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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JuneSeptember 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________to______________
Commission File Number 0-20191
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* * * * * *
ODS NETWORKS, INC.
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(Exact name of Registrant as specified in its charter)
Delaware 75-1911917
- ------------------------------- -----------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1101 East Arapaho Road, Richardson, Texas 75081
-----------------------------------------------
(Address of principal executive offices)
(Zip Code)
(972) 234-6400
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, if changed since last report)
* * * * * *
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, $.01 par
value, on JulyOctober 31, 1998 was 16,887,233.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------18,507,233.
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ODS NETWORKS, INC.INC AND SUBSIDIARIES.
INDEX
PART I - FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of JuneSeptember 30, 1998
and December 31, 1997 . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Operations for the three
months ended JuneSeptember 30, 1998 and JuneSeptember 30, 1997. . . . . . . . 4
Condensed Consolidated Statements of Operations for the sixnine
months ended JuneSeptember 30, 1998 and JuneSeptember 30, 1997. . . . . . . . 5
Condensed Consolidated Statements of Cash Flows for the sixnine
months ended JuneSeptember 30, 1998 and JuneSeptember 30, 1997. . . . . . . . 6
Notes to Condensed Consolidated Financial Statements . . . . . . . . . 7
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition. . . . . . . . . . . . . . 10
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders . . 18
Item 5. Other Information2. Changes in Securities . . . . . . . . . . . . . . . . . . . 18. 20
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . 18.. . . 20
Signature Page . . . . . . . . . . . . . . . . . . . . . . . . . 19. . . . 21
-2-
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS.
ODS NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
JuneSept. 30, Dec. 31,
1998 1997
----------- -----------------
(Unaudited)
ASSETS
ASSETS
Current Assets:
Cash and cash equivalents $12,343$14,432 $17,911
Short-term investments 8,9608,143 14,667
Accounts receivable, (net) 14,876net 8,847 8,668
Income taxes receivable 5271,412 3,159
Inventories, 16,217net 16,882 14,671
Deferred tax assets 2,5242,860 1,721
Other assets 1,181960 1,221
------- -------
Total current assets 56,62853,536 62,018
Property and equipment, (net) 11,912net 11,546 11,836
Long-term investments 2,7561,605 3,168
Intangibles, net 3,9828,042 -
Equity investments 1,8351,729 -
Other assets 164157 156
------- -------
TOTAL ASSETS $77,277$76,615 $77,178
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 7,8755,289 $ 5,381
Accrued expenses 3,8964,033 3,328
Deferred revenue 1,9902,257 1,462
------- -------
Total current liabilities 13,76111,579 10,171
Deferred tax liabilities 2,0911,549 628
Capital lease obligations 125 -
Stockholders' Equity:
Preferred stock, $.01 par value,
Authorized shares - 5,000
No shares issued and outstanding
Common stock, $.01 par value,
Authorized shares - 80,000
Issued and outstanding shares - 16,88718,507
in 1998 and 16,486 in 1997 169185 165
Additional paid-in capital 22,69829,504 19,488
Retained earnings 38,84935,324 47,032
Note receivable from shareholder (1,260) -
Foreign currency translation adjustments (303)(271) (306)
------- -------
Total stockholders' equity 61,41363,482 66,379
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $77,277$76,615 $77,178
------- -------
------- -------
See accompanying notes.
-3-
ODS NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended
----------------------
June------------------------
Sept. 30, JuneSept. 30,
1998 1997
------- ---------------- ---------
Net sales $25,215 $27,868$18,397 $26,231
Cost of sales 14,389 16,07610,670 15,702
------- -------
Gross profit 10,826 11,7927,727 10,529
Operating expenses:
Sales and marketing 8,134 7,8777,514 7,845
Research and development 2,932 2,8233,256 2,638
In-process research and development 5,3001,047 -
General and administrative 1,491 1,2581,421 1,187
------- -------
Operating loss (7,031) (166)(5,511) (1,141)
Interest income, net 356 374322 446
------- -------
Income (loss)Loss before income taxes (6,675) 208(5,189) (695)
Income tax (benefit) provision (538) 79benefit (1,728) (264)
------- -------
Income (loss)Loss before equity in affiliate (6,137) 129(3,461) (431)
Equity in net income (loss)loss of affiliate (72)(64) -
------- -------
Net income (loss) $(6,209)loss $(3,525) $ 129(431)
------- -------
------- -------
Basic and Diluted income (loss)loss per share $ (0.37)(0.21) $ .01(.03)
------- -------
------- -------
WeightedBasic and Diluted weighted average
common shares outstanding 16,739 16,423
------- -------
------- -------
Weighted averages shares outstanding assuming
dilution 16,739 16,75316,983 16,475
------- -------
------- -------
See accompanying notes.
-4-
ODS NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Six
Nine Months Ended
-----------------------
JuneSept. 30, JuneSept. 30,
1998 1997
------- ---------------- ---------
Net sales $ 43,428 $48,02961,825 $74,260
Cost of sales 24,587 27,24135,257 42,943
-------- -------
Gross profit 18,841 20,78826,568 31,317
Operating expenses:
Sales and marketing 15,936 15,01823,450 22,863
Research and development 5,599 5,6538,855 8,291
In-process research and development 5,3006,347 -
General and administrative 2,654 2,5204,075 3,707
-------- -------
Operating loss (10,648) (2,403)(16,159) (3,544)
Interest income, net 795 7111,117 1,157
-------- -------
Loss before income taxes (9,853) (1,692)(15,042) (2,387)
Income tax (benefit) provision (1,742) (643)benefit (3,470) (907)
-------- -------
Loss before equity in affiliate (8,111) (1,049)(11,572) (1,480)
Equity in net income (loss)loss of affiliate (72)(136) -
-------- -------
Net loss $ (8,183) $(1,049)$(11,708) $(1,480)
-------- -------
-------- -------
Basic and Diluted loss per share $ (0.49)(0.70) $ (0.06)(0.09)
-------- -------
-------- -------
WeightedBasic and Diluted weighted average
common shares outstanding 16,625 16,392
-------- -------
-------- -------
Weighted averages shares outstanding assuming
dilution 16,625 16,39216,746 16,420
-------- -------
-------- -------
See accompanying notes.
