SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K/A ANNUAL REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE FISCAL YEAR ENDED JULY 31, 1995 Commission File No. 1-7886 PENRIL DATACOMM NETWORKS, INC. A Delaware Corporation IRS Employer Identification No. 34-1028216 1300 Quince Orchard Blvd., Gaithersburg, Maryland 20878 Telephone - (301) 417-0552 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Title of each class: Common Stock, $.01 par value 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 and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of October 18, 1995 the aggregate market value of the Company's voting Common Stock held by non-affiliates of the Company was approximately $52 million. As of October 18, 1995 there were 9,058,552 shares of the registrant's Common Stock, $.01 par value outstanding. PART I ITEM 1. BUSINESS Penril DataComm Networks, Inc. ("Penril" or the "Company") develops and markets network access devices which enable local, remote or mobile users to access network resources located at remote sites, central sites or any other point in the network. The Company possesses each of the technologies needed for a complete network access solution including: remote Local Area Network (LAN) access, high performance modems and modem channel banks, bridges and routers, host access from asynchronous terminals and multiplexors for efficient access to the Wide Area Network (WAN). In addition, the Company's wholly-owned subsidiary, Electro-Metrics, Inc. (EMI) specializes in the production of sophisticated high frequency electronic instrumentation equipment. During the fourth quarter of fiscal 1995, the Board of Directors made the decision to sell the Technipower, Inc. subsidiary. Consequently, Technipower has been classified as a discontinued business. The Company continues to operate Technipower, including the uninterruptible power supply business consequently has provided an accrual of $1,040,000 for the estimated operating losses through the anticipated disposal date. In addition, the Company has provided an accrual of $360,000 for the difference between the estimated proceeds from the sale of Technipower and its net assets. The combination of these two accruals represent the amount shown on the Statement of Operations as Loss on Disposal of Discontinued Operations. Based on current activity of interested companies, the Company believes it will be able to accomplish the task of selling Technipower within a year. However, if the sale cannot be consummated within the year, the Company is required to include the results of operations within continuing operations and to restate prior periods to be comparative to the period being reported. Unless otherwise stated, the information contained in this Form 10-K describes the status of the continuing operations of the Company although the effect of the discontinued operation is disclosed. DATA COMMUNICATIONS Revenues from data communications products accounted for 90%, 91 % and 87% of the Company's consolidated revenues in the fiscal years ended July 31, 1995, 1994 and 1993, respectively. These revenues come through a distribution channel composed of value-added resellers (VARs), original equipment manufacturers (OEMs) and selected distributors in more than 40 countries. Sales directly to end-user customers accounted for less than 10% of the Company's revenues. PRODUCTS Penril offers its customers a wide array of network access products. Since the acquisition of Datability Inc. in May 1993, the Company has sought to create an integrated product line which combines the two companies' strengths. This combined technology base is being realized in a single, scaleable hardware platform known as "AccessBeyond"(trademark). Thus, a single hardware platform may include remote LAN access, bridging/routing, multiplexing or host access via the software running on it. Forming the functional basis for "AccessBeyond" is Penril's existing product line which is organized into four distinct areas: LAN Access High Speed Modems T1 Customer Premise Equipment Host Access LAN Access Products Linkup(trademark) Dial Access Server - The Linkup family of remote access products provide both dial-in and dial-out LAN access for TCP/IP, DEC LAT and IPX users. On the wide area network, Linkup's 4 and 8 port devices target smaller sites requiring remote node support, while the 24 port model with integrated modems supports larger installations. Linkup's asynchronous ports support host access applications. The products include Microsoft Windows-based client software along with comprehensive security and management capabilities. To simplify installation, the Company provides Network-in-a- Box(trademark), a pre-configured Linkup remote access solution with everything required for quick and easy installation. BRX Router - The BRX family includes high performance, modular switching routers that provide up to 16 LAN ports and 2 WAN ports, and are offered in either a free standing format or as a card for insertion into customer equipment. The BRX also offers high performance store and forward switching capabilities as evidenced by its 90,000 pps filtering and forwarding rate. The key to the BRX product line is in the Constellation(trademark) multiprotocol bridge/router software which provides a scaleable routing/switching solution. Each BRX product is shipped with an integrated management port which supports an SNMP-based network management software. Constellation Multiprotocol Bridge/Routing Software - Constellation uses an innovative software architecture for high performance bridging and routing featuring one of the broadest suites of protocols available in the market today (including IP, IPX, AppleTalk II, OSPF and RIP among others). WAN support includes X.25, Frame Relay and HDLC. Penril also provides virtual LAN software for advanced switching capabilities. The Company pioneered the concept of Logical Bridge Routing, a methodology which enables network managers to optimize bridge/router port configurations for efficient, high performance networks. The software provides comprehensive network management capabilities. High Speed Modems Penril's V.34bis modems offer the highest performance available today for analog modems. Based on a proprietary DSP and controller design, Penril's V.34bis modems offer many advanced features including data transmission speeds up to 33,600 bits per second, protocol intelligent compression performance (e.g. Internet Asynchronous PPP and SLIP) and remote software upgradeability for implementation of future standards. Modems are delivered in several form factors including desktop boxes and modem cards which implement up to eight modems on a single board. T1 Customer Premise Equipment The Company offers a complete line of multiplexors (MUXs) ranging from products which enable its MUX products to connect to LAN's, to large enterprise devices providing up to 304 ports or 36 trunk lines. Penril MUX products can function as a data PBX, an X.25 PAD, a statistical multiplexor, a terminal server or any combination of these. In the first quarter of fiscal 1996, the Company introduced the VCX 500, a product that implements recently ported multiplexor software onto the "AccessBeyond" hardware platform. This is the first product based on this new architecture. One unique feature of the new architecture is the ability in the future to swap cards which today perform a multiplexing function with cards that will perform other functions such as routing, switching or remote access. This means a customer could purchase the VCX 500 today to replace an older MUX in a network and then upgrade the VCX 500 with routing, switching or remote access functions as the customer's need for those functions arises. Penril is the only MUX supplier with this capability. Penril also supplies a channel bank product which provides channelized T1 support. In late 1994, the Company introduced the Cyclone product. This was the first product to implement technology from both Penril and Datability. Cyclone is a T1 channel bank packaged to include MUX and remote access capability, providing flexible WAN and LAN connectivity. Host Access The Company is a leader in the market for host access (terminal server) products. These products are multipurpose communication servers that combine both wide area and local area networking capability in a modular, cost-effective high performance chassis. The systems offer either single or multiprotocol networking capabilities and a selection of interchangeable line cards which provide a suite of WAN gateway and asynchronous communications options. Although the overall market for host access devices is in decline, the Company continues to have success by integrating its host access functions into the MUX and remote access products. ELECTRONIC INSTRUMENTATION EQUIPMENT Electronic instrumentation equipment products, which are sold by EMI, are marketed by an effective combination of EMI's small direct sales force driving a network of independent sales representatives to both commercial and