910
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<NET-INCOME> 1,846
<EPS-BASIC> 0.16
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</TABLE>