-5-
ODS NETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six
Nine Months Ended
------------------------
June-------------------------
Sept. 30, JuneSept. 30,
1998 1997
--------- ------------------- --------
Operating Activities:
Net loss ($ 8,183)11,708) ($ 1,049)1,480)
Adjustments to reconcile net income (loss)loss to
net cash provided (used) by operating activities:
In-process research and development 5,3006,347 -
Depreciation 1,692 1,5302,598 2,364
Amortization 182484 -
Equity in net loss of affiliate 72136 -
Deferred income taxes (680) (1,265)(1,558) (2,107)
Provision for doubtful accounts and returns - 3596
Changes in operating assets and liabilities:
Accounts receivable (5,349) 2,571680 1,359
Inventories (1,200) 6,631(1,865) 10,048
Other assets 9 (39)174 (369)
Accounts payable and accrued expenses 2,170 (403)(406) 1,405
Deferred revenue (12) (337)241 (512)
Income taxes 2,632 4601,747 968
--------- -------- -------
Net cash provided by (used in)
operating activities (3,367) 8,134
------- -------(3,130) 11,772
--------- --------
Investing Activities:
Payments for corporate acquisition
(net of cash acquired) (5,604) -
Equity Investment in Blue Ridge Networks (1,250) -
Purchases of short-term investments (2,437) (10,849)(17,967)
Maturities of short-term investments 9,151 10,93212,124 15,911
Purchases of long-term investments (600) (2,495)(1,606) (4,656)
Maturities of long-term investments 5 136 16
Purchases of property and equipment (1,340) (1,943)
------- -------(1,830) (2,782)
--------- --------
Net cash used in investing activities (2,075) (4,342)
------- -------(597) (9,478)
--------- --------
Financing Activities:
Issuance of common stock and warrants 1,500 -
Note receivable secured by company's
common stock (1,260) -
Repayment of Essential Communication Corp.
line of credit (400) -
Exercise of warrants and employee stock options 271 465
------- -------373 556
--------- --------
Net cash provided by (used in) financing activities (129) 465
------- -------213 556
--------- --------
Effect of foreign currency translation
adjustment on cash and cash equivalents 3 (8)
------- -------35 (59)
--------- --------
Net increase (decrease) in cash and cash
equivalents (5,568) 4,249(3,479) 2,791
Cash and cash equivalents at beginning of
period 17,911 6,565
------- ---------------- --------
Cash and cash equivalents at end of period $12,343 $10,814
------- -------
------- -------$14,432 $ 9,356
--------- --------
Supplemental disclosure of income taxes paid $ - $ 239
------- -------
------- -------310
--------- --------
--------- --------
Supplemental schedule of non cash activities:
Tax benefit of stock options exercised
and sold $ - $ 27
------- -------
------- ---------------- --------
--------- --------
See accompanying notes.
-6-
ODS NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)(Unaudited)
Note A - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The December 31, 1997 balance sheet was derived from
audited financial statements, but does not include all the disclosures required
by generally accepted accounting principles. However, the Company believes that
the disclosures are adequate to make the information presented not misleading.
In the opinion of management, all the adjustments (consisting of normal
recurring adjustments) considered necessary for fair presentation have been
included. The results of operations for the sixnine month period ended
JuneSeptember 30, 1998 are not necessarily indicative of the results which may be
achieved for the full fiscal year or for any future period. The condensed
consolidated financial statements included herein should be read in conjunction
with the consolidated financial statements and notes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 1997.
Computation of Net IncomeLoss Per Share
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 128
on December 31, 1997 and has restated all EPSearnings per share (EPS) data
presented. Under SFAS No. 128 the Company is required to report two separate
earnings per share numbers, basic EPS and diluted EPS. Diluted EPS is
essentially the same number the Company has previously reported as primary
earnings per share and includes the dilutive impact of employee stock options
and warrants.
Equity Investment
In March 1998, the Company invested $1.25 million in Blue Ridge Networks, Inc.,
a privately-held company which provides secure remote access products for local
and wide area virtual private networks. This investment was accounted for using
the equity method of accounting. The Company's share of earnings or losses of
Blue Ridge Networks, Inc. is reported in the income statement of the Company.
Business CombinationsCombination
On May 7, 1998, the Company acquired Essential Communication Corporation
("Essential"), a privately-held company based in Albuquerque, New Mexico.
Essential designs and manufactures high-speed computer network equipment. The
Company exchanged a combination of $5.8 million of cash and approximately
305,000 shares of the Company's common stock for all outstanding shares of
Essential capital stock, and the Company issued 104,000 stock options in
exchange for all unexpired and unexercised options to acquire Essential capital
stock. In connection with the acquisition, the Company recognized a one-time
charge of $5.3 million, or $0.32 per share, for in-process technology in the
second quarter of 1998. Essential's operations have been included in the
Company's condensed consolidated financial statements since May 7, 1998, and the
acquisition was accounted for using the purchase method of accounting. The
total purchase price of $9.0 million was allocated to the net assets acquired
based on their estimated fair market value, which included approximately $4.1
million of intangible assets to be amortized over five years on a straight-line
basis; and approximately $5.3 million of in-process research and development.
The in-process research and development was expensed at the date of the
acquisition. Pro forma financial information has not been presented. The
acquisition of Essential does not meet the reporting requirements for a
significant subsidiary.
-7-
Acquistion of Assets
On September 25, 1998 the Company completed an acquisition of certain assets
from Science Applications International Corporation ("SAIC"), a privately-held
company in San Diego, California. The Company acquired certain assets of the
Computer Misuse and Detection System ("CMDS") Division of SAIC and certain other
information security products under development. In exchange for the CMDS
assets, the information security products under development and $1.5 million
dollars in cash, ODS issued to SAIC 1.6 million shares of the Company's common
stock and warrants to purchase 1,500,000 shares of its common stock. Two
separate warrants each grant SAIC the right to purchase 750,000 shares of ODS
common stock. The first warrant has an exercise price of $8.00 per share and a
term of 18 months. The second warrant has an exercise price of $10.50 per share
and a term of 24 months. ODS' acquisition has been accounted for as a purchase
of software, in-process research and development and certain other assets. The
transaction value of approximately $6.9 million less the $1.5 million cash
received was allocated to the net assets acquired based on their estimated fair
market value. Assets acquired included approximately $1.1 million of in-process
research and development, $0.1 million of other intangible assets and
approximately $4.2 million of purchased software to be amortized over five years
on a straight-line basis. During the third quarter of 1998 the Company
recognized a one-time charge of $0.7 million (net of taxes), or $0.04 per share,
for write-off of the acquired in-process research and development. The
acquisition of certain assets of SAIC does not meet the reporting requirements
for pro forma financial information.
Exchange of Stock Options in First Quarter 1998
On January 21, 1998, the Compensation Committee of the Board of Directors
approved a stock option exchange program (the Exchange Program), pursuant to
which certain employees and officers holding incentive stock options (i) awarded
under the Company's 1987 Incentive Stock Option Plan in 1997 and (ii) awarded
prior to December 31, 1997, under the Company's 1995 Stock Option Plan (the 1995
Plan), were given the opportunity to exchange such options (Existing Options)
for new options (New Options), based on the fair market value of the Company's
Common Stock at the close of business on January 30, 1998. All directors of the
Company, including the President and Chief Executive Officer and the Senior Vice
President, were ineligible to participate in the Exchange Program.