government agencies. Revenues from these products accounted for 10%, 9% and 13% of the Company's consolidated revenues in the fiscal years ended July 31, 1995, 1994 and 1993, respectively. Electro-Metrics products incorporate technologies that detect, process and measure very weak signals and provide accurate frequency discrimination over a very wide frequency spectrum up to 60 gigahertz. EMI's test equipment products measure and record electromagnetic field strength for testing electromagnetic interference or electromagnetic susceptibility. The equipment offers simple, automated test set-ups, data handling and recording for operators with a minimum of skill and experience. Recently, EMI has expanded its wideband radio technology to the design of equipment for communications security and remote control applications in satellite communications terminals for commercial as well as government users. The acquisition in 1993 of a start-up company's patents and fiber optic modem technology has given EMI an entry into the satellite communications terminal control market. Electro-metrics has also identified new strategic opportunities in test and compliance instrumentation for the rapidly emerging wireless voice and data communications markets. SUPPLIERS Material and components for the Company's products are purchased from outside suppliers. While most components are available from several suppliers, a few are provided from sole-source vendors. The Company believes that in most cases alternative sources of supply could be obtained within a reasonable time period; however, an interruption in the supply of such components could have a temporary adverse effect on the Company's operations. PATENTS, COPYRIGHTS AND LICENSES As with many companies in high technology industries, the Company owns or is licensed under a number of patents and copyrights and may desire in the future to obtain additional licenses related to its products. The Company believes, based on industry practice, that any necessary licenses could be obtained. The costs of such licenses may vary significantly depending on the nature of the patent or copyright. BACKLOG A significant portion of data communications revenues are based on customer purchase orders with immediate shipment requirements. Backlog, which tends not to be significant in data communications products, is a result of the occasional customer order with future scheduled shipment requirements or misalignment of demand and production of a particular product. Because data communications revenues constitute such a significant portion of the revenues of the Company, it is the opinion of the Company's management that the dollar amount of backlog at any given time is not indicative of the actual level of revenues which will ultimately be realized during future periods. Consequently, the Company's management believes that the amount of backlog is not a material consideration in understanding the Company's business operations. COMPETITION The Company encounters substantial competition in the marketing of its products and many of its competitors have greater financial, marketing and technical resources. Important competitive factors in the markets for the Company's products are established customer base, product performance and features, service and support as well as price. The Company believes that it competes favorably with respect to these factors. There can be no assurance that the Company's products will compete successfully with competitive products that may be offered in the future or that aggressive pricing will not negatively impact the profitability of the Company. RESEARCH AND DEVELOPMENT Under its own sponsorship, the Company is continuously engaged in the development of new products as well as the development and enhancement of its existing products. The Company expensed approximately $8,260,000 (14% of consolidated revenues) for product development and engineering during fiscal 1995 compared to $9,567,000 (14% of consolidated revenues) in fiscal 1994 and $6,373,000 (13% of consolidated revenues) in fiscal 1993. ENVIRONMENTAL MATTERS The Company's compliance with federal, state and local environmental laws has had no material effect upon the Company's capital expenditures, earnings or competitive position. EMPLOYEES As of July 31, 1995, the Company employed 324 full-time and 16 part-time employees. The Company believes that its future success will depend largely on its ability to retain certain key personnel and to recruit and retain additional highly skilled employees who are in great demand. The Company has employment contracts with certain officers, but does not have employment contracts with its other employees. The Company has experienced no work stoppages and believes that its employee relations are satisfactory. INTERNATIONAL OPERATIONS The Company has subsidiaries located in the United Kingdom and Hong Kong. Reference is made to Note 11 of the Notes to Consolidated Financial Statements contained in Part II, Item 8. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded over-the-counter and quoted on the NASDAQ National Market System under the symbol PNRL. The following table sets forth the high and low sales prices as reported by NASDAQ for the periods indicated. 1995 1994 High Low High Low First Quarter $ 4 1/8 $ 2 3/4 $ 5 3/4 $ 3 3/4 Second Quarter 3 3/8 2 1/8 7 1/8 4 7/8 Third Quarter 4 3/4 2 3/4 7 1/2 5 1/4 Fourth Quarter 6 3 1/8 6 3 1/8 The current quoted price of the stock is listed daily in the Wall Street Journal in the NASDAQ National Market System section. The number of holders of record of the Company's Common Stock as of October 18, 1995 was 1,132. Reference is made to Note 9 of the Notes to Consolidated Financial Statements contained in Part II Item 8 for the maximum cash dividends per share permitted under the bank credit facilities. ITEM 6. SELECTED FINANCIAL DATA Data from the Consolidated Statements of Operations included in the following table pertain to the Company's continuing and discontinued operations(in thousands except per share amounts). The results include the operations of Datability, Inc. ("Datability") from May 6, 1993, the date of acquisition. This transaction is described more fully in Note 4 to the accompanying Consolidated Financial Statements. Years Ended July 31, 1995 1994 1993 1992 1991 ------- ------- ------- ------- ------- Continuing operations Net Revenues $ 58,219 $ 67,842 $ 50,576 $ 40,336 $ 46,998 Net Income(Loss) (4,492) 2,408 868 593 6,913 Earnings(Loss) per share (.60) .31 .13 .09 1.01 Discontinued operations Net Revenues 3,351 5,991 6,226 6,599 5,589 Net Income(Loss) (1,783) (891) (737) 501 5 Loss on Disposal (1,400) -- -- -- -- Earnings(Loss) per share Discontinued operations (.24) (.12) (.11) .07 -- Loss on disposal (.18 -- -- -- -- Cash Dividends per share -- .02 -- .02 -- At Year End: Total Assets 45,132 51,823 50,153 29,367 32,333 Long-Term Debt 5,681 8,890 10,217 1,875 5,196 Shareholders' Equity 21,723 28,580 27,501 22,177 20,901 The above data gives effect to the stock split paid in the form of a stock dividend in fiscal 1991 of 33-1/3%. /TABLE Quarterly Financial Data A summary of the Company's consolidated results of continuing operations for each of the fiscal quarters for the years ended July 31, 1995 and 1994 is shown in the table below. Fiscal 1995 Quarters Ended: October 31,1994 January 31, 1995 April 30, 1995 July 31, 1995 - --------------------------- -------------- --------------- --------------- ------------- Revenues $ 14,556 $ 14,326 $ 14,053 $ 15,284 Gross profit 6,846 6,514 6,185 6,145 Net loss (614) (786) (1,166) (1,926) Net loss per share (.08) (.10) (.15) (.25) Fiscal 1994 Quarters Ended: October 31,1993 January 31, 1994 April 30, 1994 July 31, 1994 - ---------------------------- --------------- ---------------- -------------- ------------- Revenues $ 16,990 $ 17,277 $ 17,132 $ 16,439 Gross profit 8,773 8,594 8,517 8,410 Net income 694 823 375 517 Net income per share .09 .10 .05 .07 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the results of operations includes the results of Datability from May 6, 1993, the date of acquisition, and pertains only to the Company's continuing operations unless otherwise noted. As discussed in Note 3 to the Consolidated Financial Statements, operating results reflect the Technipower, Inc subsidiary, including the uninterruptible power supply business, as a discontinued operation. Liquidity and Capital Resources During fiscal 1995, the Company generated cash of $3,933,000 from continuing operating activities. Non-cash expenses, including depreciation of $4,621,000, coupled with reductions in accounts receivable and inventories and an increase in accounts payable offset the net loss of $4,492,000. The decrease in accounts receivable of $2,384,000 is the result of lower sales volume. The reduction of inventories of $915,000 is due to a concentrated effort during the fourth quarter of fiscal 1995 to bring inventories in line with current sales volumes and the expected phase-out of older products. The inventory