As a result of significant declines in the market value of the Company's
Common Stock since issuance of the Existing Options, the Existing Options were
exercisable at prices which substantially exceeded the market value of the
Common Stock. In approving the Exchange Program and in keeping with the
Company's philosophy of utilizing equity incentives to motivate and retain
qualified employees, the Compensation Committee acknowledged that retention and
attraction of qualified employees are critical to the Company's success and its
ability to continue to meet its performance objectives. Additionally,
recognizing that stock options constitute a significant component of the
Company's compensation structure, the Compensation Committee deemed it important
to regain the incentive intended to be provided by the New Options to purchase
shares of the Company's Common Stock and therefore serve as a significant factor
in the Company's ability to continue to attract and retain the services of
superior quality personnel.
Pursuant to the Exchange Program, holders of the Existing Options were
offered the opportunity to exchange, on a share-for-share basis, such options
for New Options having an exercise price of $7.50 per share, the fair market
value of the Company's Common Stock on the exchange date of January 30, 1998.
Each New Option was awarded under the 1995 Plan and vests and is exercisable
with respect to 20% of the shares covered thereby on each anniversary date
thereof. Eligible
-8-
employees holding Existing Options for an aggregate of 646,800 shares of
Common Stock with an average per share exercise price of approximately $15.87
elected to participate in the Exchange Program and were issued New Options
covering the same aggregate number of underlying shares as they had held
pursuant to their respective Existing Options. Other than the new exercise
price and the commencement of a new vesting schedule, the option agreements
relating to the New Options are substantially identical to the option
agreements of the Existing Options they replaced.
-8-
Note B - Inventories (in Thousands)(In thousands)
Inventories consist of:
June
Sept. 30, Dec. 31,
1998 1997
--------- ----------------- --------
Raw materials $ 5,8465,787 $ 4,077
Work in process 1,884866 2,004
Finished products 6,0077,689 6,593
Demonstration systems 2,4802,540 1,997
------- -------
$16,217$16,882 $14,671
------- -------
------- -------
Note C - Intangible Assets, Net (In thousands)
Intangible assets consist of:
Sept. 30, Dec. 31,
1998 1997
-------- --------
CMDS Purchased Software $ 4,186 $ -
CMDS Intangible Asset 135 -
Essential Goodwill 1,127 -
Essential Intangible Asset 2,594 -
-------- -------
$ 8,042 $ -
-------- -------
-------- -------
Note D - Accrued Expenses (in Thousands)(In thousands)
Included in accrued expenses are the following:
June
Sept. 30, Dec. 31,
1998 1997
-------- --------
Accrued sales commissions $ 897862 $ 563
Accrued property taxes 365431 689
Accrued vacation expense 881851 724
Accrued warranty expense 475 475
Other (individually less than
5% of current liabilities) 1,2781,414 877
------- -------
$ 3,8964,033 $ 3,328
------- -------
------- -------
Note DE - Note Receivable from Shareholder
Note receivable from shareholder of $1.3 million at September 30, 1998
represents amounts loaned to an officer during the third quarter of 1998 secured
by the Company's common stock. These amounts have been classified as
contra-equity because in the event the officer fails to remit payment, the
Company will receive shares of the Company's common stock. Subsequent to
September 30, 1998 and through October 31, 1998, payments of approximately
$71,000 were received.
-9-
Note F - Earnings per Share (in Thousands,(In thousands, except per share amounts)
Three Months Ended JuneSept. 30, SixNine Months Ended JuneSept. 30,
---------------------------- --------------------------- -------------------------
1998 1997 1998 1997
------- ------- --------------- --------
Numerator:
Net income (loss) $(6,209)loss $(3,525) $ 129 $(8,183)(431) $(11,708) $ (1,049)(1,480)
------- ------- --------------- --------
Numerator for basic and diluted
earnings per share $(6,209)$(3,525) $ 129 $(8,183)(431) $(11,708) $ (1,049)(1,480)
Denominator:
Denominator for basic earnings
per share - weighted average
common shares outstanding 16,739 16,423 16,625 16,39216,983 16,475 16,746 16,420
Effect of dilutive securities:
Stock options and warrants 0 330 0 0 0
------- ------- -------- --------
Denominator for diluted earnings
per share - adjusted weighted
average common shares out-
standing 16,739 16,753 16,625 16,392
-------16,983 16,475 16,746 16,420
------- ------- -------- ---------------
------- ------- -------- --------
Basic income (loss)and Diluted loss per share $(0.37) $ .01 $(0.49) $(0.06)
-------(0.21) $ (.03) $ (0.70) $ (0.09)
------- ------- -------- ---------------
------- ------- -------- Diluted income (loss) per share $(0.37) $ .01 $(0.49) $(0.06)
------- ------- ------- --------
------- ------- ------- --------
-9-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This quarterly report, other than historical information, may include
forward-looking statements with respect to financial results, product
introductions, market demand, industry trends, sufficiency of cash resources
and certain other matters. These statements are made under the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995 and
involve risks and uncertainties which could cause actual results to differ
materially from those in the forward-looking statements, including those
discussed in the section entitled "Factors That May Affect Future Results of
Operations" and elsewhere in this filing, as well as those discussed in the
Company's Annual Report on Form 10-K and other filings with the Securities
and Exchange Commission.THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS, WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS CONCERNING: GROWTH AND FUTURE OPERATING RESULTS; DEVELOPMENTS IN
THE COMPANY'S MARKETS AND STRATEGIC FOCUS; NEW PRODUCTS AND PRODUCT
ENHANCEMENTS; POTENTIAL ACQUISITIONS AND THE INTEGRATION OF ACQUIRED
BUSINESSES, PRODUCTS AND TECHNOLOGIES; STRATEGIC RELATIONSHIPS; AND FUTURE
ECONOMIC, BUSINESS AND REGULATORY CONDITIONS. SUCH FORWARD-LOOKING STATEMENTS
ARE GENERALLY ACCOMPANIED BY WORDS SUCH AS "PLAN," "ESTIMATE," "EXPECT,"
"BELIEVE," "SHOULD," "WOULD," "COULD," "ANTICIPATE," "MAY" OR OTHER WORDS
THAT CONVEY UNCERTAINTY OF FUTURE EVENTS OR OUTCOMES. THESE FORWARD-LOOKING
STATEMENTS AND OTHER STATEMENTS MADE ELSEWHERE IN THIS REPORT ARE MADE IN
RELIANCE ON THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE SECTION
BELOW ENTITLED "FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS" SETS
FORTH AND INCORPORATES BY REFERENCE CERTAIN FACTORS THAT COULD CAUSE ACTUAL
FUTURE RESULTS OF THE COMPANY TO DIFFER MATERIALLY FROM THESE STATEMENTS.