management efforts will continue into fiscal 1996 so that any impact from the introduction of new products and the phase-out of older products is minimized. The increase of accounts payable of $1,817,000, was caused by the management of payments to vendors in light of the tight cash position that existed at year-end. As discussed more fully in Note 9 to the Consolidated Financial Statements, subsequent to year end, the Company completed the sale of 1,465,000 shares of the Company's unregistered common stock for $7,325,000 in a private placement to Pequot Partners Fund, L.P., Pequot Endowment Fund, L.P. and Pequot International Fund, Inc. The proceeds have been used to repay $1,500,000 of term debt as discussed below, and for working capital needs. In addition, in October 1995, the Company completed the sale of 50,000 shares of its unregistered common stock to Cramer Partners, L.P. The proceeds of $250,000 will be used for working capital needs. In conjunction with the sale of common shares discussed above, the Company amended the credit agreement with its principal bank. The agreement, as amended, provides for a working capital facility of $5,500,000 with borrowings based on qualified accounts receivable and inventory. At October 13, 1995, the Company had utilized $4,430,000 under the facility. The working capital facility expires on December 31, 1995 at which time, although there are no assurances, the management believes it will be able to renew the credit agreement provided the term loans are repaid as described below. Under the agreement the Company was required to repay $3,300,000 of the term debt during fiscal 1995. As noted above, the Company was required and did repay $1,500,000 of the term notes principal balance. The remaining balance of the term notes after making this payment was $2,000,000 (compared to $6,668,000 at July 31, 1994). Required principal payments for the remaining term notes is $137,000 a month plus accrued interest. Under the terms of the credit agreement as amended, the Company is required to repay the remaining term notes prior to December 31, 1995 with the proceeds from the sale of assets. The Company is currently attempting to sell the Company's Technipower subsidiary including the uninterruptible power supply business to comply with this provision. While there is no assurance the Company will be able to sell Technipower prior to December 31, 1995, the Company believes it has other remedies available should the sale not occur. See Note 6 for terms of the current bank financing agreement. The ability of the Company to generate adequate cash for operational and capital needs is dependent on the success of the Company to increase sales of its data communications products coupled with the sale of assets, including the Technipower subsidiary. In addition it may be necessary to raise cash from other sources including sales of securities or other assets of the Company. Results of Operations Revenues for the consolidated operations fiscal 1995 were $58,219,000 compared to $67,842,000 for fiscal 1994, a decrease of 14%. Revenues for fiscal 1994 increased 34% compared to fiscal 1993 revenues of $50,576,000. Revenues for the data communications segment in fiscal 1995 were $52,610,000 compared to $61,965,000 for fiscal 1994 a decrease of 15%. Revenues for fiscal 1994 increased 40% compared to fiscal 1993 revenues of $44,158,000. The increase in revenues in fiscal 1994 over fiscal 1993 is the result of the acquisition of Datability, Inc at the beginning of the fourth quarter of fiscal 1993. The decrease in revenues in fiscal 1995 compared to fiscal 1994 is partially attributable to the declining market for terminal servers and multiplexors; two main products of the Company's data communications business segment. In addition to these declines, the Company experienced unexpected delays in the shipment of new products including the newer V.34 and V.34bis modems. The Company began shipping limited quantities of V.34 modems in the third quarter of fiscal 1995 and V.34bis modems in early fiscal 1996. Using the current product line as a functional basis, the Company has embarked on a program to replace the older products with a new, single hardware platform which includes such functions as remote LAN access, bridging/routing, multiplexing or host access. These new products, known as "AccessBeyond", will be introduced during fiscal 1996 and beyond. Revenues for the electronic instrumentation segment in fiscal 1995 were $5,609,000 compared to $5,877,000 in fiscal 1994 a decrease of 4%. Revenues decreased 8% in fiscal 1994 compared to fiscal 1993 revenues of $6,418,000. The decline in revenues is primarily due to a decrease in orders for large integrated systems installations from foreign governments. Gross margins for the Company's data communications segment decreased in fiscal 1995 to 44% from 52% in fiscal 1994. This decrease is the result of lower manufacturing efficiencies related to inventory reduction programs and the lower volumes experienced in fiscal 1995, as well as the higher costs associated with the initial production of the V.34 modems that the Company started shipping in fiscal 1995. Gross margins in fiscal 1994 improved slightly over 1993 as a result of the higher sales volumes in general and of internetworking products in particular which carried higher gross margins than did other products. Gross margins for the Company's electronic instrumentation segment decrease slightly in fiscal 1995 to 44% from 45% in fiscal 1994. In fiscal 1994 gross margins increased from 36% due to the introduction of new products and the increased profitability of system integration installations. Selling, general and administrative expenses for the Company's data communications segment decreased $51,000 in fiscal 1995 to $18,764,000 from $18,815,000. During the first half of fiscal 1994, the data communications segment eliminated several administrative positions in its Carlstadt, New Jersey facility. In fiscal 1995, the Company underwent a cost reduction program to reduce staffing at its Gaithersburg, Maryland facility. These reductions resulted in personnel cost reductions of $967,000 in fiscal 1995 compared to fiscal 1994. As a result of the lower revenue levels, commissions decreased by $285,000. Partially offsetting these reductions were increases in depreciation and amortization of $573,000 for equipment used for demonstrations to customers and additional reserves for bad debts of $550,000. Selling, general and administrative expenses increased $4,220,000 to $18,815,000 in fiscal 1994 from $14,595,000 in fiscal 1993 as a result of the Datability acquisition. Selling, general and administrative expenses for the Company's electronic instrumentation segment decreased $338,000 in fiscal 1995 to $1,562,000 from $1,900,000 in fiscal 1994 primarily due to lower commission expense to outside sales representatives. In fiscal 1994 these expenses decreased $36,000 from $1,936,000 in fiscal 1993. Product development and engineering expenses were 14% of revenues for both fiscal 1995 and 1994, up from 13% in fiscal 1993. Product development and engineering expenses for the data communications segment in fiscal 1995 were $7,438,000 compared to $8,817,000 in fiscal 1994, or a decrease of $1,379,000. This decrease is attributable primarily to lower personnel costs as a result of the Company's cost reduction efforts during fiscal 1995. Product development and engineering expenses for the electronic instrumentation segment increased slightly in fiscal 1995 to $821,000 from $750,000 in fiscal 1994. This increase is due to the efforts to develop the satellite communications terminal controller market. The Company's increase in fiscal 1994 in product development and engineering expenses of $3,194,000 from the fiscal 1993 expenses of $6,373,000 was a result of the Datability acquisition in fiscal 1993. The increase in amortization of cost over net assets acquired for fiscal 1995 and fiscal 1994 over the amount expensed in fiscal 1993 is the result of the Datability acquisition in the last quarter of fiscal 1993. Interest expense was $1,227,000 for fiscal 1995 compared to $907,000 for fiscal 1994 and $330,000 for fiscal 1993. The increase in the prime rate from 7% in fiscal 1994 to 9% (reduced to 8-3/4% in the fourth quarter of fiscal 1995) during fiscal 1995 combined with the increase in the rate charged by the Company's principal bank from prime plus 1/2% to prime plus 2% led to the increase in interest expense in fiscal 1995 over fiscal 1994. The Datability acquisition in the fourth quarter of fiscal 1993 resulted in the Company borrowing $6,800,000 from its principal bank and assuming another $1,354,000 in subordinated debt. This increased debt load combined with the working capital needed in fiscal 1994 to finance the increase in accounts receivable and inventories caused the increase in interest expense in fiscal 1994 compared to fiscal 1993. The benefit from income taxes is determined under Statement of Financial Accounting Standards No. 109 (SFAS 109), Accounting for Income Taxes which the Company adopted in fiscal 1994. This statement requires the Company to record the deferred tax asset generated by net operating loss carryforwards, general business and other tax credits and to establish a valuation reserve based on an estimate of the realizability of the deferred tax asset. This analysis resulted in a benefit from income taxes, net of certain state taxes due, of $578,000 in fiscal 1995 and $513,000 in fiscal 1994. At July 31, 1995, the Company had deferred tax assets of $6,154,000 with a valuation reserve of $4,454,000 to reduce deferred tax assets to the amount expected to be realized. Management expects the realization of the remaining asset to occur through the sale of the Company's Technipower subsidiary which the Company has decided to sell, selling other non- core business assets and projected income resulting from new products being introduced in fiscal 1996 and 1997. In summary, principally due to the cumulative effect of the decrease in revenues and the lower gross margins experienced as a result of the manufacturing inefficiencies caused by the lower volumes, the data communications segment had a loss before tax benefits of $5,191,000. The electronic instrumentation segment had a profit before taxes of $121,000. With a tax benefit of $578,000 the Company had a loss from continuing operations of $4,492,000 ($.60 per share) for fiscal 1995. After the operational loss of the discontinued business and estimated loss from the disposal of that business, the Company had a net loss of $7,675,000 ($1.02 per share) for the year ended July 31, 1995. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEPENDENT AUDITORS' REPORT Board of Directors and Shareholders Penril DataComm Networks, Inc. Gaithersburg, Maryland We have audited the accompanying consolidated balance sheets of Penril DataComm Networks, Inc. and subsidiaries as of July 31, 1995 and 1994, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended July 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Penril DataComm Networks, Inc. and subsidiaries as of July 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 1995 in conformity with generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, during the fiscal year ended July 31, 1994 the Company changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109. \s\Deloitte & Touche LLP - ------------------------ Deloitte & Touche LLP Washington, D.C. October 17, 1995 (February 9, 1996 as to Note 12) PENRIL DATACOMM NETWORKS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) Year ended July 31, 1995 1994 1993 -------- -------- -------- NET REVENUES FROM CONTINUING OPERATIONS $ 58,219 $ 67,842 $ 50,576 COSTS AND EXPENSES Cost of revenues 32,529 33,822 26,172 Selling, general and administrative 20,326 20,715 16,531 Product development and engineering 8,260 9,567 6,373 Amortization of cost over net assets acquired 834 816 308 ------- ------- ------- 61,949 64,920 49,384 OPERATING INCOME (LOSS) FROM CONTINUING OPERATIONS (3,730) 2,922 1,192 OTHER EXPENSE Interest expense (1,227) (907) (330) Other, net (113) (120) (60) ------ ------ ------ (1,340) (1,027) (390) ------ ------ ------ INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES (5,070) 1,895 802 BENEFIT FOR INCOME TAXES 578 513 66 ------ ------ ------ INCOME (LOSS) FROM CONTINUING OPERATIONS $ (4,492) $ 2,408 $ 868 LOSS FROM DISCONTINUED OPERATIONS, net of income taxes (1,783) (891) (737) LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS, net of income taxes (1,400) -- -- ------ ------ ------ NET INCOME (LOSS) $ (7,675) $ 1,517 $ 131 ====== ====== ====== NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE Continuing operations $ (.60) $ .31 $ .13 Discontinued operations (.24) (.12) (.11) Loss on disposal of discontinued operations (.18) -- -- ------ ------ ------ (1.02) .19 .02 ====== ====== ====== Shares used in per share calculation 7,559 7,809 6,950 ====== ====== ====== See notes to consolidated financial statements. PENRIL DATACOMM NETWORKS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands except share amounts) July 31, 1995 1994 ASSETS ------ ------ Current Assets Cash $ 1,087 $ 995 Accounts receivable, less allowance for doubtful accounts of $1,134 in 1995 and $997 in 1994 14,766 17,150 Inventories 14,080 14,995 Deferred income taxes 1,700 539 Net assets of discontinued operations 1,376 3,468 Other current assets 803 506 ------ ------ TOTAL CURRENT ASSETS 33,812 37,653 ------ ------ Property and Equipment, net 3,122 4,703 Excess of Cost Over Net Assets Acquired, net 5,689 6,577 Other Assets 2,509 2,890 ------ ------ TOTAL ASSETS $ 45,132 $ 51,823 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Short-term borrowings $ 5,095 $ 3,225 Current portion of long-term debt 5,164 3,153 Accounts payable 8,673 6,856 Accrued compensation and commissions 1,081 1,291 Deferred revenue 1,245 861 Other accrued expenses 892 1,291 ------ ------ TOTAL CURRENT LIABILITIES 22,150 16,677 Long-Term Debt, net of current portion 517 5,737 Other Noncurrent Liabilities 742 829 ------ ------ TOTAL LIABILITIES 23,409 23,243 ------ ------ Commitments and Contingencies Shareholders' Equity Serial preferred stock, $.01 par value; authorized, 100,000 shares; issued, none -- -- Common stock, $.01 par value; authorized, 20,000,000 shares; issued and outstanding, 7,542,815 shares in 1995 and 7,442,368 shares in 1994 76 74 Additional paid-in capital 22,384 21,704 Retained earnings (deficit) (677) 6,998 ------ ------ 21,783 28,776 Equity adjustment from foreign currency translation (60) (196) ------ ------ TOTAL SHAREHOLDERS' EQUITY 21,723 28,580 ------ ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 45,132 $ 51,823 ====== ====== See notes to consolidated financial statements. PENRIL DATACOMM NETWORKS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Year Ended July 31, 1995 1994 1993 ------ ------ ------ CASH FLOWS FROM CONTINUING OPERATIONS Net Income (Loss) from operations $ (4,492) $ 2,408 $ 868 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 4,621 3,837 2,755 Benefit from deferred taxes (578) (538) -- Other (105) 136 (326) (Increase) decrease in assets: Accounts receivable 2,384 (1,508) (3,347) Inventories 915 (1,924) (2,809) Other current assets (297) (68) (116) Increase (decrease) in liabilities: Accounts payable 1,817 (788) 1,280 Other liabilities (332) 730 (111) Net cash provided by (used in) continuing ------ ------ ------ operating activities 3,933 2,285 (1,806) CASH FLOWS FROM DISCONTINUED OPERATIONS Loss from discontinued operations (3,183) (891) (737) Non-cash charges and changes in working capital 824 539 (116) Provision for loss on disposal of discontinued operations 1,400 -- -- ------ ------ ------ Net cash used in discontinued operations (959) (352) (853) ------ ------ ------ Net cash provided by (used in) operations 2,974 1,933 (2,659) CASH FLOWS FROM INVESTING ACTIVITIES Acquisition costs -- -- (208) Expenditures for purchased technology (1,049) (1,126) (973) Expenditures for property, equipment and other (690) (1,261) (1,190) ------ ------ ------ Net cash used in investing activities (1,739) (2,387) (2,371) CASH FLOWS FROM FINANCING ACTIVITIES Net borrowings under line of credit 1,870 2,740 485 Borrowings on long-term debt -- 1,724 9,500 Payments on long-term debt (3,300) (4,184) (6,755) Issuance of common stock 193 319 908 Dividends paid -- (147) -- Other 94 221 (110) ------ ------ ------ Net cash provided by (used in) financing activities (1,143) 673 4,028 CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE YEAR 995 776 1,778 ------ ------ ------ CASH AND CASH EQUIVALENTS AT THE END OF THE YEAR $ 1,087 $ 995 $ 776 ====== ====== ====== SUPPLEMENTAL INFORMATION Cash payments for income taxes $ 113 $ 59 $ 127 ====== ====== ====== Cash payments for interest $ 1,103 $ 795 $ 260 ====== ====== ====== See notes to consolidated financial statements. PENRIL DATACOMM NETWORKS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED JULY 31, 1995, 1994 AND 1993 (In thousands, except shares) Additional Retained Common Stock Paid-in Unearned Earnings Currency Shares Amount Capital Compensation (Deficit) Adjustment --------------- --------- ------------ -------- ---------- BALANCE AUGUST 1, 1992 5,940,993 $ 59 $ 16,538 $ - $ 5,497 $ 83 Net income 131 Issuance of common stock- For acquisition of Datability, Inc. 1,050,000 11 4,583 Upon exercise of stock options 56,663 1 115 For employee stock award program 63,080 245 (143) Upon exercise of warrants 220,000 2 790 Foreign currency translation adjustment (411) --------- ----- ------- ----- ------ ------ BALANCE JULY 31, 1993 7,330,736 73 22,271 (143) 5,628 (328) Net income 1,517 Dividends paid (147) Issuance of common stock- Upon exercise of stock options 132,700 1 367 Upon exercise of warrants 180,000 2 400 Shares retired in connection with the exercise of options and warrants (66,840) (1) (458) Shares returned in conjunction with the valuation of Datability, Inc. (124,388) (1) (828) Shares returned in conjunction with employee stock award program (9,840) (32) 