-10-
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain financial
data as a percentage of net sales:
THREE MONTHS ENDED JUNE
Three Months Ended Sept. 30, SIX MONTHS ENDED JUNENine Months Ended Sept. 30,
---------------------------- --------------------------- -------------------------
1998 1997 1998 1997
------ ------ ------ -----------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 57.1 57.7 56.6 56.7
------ ------ ------ ------58.0 59.9 57.0 57.8
----- ----- ----- -----
Gross profit 42.9 42.3 43.4 43.342.0 40.1 43.0 42.2
Sales and marketing expenses 32.2 28.3 36.7 31.340.9 29.9 37.9 30.8
Research and development expenses 11.5 10.1 12.9 11.817.7 10.0 14.3 11.2
In-process research and development 21.15.7 - 12.210.3 -
General and administrative expenses 5.97.7 4.5 6.1 5.2
------ ------ ------ ------6.6 5.0
----- ----- ----- -----
Operating income (loss) (27.8) (0.6) (24.5) (5.0)loss (30.0) (4.3) (26.1) (4.8)
Interest income, net 1.4 1.3 1.8 1.5
------ ------ ------ ------
Income (loss)1.7 1.8 1.6
----- ----- ----- -----
Loss before income taxes (26.4) 0.7 (22.7) (3.5)(28.2) (2.6) (24.3) (3.2)
Income tax (benefit) provision (2.1) 0.3 (4.0) (1.3)
------ ------ ------ ------
Income (loss)benefit (9.4) (1.0) (5.6) (1.2)
----- ----- ----- -----
Loss before equity in
affiliate (24.3) 0.4(18.8) (1.6) (18.7) (2.2)(2.0)
Equity in net income (loss)loss of affiliate (0.3)(0.4) - (0.1)(0.2) -
------ ------ ------ ----------- ----- ----- -----
Net income (loss) (24.6)loss (19.2)% 0.4% (18.8)(1.6)% (2.2)(18.9)% ------ ------ ------ ------
------ ------ ------ ------(2.0)%
----- ----- ----- -----
----- ----- ----- -----
Switching product sales 52.1% 42.3% 47.5% 35.7%55.3% 41.3% 49.8% 37.7%
Shared bandwidth hub sales 40.7 52.3 44.5 58.334.1 50.2 41.4 55.4
Other sales 7.2 5.4 6.0 6.0
------ ------ ------ ------10.6 8.5 8.8 6.9
----- ----- ----- -----
Net sales 100.0% 100.0% 100.0% 100.0%
------ ------ ------ ------
------ ------ ------ ----------- ----- ----- -----
----- ----- ----- -----
Domestic sales 75.8% 68.3% 77.7% 72.586.0% 71.0% 80.2% 72.0
Export sales to:
Europe 14.1 7.7 13.3 8.79.2 7.5 12.1 8.3
Canada 2.7 2.3 3.53.7 3.2 3.6
Asia 7.2 18.6 5.1 12.51.4 16.5 4.0 13.9
Latin America .2 3.1 .4 2.7
------ ------ ------ ------0.7 1.3 .5 2.2
----- ----- ----- -----
Net sales 100.0% 100.0% 100.0% 100.0%
------ ------ ------ ------
------ ------ ------ ----------- ----- ----- -----
----- ----- ----- -----
-10-
RESULTS OF OPERATIONS
NET SALES. Net sales for the quarter and sixnine months ended JuneSeptember
30, 1998 decreased to $25.2$18.4 million and $43.4$61.8 million, respectively, compared
to $27.9$26.2 million and $48.0$74.3 million, respectively, for the same periods of
1997 as sales of the Company's new network switching and security products
did not increase quickly enough to offset the decrease in sales of its prior
generation shared bandwidth intelligent hubs.
Export sales for the quarter and sixnine months ended JuneSeptember 30, 1998
decreased to $6.1$2.6 million and $9.7$12.2 million, respectively, compared to $8.8$7.6
million and $13.2$20.8 million, respectively, for the same periods of 1997
primarily due to adverse economic developments in Malaysia and South Korea.
Sales to FORE Systems, Inc. ("FORE Systems") were 15.4% and 10.8%,
respectively, of net sales during the quarter and six months ended June 30,
1998. Direct net sales to various agencies of the U.S. Government were 15.0%14.8%
and 14.5%16.1%, respectively, of net sales during the quarter and sixnine months
ended JuneSeptember 30, 1998, compared to 13.2%14.0% and 11.6%12.5%, respectively, of net
sales for the same periods of 1997. Sales to Electronic Data Systems
Corporation ("EDS")
-11-
were 2.2%8.2% and 7.0%7.4%, respectively, of net sales during the quarter and sixnine
months ended JuneSeptember 30, 1998, compared to 14.6%17.1% and 14.5%15.4%, respectively,
of net sales for the same periods of 1997. Sales to Sapura Holdings Sdn. Bhd.
("Sapura") were 5.0%0.1% and 3.1%2.2%, respectively, of net sales during the quarter
and sixnine months ended JuneSeptember 30, 1998, compared to 13.9%12.3% and 8.1%9.6%,
respectively, of net sales for the same periods of 1997.
GROSS PROFIT. Gross profit decreased to $10.8$7.7 million or 42.9%42.0% of net
sales for the secondthird quarter of 1998 compared to $11.8$10.5 million or 42.3%40.1% of net
sales for the secondthird quarter of 1997. Gross profit decreased to $18.8$26.6 million
or 43.4%43.0% of net sales for sixnine months ended JuneSeptember 30, 1998 compared to
$20.8$31.3 million or 43.3%42.2% of net sales for the same period of 1997. Gross profit
margins in future periods may be affected by several factors such as
continued product transition, declining market demand for prior generation
products, obsolescence or surplus of inventory, shifts in product mix,
changes in channels of distribution, sales volume, fluctuation in
manufacturing costs, pricing strategies of the Company and its competitors
and fluctuations in sales of integrated third-party products. Gross profit
margins are typically lower on sales of integrated third-party products.
SALES AND MARKETING. Sales and marketing expenses increaseddecreased to $8.1$7.5
million or 32.2%40.9% of net sales for the secondthird quarter of 1998 from $7.9$7.8 million
or 28.3%29.9% of net sales for the secondthird quarter of 1997. Sales and marketing
expenses increased to $15.9$23.5 million or 36.7%37.9% of net sales for sixnine months
ended JuneSeptember 30, 1998 compared to $15.0$22.9 million or 31.3%30.8% of net sales for
the same period of 1997. The increase in sales and marketing expense was
primarily due to the acquisition of Essential on May 7, 1998 and increased
marketing efforts. Sales and marketing expenses may vary as a
percentage of net sales in the future.
RESEARCH AND DEVELOPMENT. Research and development expenses, excluding
the one-time charge for in-process research and development, increased to
$2.9$3.3 million or 11.5%17.7% of net sales for the secondthird quarter of 1998 from $2.8$2.6
million or 10.1%10.0% of net sales for the secondthird quarter of 1997. Research and
development expenses, excluding the one-time charge for in-process research
and development, decreasedincreased to $5.6$8.9 million or 12.9%14.3% of net sales for sixnine
months ended JuneSeptember 30, 1998 compared to $5.7$8.3 million or 11.8%11.2% of net
sales for the same period of 1997. The third quarter ended September 30, 1998
was impacted by the hiring of certain CMDS research and development personnel
in September 1998, and the nine months ended September 30, 1998 was impacted
by the acquisition of Essential's engineering personnel in May of 1998. The
Company expects to continue to invest in research and development activities
in the future in order to broaden its family of network switching, management
and security products.