21 Amortization of unearned income 106 Foreign currency translation adjustment 132 --------- ----- ------- ----- ------ ------ BALANCE JULY 31, 1994 7,442,368 74 21,720 (16) 6,998 (196) Net loss (7,675) Issuance of common stock- Upon exercise of stock options 33,067 1 73 Upon exercise of warrants 80,000 1 194 For acquisition of patent rights 50,000 1 118 Shares retired in connection with options, warrants, and awards (62,620) (1) (194) 16 Deferred tax benefit from exercise of options - - 473 Foreign currency translation adjustment 136 --------- ------ ------- ---- ------- ------ BALANCE JULY 31, 1995 7,542,815 $ 76 $ 22,384 $ -- $( 677) $ (60) See notes to consolidated financial statements. PENRIL DATACOMM NETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED JULY 31, 1995, 1994 AND 1993 1. Summary of Significant Accounting Policies Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have been eliminated. The Company operates in the high technology electronics equipment industry. It designs, develops and manufactures products for three distinct business segments: data communications, uninterruptible power supplies and radio frequency communication products. Revenue Recognition: Revenues are recognized at the time of shipment of the product or performance of product-related services. Inventories: Inventories are stated at the lower of cost (first-in, first-out method) or market. The inventories include the cost of material and, when applicable, labor and manufacturing overhead. Property, Equipment and Depreciation: Additions to property and equipment are recorded at cost. The Company provides depreciation for financial reporting purposes using primarily the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the term of the related lease or their estimated useful lives, whichever is shorter. Excess of Cost Over Net Assets Acquired: The excess of cost over net assets acquired is amortized using the straight-line method over ten years. The Company periodically evaluates the intangible assets in relation to the operating performance and future contribution to the underlying business and makes adjustments, if necessary, for any impairment of these assets. Income Taxes: During fiscal 1994, the Company changed its method of accounting for income taxes to comply with the provisions of Statement of Financial Accounting Standards No. 109 (FAS 109), "Accounting for Income Taxes." Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. A valuation allowance is established to reduce deferred tax assets to the amount expected to be realized. Earnings Per Share: Earnings per share for fiscal 1995 is calculated based on the weighted average common shares outstanding. Earnings per share for previous years is calculated using the modified treasury stock method, which limits the assumed purchase of treasury shares to 20% of the outstanding common shares. Any remaining proceeds are assumed first to retire debt, with any remaining proceeds invested in commercial paper. The difference between fully diluted and primary earnings per share was not significant in any year. On September 22, 1995, the Company completed the sale of 1,465,000 shares of its common stock and used $1,500,000 of the proceeds to pay down its term debt. If this transaction had occurred at the beginning of fiscal 1995, the unaudited proforma net loss per share on continuing operations for the year would have been $.55. Software Development Costs: Certain acquired software development costs are being amortized over their estimated economic life, principally five years, commencing when each product is available for general release. Internal software development and any other costs of development are expensed as incurred. Reclassifications: Certain reclassifications have been made to prior period consolidated financial statements to conform to the July 31, 1995 presentation. 2. Business Segment Reporting The Company's consolidated operations are made up of three business segments: Data Communications, Electronic Instrumentation, and Uninterruptible Power Supplies ("UPS"). The UPS segment manufactures uninterruptible power supplies and power regulating equipment. The results of the UPS segments' operations have been reported as discontinued operations in the Company's consolidated financial statements. Intersegment sales are not material. The Data Communications segment designs, develops and manufactures high performance modems, modem channel banks, bridges, routers and multiplexors, for accessing Wide Area Networks (WAN's)and Local Area Networks (LAN's). The Electronic Instrumentation segment designs and manufactures equipment and systems for analysis of electromagnetic interference and communications security including applications in satellite communications. The table below does not include net assets of discontinued operations within Identifiable Assets for the years presented. Net assets for discontinued operations were $1,376,000, $3,468,000, and $3,859,000 for fiscal years 1995, 1994 and 1993 respectively. Year Data Electronic Ended Communications Instrumentation Total ----- -------------- --------------- ------ (thousands of dollars) Revenues 1995 52,610 5,609 58,219 1994 61,965 5,877 67,842 1993 44,158 6,418 50,576 Income(Loss) 1995 (5,191) 121 (5,070) from Continuing 1994 1,892 3 1,895 Operations 1993 1,045 (243) 802 Identifiable 1995 39,243 4,514 43,757 Assets 1994 44,231 4,124 48,355 1993 41,879 4,265 46,144 Depreciation Amortization 1995 4,421 200 4,621 1994 3,676 161 3,837 1993 2,659 96 2,755 Capital Expenditures 1995 1,702 37 1,739 1994 2,207 180 2,387 1993 2,212 159 2,371 3. Discontinued Operations In July 1995, the Board of Directors decided to focus more of the Company's resources on its main business of data communications and therefore decided to sell Technipower, Inc. (Technipower), business segment and wholly owned subsidiary manufacturing uninterruptible power supplies and power regulating equipment. As a result of this action, the Company recorded estimated costs relating to the disposition of Technipower of $1,400,000. Previously reported financial statements have been restated to reflect Technipower as a discontinued operation and discontinued business segment. The following is a summary of operating and segment information for Technipower(in thousands): Year Ended July 31, 1995 1994 1993 ----- ----- ----- Revenues $ 3,351 $ 5,991 $ 6,226 Loss from operations before income taxes (1,783) (891) (737) Loss on disposal before income taxes (1,400) -- -- ------ ------ ------ Total loss from discontinued operations $(3,183) $ (891) $ (737) ====== ===== ===== Depreciation and Amortization $ 215 $ 308 $ 266 ====== ===== ===== Capital Expenditures $ 130 $ 261 $ 177 ====== ===== ===== Identifiable Assets at year end $ 3,437 $ 3,988 $ 5,020 ====== ===== ===== Because the Company expects to retain the tax benefits associated with the discontinued operation, no income tax benefit has been recorded for any year. The loss on disposal before income taxes for fiscal 1995 includes an accrual of approximately $1,000,000 in operating losses through the anticipated disposal date of Technipower. Net assets of the discontinued operations consist of the following (in thousands): July 31, 1995 1994 ----- ----- Current assets $ 2,784 $ 3,128 Current liabilities 650 495 ----- ----- Net current assets 2,134 2,633 Property, plant and equipment, net 375 474 Other non-current tangible assets, net 22 62 Non-current liabilities 10 25 ----- ----- Net tangible assets 2,521 3,144 Intangible assets, net 255 324 ----- ----- 2,776 3,468 Estimated loss on disposal (1,400) -- ----- ----- $ 1,376 $ 3,468 ===== ===== 4. Acquisitions On May 6, 1993, the Company acquired all of the outstanding stock of Datability, Inc. The acquisition was accounted for by the purchase method, and accordingly, the results of operations of Datability are included in the Consolidated Statement of Operations from the date of acquisition. Datability has been consolidated with the Company's data communications operations located in Gaithersburg, Maryland. The acquisition was accomplished through the issuance of 1,050,000 shares of the Company's common stock. The purchase price totalled $4,980,000 including acquisition costs of $386,000. At the acquisition date, the purchase price exceeded net assets acquired by $8,169,000. Under terms of the agreement, the final purchase price was dependent upon the valuation of the net assets acquired. During fiscal 1994, a valuation adjustment of $829,000 resulted in 124,388 shares of the Company's common stock being returned to the Company thereby reducing the excess of cost over net assets acquired. The unaudited proforma results from continuing operations of the Company for the fiscal year ended July 31, 1993, assuming the acquisition of Datability had occurred at the beginning of the year, is as follows (in thousands except per share amounts): Net revenues $ 62,651 Net income (loss) (1,402) Earnings (loss) per common and equivalent share (.20) The unaudited proforma results reflect proforma adjustments for the amortization of goodwill, recognition of interest expense and the issuance of 1,050,000 shares of the Company's stock. The unaudited proforma results do not purport to represent what the actual results would have been had the acquisition occurred at the beginning of the year nor do they purport to represent the future results of the combined entity. 