-11-
IN-PROCESS RESEARCH AND DEVELOPMENT. During the secondthird quarter of 1998,
the Company incurred a one-time charge associated with the acquisition of
certain assets of SAIC of $1.1 million to expense the purchased in-process
research and development that had not reached technological feasibility. For
the nine months ended September 30, 1998, the Company incurred one-time
charges associated with the acquisition of Essential and certain assets of
$5.3SAIC of $6.4 million to expense the purchased in-process research and
development that had not reached technological feasibility.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
increased to $1.5$1.4 million or 5.9%7.7% of net sales for the secondthird quarter of 1998
from $1.3$1.2 million or 4.5% of net sales for the secondthird quarter of 1997. General
and administrative expenses increased to $2.7$4.1 million or 6.1%6.6% of net sales
for sixnine months ended JuneSeptember 30, 1998 compared to $2.5$3.7 million or 5.2%5.0% of
net sales for the same period of 1997. The increase in general and
administrative expenses for the secondthird quarter of 1998 was primarily due to
the amortization of intangibles related to the acquisition of Essential on
May 7, 1998. General and administrative expenses may vary as a percentage of
net sales in the future.
-12-
INTEREST. Net interest income remained relatively constant at $0.4were to $0.3 million and $0.8$1.2 million,
respectively, for the quarter and sixnine months ended JuneSeptember 30, 1998
compared to $0.4 million and $0.7$1.2 million, respectively, for the same periods
of 1997. Net interest income may vary in the future based on the Company's
cash flow and rate of return on investments.
INCOME TAXES. The Company's effective income tax rate was 8%33.3% and
17.7%23.0%, respectively, for the quarter and sixnine months ended JuneSeptember 30, 1998
compared to the 38.0% for the same periods of 1997. The effective tax rate
represented by the Company's provisionincome tax benefit for income taxes in the second quarternine months ended
JuneSeptember 30, 1998 of 23.0% would have been approximately 37.1%,35.6% disregarding
the expenses associated with the Company's write-off of purchased$5.3 million of
in-process research and development costs which were not deductible for tax
purposes.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of liquidity at JuneSeptember 30, 1998 were
$12.3$14.4 million of cash and cash equivalents, $9.0$8.1 million of short-term
investments, $2.8$1.6 million of highly liquid investments with a stated maturity
beyond one year and an available line of credit.year. As of JuneSeptember 30, 1998, working capital was $42.9$42.0 million
compared to $51.8 million as of December 31, 1997.
Cash flows used in operations for the first sixnine months of 1998 were $3.4$3.1
million, primarily due to an increase in inventory and accounts receivable
balances and a net loss for the
period partially offset by an increase in accounts payable.income taxes receivable. Future
fluctuations in accounts receivable and inventory balances will be dependent
upon several factors, including but not limited to quarterly sales, ability
to collect accounts receivable timely, the Company's strategy as to building
inventory in advance of receiving orders from customers, and the accuracy of
the Company's forecasts of product demand and component requirements.
Cash used in investing activities in the first sixnine months of 1998 was
$2.1$0.6 million, primarily due to property and equipment purchases of $1.3
million, an equity investment in Blue Ridge Networks,
Inc. of $1.25 million, and cash used in the acquisition of Essential
CommunicationsCommunciation Corporation of $5.6 million and purchases of property and
equipment of $1.8 million, partially offset by net maturities of short-term and long-term
investments
of $6.1$8.1 million.
Cash used inprovided by financing activities in the first sixnine months of 1998
was $0.1$0.2 million, due to the repayment$1.5 million cash received from the issuance of
Essential's line of creditCommon Stock and warrants in connection with the amount ofSAIC transaction and $0.4
million offset byfrom the issuance of Common Stock relating to the exercise of certain
employee stock options partially offset by the $1.2 million note receivable
from shareholder and repayment of Essential's line of credit in the amount of
$0.3$0.4 million.
During the first sixnine months of 1998, the Company funded its operations
solely -12-
through cash flows from operations.
The Company has a bank line of credit
agreement with $15.0 million of maximum available borrowings. Borrowings
under this line are secured by the Company's accounts receivable and
inventory and are subject to certain limitations and conditions, including
the maintenance of certain financial ratios and minimum net tangible worth
amounts. Borrowings on this line accrue interest at prime with interest due
monthly and principal due April 12, 1999. As of June 30, 1998, the Company
had no borrowings outstanding under its bank credit facility and had $15.0
million available for allowable borrowings at an applicable interest rate of
8.5% per annum.
The Company intends to seekexplore the possible acquisitions of businesses,
products and technologies that are complementary to those of the Company.
The Company is continuing to identify and prioritize additional networking
and security technologies which it may wish to develop, either internally or
through the licensing or acquisition of products from third parties. While
the Company engages from time to time in discussions with respect to
potential acquisitions, there can be no assurances that any such acquisitions
will be made or that the Company will be able to successfully integrate any
acquired business. In order to finance such acquisitions, it may be
necessary for the Company to raise additional funds through public or private
financings. Any equity or debt financings, if available at all, may be on
terms which are not favorable to the Company and, in
-13-
the case of equity financings, may result in dilution to the Company's
stockholders.
YEAR 2000 COMPLIANCE
Many currently installed systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result computer systems and/or software used by
many companies will need to be upgraded to comply with such "Year 2000"
requirements.
The Company believes that the purchasing patterns of customers and
potential customers may be significantly affected by Year 2000 issues. Many
companies are expending significant resources to correct, patch or replace
their current software systems to achieve Year 2000 compliance. These
expenditures may result in reduced funds available to purchase products such
as those offered by the Company.
The Company has reviewed its products offered to customers, and has
determined that the versions currently offered to customers are Year 2000
compliant. Nonetheless, there can be no assurance that the Company's
products, particularly when such products incorporate third-party products,
contain all necessary date code changes necessary to ensure Year 2000
compliance. Although the Company has not experienced any Year 2000-related
product liability claims or lawsuits to date, production of products that are
not Year 2000 compliant may entail the risk of such claims and lawsuits. The
Company's defense against any future lawsuits, regardless of their merit,
could result in substantial expense to the Company as well as the diversion
of management time and attention. In addition, Year 2000 product liability
claims, regardless of the merit or eventual outcome of such claims, could
affect the Company's business reputation and its ability to retain existing
customers or attract new customers which, in turn, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company's Year 2000 compliance program consists of the following
phases: (i) identification and assessment of internal Year 2000 issues, (ii)
correction of internal Year 2000 issues, and (iii) review of disclosures of
major suppliers and vendor confirmations as to Year 2000 compliance. An
inventory and analysis of internal management systems, information systems
and equipment has been completed and the Company has determined that it will
be necessary to upgrade portions of its software so that its computer systems
will be Year 2000 compliant. These modifications and replacements are being
and will continue to be made in conjunction with the Company's overall
information systems initiatives, are 75% complete and are scheduled to be
completed by March 31, 1999. In addition, the Company has begun contacting
third-party vendors to ensure that any of their products that are
incorporated into the Company's products or currently in use by the Company
can adequately deal with the change in century. Areas being addressed
include major third-party suppliers of components of the Company's products
as well as full reviews of the Company's manufacturing equipment, telephone
and voice mail systems, security systems and other office support systems.