5. Balance Sheet Detail (in thousands) July 31, 1995 1994 ------ ------ Inventories: Raw material $ 6,930 $ 6,133 Work in process 1,458 1,768 Finished goods 5,692 7,094 ------ ------ Total inventories $ 14,080 $ 14,995 ====== ====== Property and equipment, net: Machinery, and equipment $11,734 $11,236 Purchased software and technology 5,486 5,466 Leasehold improvements 980 981 ------ ------ Total property and equipment, at cost 18,200 17,683 Less accumulated depreciation and amortization 15,078 12,980 ------ ------ Total property and equipment, net $ 3,122 $ 4,703 ====== ====== Excess of cost over net assets acquired,net Cost $ 8,090 $ 8,144 Less accumulated amortization 2,401 1,567 ------ ------ $ 5,689 $ 6,577 ====== ====== 6. Financing Bank Financing: In conjunction with the sale of common stock as described more fully in Note 9, the Company amended the credit agreement with its principal bank subsequent to July 31, 1995. The agreement as amended, provides for a working capital facility of $5,500,000 with borrowings based on qualified accounts receivable and inventory. Interest accrues at the bank's prime rate plus 2% with a commitment fee of 3/8% assessed on the unused portion of the facility. The agreement expires December 31, 1995. At July 31, 1995, the Company had utilized $5,192,000 of which $97,000 was for outstanding letters of credit. Average monthly borrowings under the working capital facility were $4,621,000 at a weighted average interest rate of 9.6% for fiscal 1995, $1,475,000 at a weighted average interest rate of 7.2% for fiscal 1994, and $471,000 at a weighted average interest rate of 6.0% for fiscal 1993. In addition, the Company at July 31, 1995 had $3,848,000 in term loans with its principal bank which expire December 1996 through September 1997. These notes require monthly payments with interest at the bank's prime rate plus 2%. The agreement as amended in September 1995, requires $1,500,000 of the proceeds from the equity financing be applied to reduce the principal balance of the term loans. In addition, the Company is required to repay the remaining term loans by December 31, 1995 with proceeds from the sale of assets. The amended bank facility requires the Company to maintain a ratio of current assets to current liabilities of at least 1.6 to 1, a ratio of adjusted earnings to interest expense of (4.2) to 1 at July 31, 1995 and (4.9) to 1 at October 31, 1995, and a ratio of adjusted earnings to fixed charges of (1.2) to 1 at July 31, 1995 and (2.0) to 1 at October 31, 1995. Subordinated debt: In April 1995, as part of the bank financing arrangements, the Company was required to amend its subordinated debt agreement. This amendment reduced the principal payment due May 6, 1995 to $75,775 with additional principal payments allowed only after the bank term loans have been reduced by $3,000,000. Interest, which is payable monthly, accrues at the prime rate plus 1%. The outstanding principal balance is due on May 6, 1996. Principal and interest payments must be suspended in the event the Company is in default of its loan agreement with its principal bank. At July 31, 1995, the Company had outstanding subordinated debt of $979,000. Long-Term Debt: Long-term debt at July 31, 1995 and 1994 consisted of (in thousands): 1995 1994 ------ ------ Term Loans $ 3,848 $ 6,668 Subordinated Debt 979 1,054 ------ ------ 4,827 7,722 Capital leases and other 854 1,168 ------ ------ 5,681 8,890 Less current portion (5,164) (3,153) ------ ------ Long-term debt $ 517 $ 5,737 ====== ====== Future maturities of long-term debt (of which $1,847,000 was paid by October 17, 1995) are as follows: Year Ending July 31, 1996 $ 5,164 1997 201 1998 151 1999 165 ------ Total $ 5,681 ====== 7. Income Taxes Effective August 1, 1993, the Company changed its method of accounting for income taxes to comply with the provisions of Statement of Financial Accounting Standards No. 109 (FAS 109), "Accounting for Income Taxes." The provisions of FAS 109 changes the asset recognition of net operating loss and tax credit carryforwards. There was no cumulative effect of adopting this accounting change. The differences between the tax provision (benefit) from continuing operations calculated at the statutory federal income tax rate and the actual tax benefit for each year is shown in the table below. 1995 1994 1993 ------ ------ ------ Tax provision at federal statutory rate $ (1,724) $ 644 $ 273 Amortization of non- deductible intangibles 283 283 192 State & foreign taxes, net of federal benefit (218) 236 78 Utilization of net operating loss carryforward -- (1,195) (668) Change in valuation allowance 1,134 (538) - Other (53) 57 59 ------ ------ ------ Income tax benefit $ (578) $ (513) $ (66) The primary components of temporary differences which give rise to the Company's net deferred tax asset are shown in the table below. At July 31, 1995 the Company had federal net operating loss carryforwards of approximately $6,691,000 of which $1,505,000 expires in 2007 and $5,186,000 expires in 2010 and general business and other tax credits of $1,248,000 to reduce future tax liabilities through 2008. As of July 31, 1995 1994 ---- ---- Deferred tax assets: Reserves and other contingencies $ 1,838 $ 1,152 Depreciation and amortization 16 201 Other -- 199 Net operating loss 2,854 264 General business and other tax credits 1,248 1,302 Loss on discontinued operations 582 -- Valuation reserve (4,454) (2,148) ------ ------ Total deferred tax assets 2,084 970 Deferred tax liabilities: Amortization of technologies (384) (431) ------ ------ Net deferred tax assets $ 1,700 $ 539 ====== ====== 8. Commitments and Contingencies The Company leases office and manufacturing facilities and equipment under lease agreements, certain of which are renewable at the Company's option and/or provide for increases in rent related to increases in the Consumer Price Index and other factors. Rent expense for the fiscal years 1995, 1994 and 1993 was $1,941,000, $1,754,000, and $1,370,000, respectively. Approximate aggregate future minimum rentals applicable to operating leases in effect at July 31, 1995 are as follows (in thousands): Year Ending July 31, 1996 $ 1,762 1997 1,717 1998 1,777 1999 1,824 2000 934 Beyond 2000 1,539 ------ Total minimum rentals $ 9,553 ====== The Company initiated a lawsuit in December 1994 against Network Systems Corporation ("NSC") for breach of contract, fraudulent inducement and defamation. The suit is seeking specific performance, compensatory damages of $2,000,000 and punitive damages of $5,000,000. The litigation arises out of a contract in which the Company agreed to develop certain computer hardware and software to NSC's specifications. NSC subsequently brought a counterclaim alleging negligent misrepresentation, fraud and breach of contract by the Company. NSC is seeking recision of the contract, restitution of monies paid by NSC to the Company, compensatory damages of $5,000,000 and punitive damages in an unspecified amount. As of July 31, 1995, the litigation was in the discovery stage. The Company has initiated a lawsuit against Standard Microsystems Corp. ("SMC") for breach of contract including failure to transfer technology, unfair competition and false representations. The suit seeks damages of $8 million. SMC subsequently brought a counterclaim alleging breach of contract and recovery of amounts due under the contract which are approximately $1 million. As of July 31, 1995, the litigation was in the discovery stage. In April 1994, the Company was involved in a jury trial in which a former employee in the Company's Chicago sales office alleged employment discrimination based on sex. The suit sought compensatory damages and punitive damages together with attorney's fees, costs and interest thereon. The court entered judgement in favor of the plaintiff in the amount of $240,000 plus attorney's fees and costs in the amount of $146,000. These judgements have been appealed. On September 8, 1995, oral arguments were presented to the Court of Appeals and the Court has taken the case under advisement. Management believes the Company's position is sound and that the Company should prevail on the appeal. The Company is involved in other routine litigation. Management believes none of the litigation will have a material adverse effect on the Company's financial position or results of operations. 9. Shareholders' Equity Subsequent Event: On September 22, 1995, the Company issued an aggregate of 1,465,000 shares of its unregistered common stock to Pequot Partners Fund, L.P., Pequot Endowment Fund, L.P and Pequot International Fund, Inc. (collectively the "Investors") for $7,325,000 in a private transaction. The Company is required to file a shelf registration with the SEC prior to December 31, 1995 covering the shares issued in the transaction and keep the shelf registration effective for three years. The Investors may request one public registration after the three years until the later of September 22, 1999 or 30 days after the Company files its annual report on form 10-K for the fiscal year ended July 31, 1999. If the Company does not keep the shelf registration effective for the required three years, the Investors are entitled to require the Company to effect up to two public registrations during that time. As part of the transaction, the Company has agreed to increase the Board of Directors of Penril by one and, so long as the Investors collectively own in the aggregate not less than 10% of the issued and outstanding common stock, the Investors are entitled to fill such vacancy by designating one person to the Board of Directors. Serial Preferred Stock: The Company's Serial Preferred Stock may be issued in one or more series. The shares of any series may be convertible into Common Stock, may have priority over Common Stock in the payment of dividends and in the distribution of assets in the event of liquidation or dissolution of the Company, and may have preferential or other voting rights, all as determined by the Board of Directors at the time it approves the series. Employee Stock Options and Stock Awards: On October 8, 1986, the Company adopted the 1986 Incentive Plan (the "1986 Plan"). Under the 1986 Plan, which will terminate on October 8, 1996, awards may be granted to key employees of the Company and its subsidiaries in one or more of the following forms: (i) Incentive Stock Options; (ii) Non-qualified Stock Options; and (iii) Restricted Stock Awards. The option price of shares of Common Stock subject to options granted under the 1986 Plan will not be less than 100% (110% in the case of Incentive Stock Options granted to optionees holding more than ten percent of the voting stock of the Company at the date of grant) of the fair market value of shares of Common Stock at the date of grant. No option will be exercisable more than ten years (five years in the case of Incentive Stock Options granted to optionees holding more than ten percent of the Voting Stock of the Company on the date of grant) from the date it is granted. An aggregate of 1,503,822 shares were reserved for issuance under the 1986 Plan at July 31, 1995. The terms of Restricted Stock Awards ("Stock Awards") granted under the 1986 Plan are determined at the time of issuance and are evidenced by a written Restricted Stock Agreement. Any Stock Awards granted are subject to approval by a majority of all "disinterested directors" as defined in Rule 16b-3 of the General Rules and Regulations under the Securities Exchange Act of 1934. Of the total shares reserved under the 1986 Plan, a maximum of 400,000 shares are available for grant in the form of Stock Awards. On October 1, 1992, the Company granted Stock Awards for 71,220 common shares of the Company to all manufacturing, engineering, marketing and administrative employees of the Gaithersburg, Maryland facility. The Stock Awards granted vested over two years and employees had to be employed by the Company when the vested shares were issued. Of the total shares awarded, 53,020 were issued. The Company issued 29,560 shares on October, 1993 which represented 50% of the Stock Awards outstanding on that date and the remaining 23,460 shares on October 1, 1994. Compensation related to the Stock Award Program was amortized over the vesting period. Non-Employee Director Stock Options: On December 9, 1987, the Company adopted the Non-Employee Directors' Stock Option Plan ("Directors Plan"). Under the Directors Plan an option to purchase 24,000 shares is automatically granted to each non-employee director on the first day of his initial term. In addition, options to purchase shares are automatically granted to each non-employee director on the fifth business day after the Annual Report on Form 10-K is filed with the Securities and Exchange Commission as follows: in each of the first two successive years after the initial grant an option to purchase 6,000 shares is granted, and in each of the next five successive years an option to purchase 3,000 shares is granted. The option price per share of any option granted under the Directors Plan is the fair market value of a share of Common Stock on the date the option is granted. No option will be exercisable more than ten years from the date of grant. An aggregate of 273,333 shares were reserved for issuance under the Directors Plan at July 31, 1995. A summary of stock option transactions during the three years ended July 31, 1995 is as follows: 1986 Incentive Plan Directors Plan ------------------ ------------------ Number Average Number Average of Price of Price Shares Per Share Shares Per Share ------- -------- -------- --------- Outstanding August 1, 1992 617,168 4.01 180,000 3.02 Granted 635,250 4.28 15,000 3.75 Exercised (26,666) 2.60 (30,000) 1.53 Canceled (33,000) 3.79 - - --------- ------ ------- ------ Outstanding July 31, 1993 1,192,752 4.15 165,000 3.35 Granted 81,500 4.76 39,000 4.84 Exercised (132,700) 2.77 - - Canceled (104,133) 4.67 - - --------- ------ ------- ------ Outstanding July 31, 1994 1,037,419 $ 4.15 204,000 $ 3.64 Granted 348,000 3.12 18,000 3.25 Exercised (33,067) 2.23 - - Canceled (233,617) 4.15 - - --------- ------ ------- ------ Outstanding July 31, 1995 1,118,735 $ 3.89 222,000 $ 3.61 Exercisable Options at July 31, 1995 531,968 $ 4.14 158,000 $ 3.37 Warrants: In March, 1987, Henry D. Epstein joined the Company as President and Chief Executive Officer and was issued Class A warrants to purchase 400,000 shares of Common Stock at $2.23 per share and Class B warrants to purchase 80,000 shares of Common Stock at $2.34 per share. Mr. Epstein exercised 220,000 Class A warrants in January 1993, 80,000 Class A warrants in January 1994 and 100,000 Class A warrants in February 1994. In February 1995, Mr. Epstein exercised all 80,000 Class B warrants. All exercises were accomplished by delivery of shares previously held. In October 1992, the Company issued a warrant to purchase 166,000 shares of common stock at $4.50 per share, the fair market value on the date of issuance, to Coast Federal Savings Bank ("Coast") in settlement of a law suit brought against the Company. In addition, the Company issued Class E warrants to purchase 25,000 shares of common stock at $3.625 per share, the fair market value on the date of issuance, to Mr. Henry Epstein in consideration for Mr. Epstein, in his capacity as a stockholder of Penril, assisting Penril in settling the litigation with Coast. The Coast warrant expired June 7, 1995. The Class E warrants were exercised subsequent to July 31, 1995. Cash Dividends: The Company declared a $.02 per share cash dividend to the holders of record on December 16, 1993 and paid December 30, 1993. There were 7,332,296 shares outstanding on the record date. No cash dividends are allowed under the current banking arrangement. 10. Retirement and Savings Plan The Company's Retirement and Savings Plan ("401(k) Plan") is a defined contribution plan including provisions of section 401(k) of the Internal Revenue Code. Employees of the Company who have completed 90 days of service ("Participants") are eligible to participate in the 401(k) Plan. The 401(k) Plan permits, but does not require, the Company to match employee contributions. In addition, the Company may make discretionary contributions to the 401(k) Plan which will be allocated to each Participant based on the ratio of such Participant's eligible compensation to the total of all Participants' eligible compensation. Amounts contributed by the Company vest as to 30% after 1 year of eligible service, 60% after 2 years of eligible service and 100% after 3 years of eligible service. Participants may elect to direct the investment of their contributions in accordance with the provisions of the 401(k) Plan. The Company made matching contributions of $55,000, $46,000 and $45,000 during fiscal 1995, 1994 and 1993, respectively. There were no additional Company contributions in any year. The Company provides no post-employment or post-retirement benefits. 