The Company has also initiated formal communications with significant
suppliers and customers to determine the extent to which the Company is
vulnerable to those third parties' failure to remediate their own Year 2000
issues. This review and confirmation process is approximately 75% complete
and is scheduled to be completed by March 31, 1999. No information technology
initiatives have been deferred by the Company as a result of its Year 2000
project.
The Year 2000 project cost to the Company is estimated to be immaterial.
Costs incurred and expected to be incurred consist primarily of the cost of
-14-
Company personnel involved in updating applications and operating systems and
the costs of software updates and patches (many of which are provided free of
charge from the vendors). Such immaterial expenses are being funded through
operating cash flows. The Company has utilized the Company's internal
technical personnel, and intends to continue to use such personnel, to
address Year 2000 issues, rather than contract with third-party consultants.
Based on available information, the Company does not believe any
material exposure to significant business interruption exists as a result of
Year 2000 compliance issues, or that the cost of remedial actions will have a
material adverse effect on its business, financial condition or results of
operations. Accordingly, and as Year 2000 project is on schedule to be
completed by March 31, 1998, the Company has not formulated a most reasonably
likely worse case scenario or adopted any formal contingency plan in the
event its Year 2000 project is not completed in a timely manner.
Significant uncertainty still exists as to the global implications of
the Year 2000 issue. Costs of defending and resolving Year 2000-related
disputes, reductions in product development programs by customers or the
failure of the Company to adequately resolve internal Year 2000 compliance
issues could result in a material adverse effect on the Company's business,
operating results and financial condition.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
As noted above, this report includes foregoing discussions including
forward-looking statements that involve risksNumerous factors may affect the Company's business and uncertainties. In additionfuture results of
operations. These factors include, but are not limited to, those factors discussed elsewhere in this quarterly reportfrequent product
introductions and those
discussedrapid technological changes; competition and market
acceptance of the Company's products; acquisitions within the industries the
Company competes; acquisitions by the Company and the ability to integrate
such acquisitions; frequent product transitions; the availability of
components used in the Company's annual reportmanufacturing processes; alliances with
third-parties; dependence on key customers; risks and uncertainties related
to international operations and currency fluctuations; dependence on
proprietary technology; Year 2000 compliance issues; industry trends and
developments; and general economic conditions. The discussion below
addresses some of these factors. For a more thorough discussion of these and
other factors that may affect the Company's business and future results, see
the discussion under the caption "Item 1 - Business" of the Company's Report
on Form 10-K and other filings withfor the Securities and Exchange Commission, the Company identifies the following
factors which could affect the Company's actual results and cause actual
results to differ materially from those in the forward-looking statements.fiscal year ended December 31, 1997.
TECHNOLOGICAL CHANGES. The market for the Company's products is
characterized by frequent product introductions, rapidly changing technology
and continued evolution of new industry standards. The market for network
intelligent hubs, switches, management and security products requires the
Company's products to be compatible and interoperable with products and
architectures offered by various vendors, including other networking
products, workstation and personal computer architectures and computer and
network operating systems. The Company's success will depend to a
substantial degree upon its ability to develop and introduce in a timely
manner new products and enhancements to its existing products that meet
changing customer requirements and evolving industry standards. The
development of technologically advanced products is a complex and uncertain
process requiring high levels of innovation as well as the accurate
anticipation of technological and market trends. There can be no assurance
that the Company will be able to identify, develop, manufacture, market and
support new or enhanced products successfully in a timely manner. Further,
the Company or its competitors may introduce new products or product
enhancements that shorten the life cycle of or obsolete the Company's
existing product lines which could have a material adverse effect on the
Company's business, operating results and financial condition.
-15-
COMPETITION AND MARKET ACCEPTANCE. The market for network intelligent hubs,
switches, management and security products is intensely competitive and
subject to frequent product introductions with improved price/performance
characteristics. Even if the Company does introduce advanced products which
meet evolving customer requirements in a timely manner, there can be no
assurance that the new Company -13-
products will gain market acceptance. Many
networking companies, including Cisco Systems, Inc. ("Cisco"), Cabletron
Systems, Inc. ("Cabletron"), BayNortel Networks Inc. ("Bay Networks"Nortel"), FORE Systems, Xylan
Corporation ("Xylan") and others, have substantially greater financial,
technical, sales and marketing resources, better name recognition and a
larger customer base than the Company. Many of the Company's large
competitors offer customers a broader product line which provides a more
comprehensive networking solution than the Company currently offers. The
Company anticipates increased competition from large telecommunication
equipment vendors which are expanding their capabilities in the data
networking market. For example, Lucent Technologies and Nortel have acquired
several networking companies to enhance their capabilities in data
networking. Further the Company anticipates increased competition from
private "start-up" companies that have developed or are developing advanced
network switching and security products. Increased competition in the
networking industry could result in significant price competition, reduced
profit margins or loss of market share, any of which could have a material
adverse effect on the Company's business, operating results and financial
condition.
The Company is pursuing a strategy to increase the percentage of its
revenue generated through indirect sales channels including value added
resellers, system integrators, original equipment manufacturers and network
service providers. There can be no assurance that the Company's products
will gain market acceptance in these indirect sales channels. Further,
competition among networking and security companies to sell products through
these indirect sales channels could result in significant price competition
and reduced profit margins.
The Company is also pursuing a strategy to broaden and further
differentiate its product line by introducing complementary network
switching, management and security products and incorporating new
technologies into its existing product line. There can be no assurance that
the Company will successfully introduce these products or that such products
will gain market acceptance. The Company anticipates competition from
networking companies, network security companies and others in each of its
product lines. The Company anticipates that profit margins will vary among
its product lines and that product mix fluctuations could have an adverse
effect on the Company's overall profit margins.
ACQUISITIONS. Cisco, Cabletron, Bay Networks, FORE Systems, Lucent Technologies,
Nortel and other competitors have recently acquired several networking and
security companies with complementary technologies, and the Company
anticipates that such acquisitions will continue in the future. These
acquisitions may permit such competitors to accelerate the development and
commercialization of broader product lines and more comprehensive networking
solutions than the Company currently offers. In the past, the Company has
relied upon a combination of internal product development and partnerships
with other networking vendors to provide competitive networking solutions to
customers. Certain of the recent and future acquisitions by the Company's
competitors may have the effect of limiting the Company's access to
commercially significant technologies. Further, the business combinations and
acquisitions in the networking and security industry are creating companies
with larger market shares, customer bases, sales forces, product offerings
and technology and marketing expertise. There can be no assurance that the
Company will be able to compete successfully in such an environment.