11. Geographic Area Information The Company's foreign operations consists principally of sales and marketing activities through subsidiaries located in Hong Kong and the United Kingdom. Certain information, including the effect of intercompany transactions, relating to the Company's operations on a geographic basis is as follows (in thousands): Revenues 1995 1994 1993 U.S. Revenue ------ ------ ------ Domestic $ 33,338 $41,397 $28,152 Export: Europe 6,780 11,129 9,738 Pacific Rim 7,195 5,257 4,989 Central and South America 3,503 4,581 4,120 Other International 4,600 4,595 2,778 ------ ------ ------ Total Exports 22,078 25,562 21,625 Total U.S. Revenue $ 55,416 $66,959 $49,777 Revenue from foreign subsidiaries 6,839 7,876 5,032 Adjustments and eliminations (4,036) (6,993) (4,233) ------ ------ ------ Total Revenues $ 58,219 $67,842 $50,576 ====== ====== ====== Income (Loss) before taxes U.S. $ (5,021) $ 2,520 $ 1,219 Foreign 688 1,479 443 Eliminations (737) (2,104) (860) ------ ------ ------ Total Income (Loss) from continuing operations before taxes $ (5,070) $ 1,895 $ 802 ====== ====== ====== Identifiable Assets U.S. $ 41,691 $47,975 $47,497 Foreign subsidiaries 3,441 3,848 2,506 ------ ------ ------ Total Identifiable Assets $ 45,132 $51,823 $50,003 ====== ====== ====== 12. Subsequent Events On December 21, 1995, the Company amended the credit agreement with its principal bank to extend the credit agreement to March 31, 1996 and eliminate the Company's obligations to comply with the financial covenants for the fiscal quarter ended January 31, 1996. In February, 1996, the Company issued an aggregate of 750,000 shares of its unregistered common stock for approximately $5,100,000 in private transactions. The Company may be requested by the holders to file a shelf registration with the SEC covering the shares issued in the transaction and keep the shelf registration effective for up to three years. In November, 1995, the Company filed an amended complaint in its suit against SMC which increased the amount of damages from $8 million to $50 million. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements -------------------- Included in Part II of this report: Independent Auditors' Report Consolidated Statements of Operations for each of the three years in the period ended July 31, 1995 Consolidated Balance Sheets as of July 31, 1995 and 1994 Consolidated Statements of Cash Flows for each of the three years in the period ended July 31, 1995 Consolidated Statements of Shareholders' Equity for each of the three years in the period ended July 31, 1995 Notes to Consolidated Financial Statements for the years ended July 31, 1995, 1994, and 1993 (a) 2. Financial Statement Schedule ----------------------------- Included in Part IV of this report: Independent Auditors' Report on Schedule Schedule II -Valuation and Qualifying Accounts Other schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the Financial Statements or notes thereto. 3. Exhibits The exhibits are set forth on the attached Exhibit Index which is incorporated by reference. Exhibits are included only in the copies of this Form 10-K filed with the Securities and Exchange Commission and NASDAQ. 4. Reports on Form 8-K None SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Penril DataComm Networks, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PENRIL DATACOMM NETWORKS, INC. By:\s\Henry D. Epstein ------------------------------ Henry D. Epstein President, Chief Executive Officer, and Chairman of the Board of Directors Date: February 16, 1996 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated: \s\Henry D. Epstein ------------------------------ Henry D. Epstein, Chief Executive Officer and Chairman of the Board of Directors Date: February 16, 1996 \s\Richard D. Rose ------------------------------ Richard D. Rose, Vice President, Chief Financial Officer and Chief Accounting Officer Date: February 16, 1996 INDEPENDENT AUDITORS' REPORT Board of Directors and Shareholders Penril DataComm Networks, Inc. Gaithersburg, Maryland We have audited the consolidated financial statements of Penril DataComm Networks, Inc. and subsidiaries as of July 31, 1995 and 1994, and for each of the three years in the period ended July 31, 1995, and have issued our report thereon dated October 17, 1995 (which report is included herein). Our audits also included the financial statement schedule of Penril DataComm Networks, Inc., listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. \s\Deloitte & Touche LLP Deloitte & Touche LLP Washington, D.C. October 17, 1995 (February 9, 1996 as to Note 12) SCHEDULE II PENRIL DATACOMM NETWORKS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (in thousands) Balance Charged Charged at to Costs to Balance Beginning and Other Deductions at End Description of Period Expenses Accounts(a) (b) of Period - ------------ --------- -------- ----------- ---------- --------- ALLOWANCE FOR DOUBTFUL ACCOUNTS APPLICABLE TO ACCOUNTS RECEIVABLE-FROM CONTINUING OPERATIONS Fiscal 1995 $ 997 $ 846 $ 5 $ (714) $ 1,134 ==== ==== == ===== ===== Fiscal 1994 $ 927 $ 196 $ 8 $ (134) $ 997 ==== ==== == ===== ===== (a) Recoveries of accounts previously written off. (b) Write-off of bad debts. INDEX TO EXHIBITS Page 1 of 2 Exhibit No. EXHIBIT DESCRIPTION Ref. - ------- ------------------- ---- 2.01 Agreement and Plan of Merger dated May 6, 1994 among the Company, Datability, Inc., PD Acquisition Corp. and the stockholders of Datability listed on Appendix I together with Appendix I thereto (Exhibit 2.01 to Form 8-K filed (May 21, 1993) * 3.01 Amended and restated By-Laws of the Company (Exhibit (3)(a)(ii) to Form 10-K filed December 18, 1987). * 3.02 Certificate of Amendment of Certificate of Incorporation of the Company (Exhibit 4.3 to Form S-3 filed April 29, 1991). * 4.01 Amended and Restated Credit Agreement dated as of May 6, 1993 between the Company and Signet Bank/Maryland. (Exhibit 4.01 to Form 8-K filed May 21, 1993) * 4.02 Amendment No.1 to the Amended and Restated Credit Agreement dated as of May 6, 1993 between the Company and Signet Bank/Maryland. Amends the agreement at 4.05 above. (Exhibit 4.01 to Form 10-Q filed March 3,1995) * 4.03 Amendment No.2 to the Amended and Restated Credit Agreement dated as of May 6, 1993 between the Company and Signet Bank/Maryland. Amends the agreements at 4.01 and 4.02 above. (Exhibit 4.07 to Form 10-K filed October 28, 1994) * 4.04 Second Amended and Restated Credit Agreement dated as of April 25, 1995 to the Amended and Restated Credit Agreement dated as of May 6, 1993 between Penril DataComm Networks, Inc. and Signet Bank/Maryland. Amends the agreements at 4.01, 4.02 and 4.03 above. (Exhibit 4.01 to Form 10-Q filed June 14, 1995) * 4.05 Amendment No.1 dated as of September 19, 1995 to the Second Amended and Restated Credit Agreement between Penril DataComm Networks, Inc. and Signet Bank/Maryland. Amends the agreement at 4.04 above. (Exhibit 4.05 to Form 10-K filed October 27, 1995) * 4.06 Subordinated Promissory Note of Datability, Inc. dated May 6, 1993 in the principal amount of $909,126 payable to the order of Howard International Corp. (Exhibit 4.02 to Form 8-K filed May 21, 1993) * 4.07 Subordinated Promissory Note of Datability, Inc. dated May 6, 1993 in the principal amount of $395,374 payable to the order of John Howard. (Exhibit 4.03 to Form 8-K filed May 21, 1993) * 4.08 Amendment No. 1 dated as of April 25, 1995 to the Subordination Agreement dated as of May 6, 1993, among Howard International Corporation, John Howard, Signet Bank/Maryland, and Datability, Inc. (Exhibit 4.02 to Form 10-Q filed June 14, 1995) * 4.09 Stock Purchase Agreement dated as of September 22, 1995 among Registrant and Pequot Partners Fund, L.P., Pequot International Fund Inc., and Pequot Endowment Fund, L.P. (Exhibit 4.01 to Form 8-K filed October 6, 1995) * INDEX TO EXHIBITS Page 2 of 2 Exhibit No. EXHIBIT DESCRIPTION PAGE - ------- -------------------- ---- 4.10 Registration Rights Agreement dated as of September 22, 1995 among Registrant and Pequot Partners Fund, L.P., Pequot International Fund Inc., and Pequot Endowment Fund, L.P. (Exhibit 4.01 to Form 8-K filed October 6, 1995) * 4.11 Amendment No.2 dated as of December 21, 1995 to the Second Amended and Restated Credit Agreement between Penril DataComm Networks, Inc. and Signet Bank/Maryland. Amends the agreement at 4.05 above. 10.01 1986 Incentive Plan of Penril DataComm Networks, Inc., As Amended (Exhibit 4.1 to Form S-8 filed April 29, 1991). * 10.02 Employment Agreement dated September 21, 1989, between the Company and Henry D. Epstein. (Exhibit 10.05 to Form 10-K filed October 11, 1989) * 10.03 Employment Agreement dated as of May 1, 1994 between the Company and Ronald A. Howard (Exhibit 10.01 to Form 8-K filed May 21, 1994) * 10.04 Amendment to Employment Agreement dated October 25, 1995 between the Company and Ronald A. Howard. Amends 10.03 above.(Exhibit 10.04 to Form 10-K filed October 27, 1995) * 10.05 1987 Non-Employee Directors' Stock Option Plan of Penril DataComm Networks, Inc., as Amended (Exhibit 4.1 to Form S-8 filed April 29, 1991). * 22 Subsidiaries of the Registrant 23 Independent Auditors' Consent * Indicates Exhibits incorporated herein by reference. Documents not so marked have been filed herewith. EXHIBIT 22 PENRIL DATACOMM NETWORKS, INC. AND SUBSIDIARIES SUBSIDIARIES OF THE REGISTRANT Jurisdiction of Name (1) Incorporation - ----------------------- --------------------- Datability, Inc. Delaware Electro-Metrics, Inc. Delaware Technipower, Inc. Delaware Penril Electronics, Inc. Delaware Penril Technologies, Inc. Delaware Penril Power Systems, Inc. Delaware Penril DataComm Ltd. United Kingdom Penril (Far East) Ltd. Hong Kong Penril International Ltd. U. S. Virgin Islands (1) This also represents the name under which the subsidiary does business.