-16-
In March 1998, the Company invested $1.25 million in Blue Ridge
Networks, Inc. a private corporation which provides secure remote access
products for local and wide area virtual private networks. On May 7, 1998,
the Company acquired Essential Communication Corporation, a privately-held
company based in Albuquerque, New Mexico. Essential designs and
manufactures high-speed computer network equipment. In September 1998, the
Company completed an acquisition of certain assets from Science Applications
International Corporation ("SAIC"), a privately-held company in San Diego,
California. The Company acquired certain assets of the Computer Misuse and
Detection System ("CMDS") Division of SAIC and certain other information
security products under development. The Company may, in the future, acquire
or invest in additional companies, business units, product lines, or
technologytechnologies to accelerate the development
-14-
of products and sales channels
complementary to the Company's existing products and sales channels.
Acquisitions involve numerous risks, including difficulties in assimilation
of operations, technologies, and products of the acquired companies; risks
of entering markets in which the Company has no or limited direct prior
experience and where competitors in such markets have stronger market
positions; the potential loss of key employees of the acquired company; and
the diversion of management's attention from normal daily operation of the
Company's business. There can be no assurance that any potential acquisition
or investment will be consummated or that anticipated
benefits of such acquisition or investment will
be realized.
PRODUCT TRANSITIONS. Once current networking products have been in the
market place for a period of time and begin to be replaced by higher
performance products (whether of the Company's or a competitor's design), the
Company expects the net sales of such networking products to decrease. In
order to achieve revenue growth in the future, the Company will be required
to design, develop and successfully commercialize higher performance products
in a timely manner. For example, the market for shared bandwidth intelligent
hubs, sales of which represented the majority of the Company's net sales over
the past several years, decreased in the first halfnine months of 1998 compared
to the same period of 1997 and may continue to decrease as switching products
with enhanced price/performance characteristics gain market acceptance.
There can be no assurance that the Company will be able to introduce new
products and gain market acceptance quickly enough to avoid adverse revenue
transition patterns during current or future product transitions.
MANUFACTURING AND AVAILABILITY OF COMPONENTS. The Company's manufacturing
operations consist primarily of final assembly, testing and quality control of
subassemblies and finished units. Materials used by the Company in its
manufacturing processes include semiconductors such as microprocessors, memory
chips and application specific integrated circuits ("ASICs"), printed circuit
boards, power supplies and enclosures. All of the materials used in the
Company's products are purchased under contracts and purchase orders with third
parties. While the Company believes that many of the materials used in the
production of its products are generally readily available from a variety of
sources, certain components are available from one or a limited number of
suppliers. For example, certain ASICs designed into the Company's
InfiniteSwitch products are supplied by FORE Systems (see "Factors That May
Affect Future Results of Operations -Competition- Competition and Market Acceptance"). The
lead times for delivery of components vary significantly and exceed twelve weeks
for certain components. If the Company should fail to forecast its requirements
accurately for components, it may experience excess inventory or shortages of
certain components which could have an adverse effect on the Company's business
and operating results. Further, any interruption in the supply of any of these
components, or the inability of the Company to procure these components from
-17-
alternative sources at acceptable prices within a reasonable time, could have
additional adverse effect on the Company's business and operating results.
THIRD-PARTY PRODUCTS. The Company believes that it is beneficial to work
with third parties with complementary technologies to broaden the appeal of
the Company's switches, intelligent hub and network security products. These
alliances allow ODS to provide integrated solutions to its customers,
combining ODS developed technology with third-party products such as certain
routers from Cisco, ATM switches from FORE Systems and Gigabit Ethernet
switch technology from Lucent Technologies. As the Company also competes
with these technology partners in certain segments of the market, there can
be no assurance that the Company will have access to all of the third-party
products which may be desirable to offer fully integrated solutions to ODS
customers.
-15-
DEPENDENCE ON KEY CUSTOMERS. A relatively small number of customers have
accounted for a significant portion of the Company's revenue. U.S. Government
agencies and strategic network integrators are expected to continue to
account for a substantial portion of the Company's net revenue. The Company
continuously faces competition from Cisco, Cabletron, Bay Networks,Nortel, FORE Systems,
Xylan and others for U.S. Government networking projects and corporate
networking installations. Any reduction or delay in sales of the Company's
products to these customers could have a material adverse effect on the
Company's operating results.
INTERNATIONAL OPERATIONS. Export sales accounted for approximately 24.3%14.0% of
the Company's revenue in the secondthird quarter of 1998. The Company expects that
export sales will represent a significant portion of its business in the
future. The Company's international operations may be affected by changes in
demand resulting from fluctuations in currency exchange rates and local
purchasing practices, including seasonal fluctuations in demand, as well as
by risks such as increases in duty rates, difficulties in distribution and
other constraints upon international trade. For example, the fluctuations in
currency exchange rates and adverse economic developments in Malaysia, South
Korea and certain other countries adversely affected demand for the Company's
products in those countries in the fourth quarter of 1997 and the first halfnine months
of 1998. These conditions may continue to adversely affect demand for the
Company's products in those countries throughout 1998. Additionally, while
the Company's current products are designed to meet relevant regulatory
requirements of the foreign markets in which they are sold, any inability to
obtain any required foreign regulatory approvals on a timely basis could have
a material adverse effect on the Company's operating results.
INTELLECTUAL PROPERTY. The Company's success and its ability to compete is
dependent, in part, upon its proprietary technology. The Company does not
hold any issued patents and currently relies on a combination of contractual
rights, trade secrets and copyright laws to establish and protect its
proprietary rights in its products. There can be no assurance that the steps
taken by the Company to protect its intellectual property will be adequate to
prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent
or superior to the Company's technology.
The Company is also subject to the risk of adverse claims and litigation
alleging infringement of intellectual property rights of others. The Company
could incur substantial costs in defending itself and its customers against
any such claim regardless of the merits of such claims. In the event of a
successful claim of infringement, the Company may be required to obtain one
or more licenses from
-18-
third parties. There can be no assurance that the Company could obtain the
necessary licenses on reasonable terms.
IMPACT OF YEAR 2000. Some of the Company's older computer programs were
written using two digits rather than four to define the applicable year. As a
result, those computer programs have time-sensitive software that recognize a
date using "00" as the year 1900 rather than the year 2000. Accordingly the
date January 1, 2000 could cause a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities.
The Company has completed an assessment and will have to modify or replace
portions of its software so that its computer systems will function properly
with respect to dates in the year 2000 and thereafter. The total Year 2000
project cost is estimated to be immaterial.
-16-
The Company has initiated communications with all of its significant
suppliers and large customers to determine the extent to which the Company's
interface systems are vulnerable to those third parties' failure to remediate
their own Year 2000 issues. There can be no guarantee that the systems of
other companies on which the Company's systems rely will be timely converted
and would not have an adverse effect on the Company's systems. The Company
has determined it has immaterial exposure to contingencies related to the
Year 2000 issue for the products it has sold.
The Company's Year 2000 project is estimated to be
completed not later than DecemberMarch 31, 1998,1999, which is prior to any anticipated
impact on its operating systems. The Company believes that with
modifications to existing software and conversions to new software, the Year
2000 issue will not pose significant operational problems for its computer
systems. However, if such modifications and conversions are not made, or are
not completed timely, the Year 2000 issue could have a material impact on the
operations of the Company.
The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future
events, including the continuous availability of certain resources and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are
not limited to, the availability and cost of personnel trained in this area,
the ability to locate and correct all relevant computer codes, and similar
uncertainties.
The Company is concerned that many enterprises will be devoting a substantial
portion of their information systems spending to resolving this upcoming year
2000 problem. This may result in spending being diverted from networking
solutions over the next two years. The year 2000 issue could lower demand
for the Company's products. This factor, while not quantified, could have a
material adverse impact on the Company's financial results.
GENERAL. Sales of networking products fluctuate, from time to time, based on
numerous factors, including customers' capital spending levels and general
economic conditions. While certain industry analysts believe that there is a
significant market for network intelligent hubs, switches, management and
security products, there can be no assurance as to the rate or extent of the
growth of such market or the potential adoption of alternative technologies.
Future declines in networking product sales as a result of general economic
conditions, adoption of alternative technologies or any other reason could
have a material adverse effect on the Company's business, operating results
and financial condition.
Due to the factors noted above and elsewhere in Management's Discussion and
Analysis of Financial Condition and Results of Operations, the Company's
future earnings and stock price may be subject to significant volatility,
particularly on a quarterly basis. Past financial performance should not be
considered a reliable indicator of future performance and investors should
not use historical trends to anticipate results or trends in future periods.
Any shortfall in revenue and earnings from the levels anticipated by
securities analysts could have an immediate and significant effect on the
trading price of the Company's common stock in any given period. Also, the
Company participates in a highly dynamic industry which often results in
volatility of the Company's common stock price.
-17--19-
PART II - OTHER INFORMATION
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting2. CHANGES IN SECURITIES.
In the third quarter of Stockholders was held on April 21, 1998, at the Holiday Inn Richardson SelectCompany issued 1.6 million shares of its
common stock to Science Applications International Corporation ("SAIC") in
Richardson, Texas. The following
is a brief description of each matter voted upon by stockholders,
including number of votes cast for, against, or withheldconnection with regard
to each matter of nominee.
(1) Election of five (5) directors to serve until the next Annual
Meeting of Stockholders and until their respective successors
are duly elected and qualified.
FOR WITHHELD
--- --------
G. Ward Paxton 14,979,571 140,512
Robert Anderson 14,979,121 140,962
J. Fred Bucy 14,982,825 137,258
T. Joe Head 14,985,320 134,763
Donald M. Johnston 14,986,070 134,013
(2) Ratification and approval of selection by the Board of Directors
of Ernst & Young LLP as independent auditors of the Registrant
for the fiscal year ending December 31, 1998.
FOR AGAINST WITHHELD
--- ------- --------
15,062,577 19,969 37,537
Item 5. OTHER INFORMATION.
Stockholder Proposals
Stockholders may submit proposals on matters appropriate for stockholder
action at subsequent annual meetings of the stockholders consistent with Rule
14a-8 promulgated under the Exchange Act. For such proposals to be considered
for inclusion in the Proxy Statement and Proxy relating to the 1999 Annual
Meeting of Stockholders, such proposals must be receivedacquisition by the Company not
later than November 20, 1998. Such proposals should be directedof certain assets of SAIC. In
addition, the Company issued to ODS
Networks, Inc., 1101 East Arapaho Road, Richardson, Texas 75081, Attention:
Secretary (telephone: (972) 234-1467; telecopy: (972) 234-1467.
PursuantSAIC (i) a warrant to new amendmentspurchase up to Rule 14a-4(c)750,000
shares of the Company's common stock at an exercise price of $8.00 per share,
exercisable at any time on or before March 25, 2000, and (ii) a warrant to
purchase up to 750,000 shares of the Company's common stock at an exercise
price of $10.50 per share, exercisable at any time on or before September 25,
2000. These issuances were deemed exempt from registration under Section 5 of
the Securities Exchange Act of 1934, as amended, if1933 in reliance upon Section 4(2) thereof. In
addition, SAIC represented its intention to acquire the securities for
investment only and not with a stockholder who intendsview to, present a proposal ator for sale in connection with, any
distribution thereof and appropriate restrictive transfer legends were
affixed to the 1999 annual meeting of stockholders does not notify the Company ofcertificates issued in such proposal on or prior to February 3, 1999, then management proxies would be
allowed to use their discretionary voting authority to vote on the proposal
when the proposal is raised at the annual meeting, even though there is no
discussion of the proposal in the 1999 proxy statement.transaction.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A.) EXHIBITS. The following exhibits are included herein:
(10.13) First Amendment Agreement to Third Amended and
Restated Revolving Credit Loan Agreement, dated
April 30, 1998, between NationsBank of Texas,
N.A. (formerly, NCNB Texas National Bank) and the
Company.
(10.14) Amendment to the ODS 401(K) Savings Plan, Effective
May 29, 1998
(27) Financial Data Schedule
(B.) REPORTS ON FORM 8-K. On May 21,October 13, 1998, the Company filed a
reportCurrent Report on Form 8-K (Item 2)5) in
order to announcereport the acquisition of
Essential Communications Corporation.
-18-certain assets from Science Applications
International Corporation during the
quarter ended September 30, 1998.
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S I G N A T U R E S
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ODS NETWORKS, INC.
(Company)
Date: August 14,November 13, 1998 BY:By: /s/ TIMOTHY W. KINNEAR
-------------------------------------- Timothy W. Kinnear
--------------------------
Timothy W. Kinnear
Chief Operating Officer and
Chief Financial Officer
(Principal Financial Officer)
BY:Date: November 13, 1998 By: /s/ KANDIS TATE THOMPSON
--------------------------------------Kandis Tate Thompson
--------------------------
Kandis Tate Thompson
Controller - Finance and Accounting
(Principal Accounting Officer)
-19--21-
EXHIBIT INDEX
EXHIBIT
- -------
10.13 First Amendment Agreement to Third Amended and Restated Revolving
Credit Loan Agreement, dated April 30, 1998, between NationsBank
of Texas, N.A. (formerly NCNB Texas National Bank) and the
Company.
10.14 Amendment to the ODS 401(K) Savings Plan, Effective May 29, 1998.
27 Financial Data Schedule
-20--22-