UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-Q
(Mark One)
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended June 30, 1996
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: 0-20124
NETWORK COMPUTING DEVICES, INC.
(Exact name of registrant as specified in its charter)
California 77-0177255
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
350 North Bernardo Avenue, Mountain View, California 94043
(Address of principal executive offices and zip code)
Registrant's telephone number: (415) 694-0650
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 was 16,567,591
at July 31, 1996.
NETWORK COMPUTING DEVICES, INC.
INDEX
DESCRIPTION PAGE NUMBER
- ---------------------------------------------- -----------
Cover Page 1
Index 2
Part I: Financial Information
Item 1: Financial Statements
Condensed Consolidated Balance Sheets as of June
30, 1996 and December 31, 1995 3
Condensed Consolidated Statements of Operations for the
Three- and Six-Month Periods Ended June 30,
1996 and 1995 4
Condensed Consolidated Statements of Cash Flows for
the Six-Month Periods Ended June 30, 1996 and 1995 5
Notes to Condensed Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Part II: Other Information
Item 1: Legal proceedings 16
Item 6: Exhibits and Reports on Form 8-K 16
Signature 17
2
NETWORK COMPUTING DEVICES, INC.
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
June 30, December 31,
1996 1995
---------- ----------
(UNAUDITED)
Current assets:
Cash and cash equivalents $10,983 $13,364
Short-term investments 15,455 22,786
Accounts receivable, net 23,298 28,591
Inventories 15,305 14,398
Prepaid expenses and other 9,744 6,863
---------- ----------
Total current assets 74,785 86,002
Property and equipment, net 6,025 6,749
Other assets 3,319 4,786
---------- ----------
Total assets $84,129 $97,537
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $7,387 $13,893
Current portion of capital lease obligations 931 1,246
Income taxes payable 412 2,666
Accrued expenses 7,798 7,429
Deferred revenue 3,572 3,298
---------- ----------
Total current liabilities 20,100 28,532
Long-term portion of capital lease obligations 571 991
Shareholders' equity:
Undesignated preferred stock - -
Common stock 65,336 63,543
Unrealized gain (loss) on available-for-sale securities (11) 31
Retained earnings (1,867) 4,440
---------- ----------
Total shareholders' equity 63,458 68,014
---------- ----------
Total liabilities and shareholders' equity $84,129 $97,537
---------- ----------
---------- ----------
See accompanying notes.
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NETWORK COMPUTING DEVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED - IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
1996 1995 1996 1995
---------- ---------- ---------- ----------
Net revenues:
Systems division $25,436 $28,830 $52,064 $61,429
Software division 3,892 6,201 7,703 11,130
---------- ---------- ---------- ---------
Total net revenues 29,328 35,031 59,767 72,559
Cost of revenues:
Systems division 22,166 21,325 43,432 44,127
Software division 636 724 1,470 1,308
---------- ---------- ---------- ---------
Total cost of revenues 22,802 22,049 44,902 45,435
---------- ---------- ---------- ---------
Gross profit margin 6,526 12,982 14,865 27,124
Operating expenses:
Research and development 4,019 2,971 8,139 5,990
Marketing and selling 9,402 8,202 18,959 17,148
General and administrative 3,527 2,032 6,036 4,014
---------- ---------- ---------- ---------
Total operating expenses 16,948 13,205 33,134 27,152
---------- ---------- ---------- ---------
Operating loss (10,422) (223) (18,269) (28)
Other income, net 385 343 824 615
Gain (loss) on sale of product lines (27) - 6,932 -
---------- ---------- ---------- ---------
Income (loss) before income taxes (10,064) 120 (10,513) 587
Provision for income taxes (income tax benefit) (4,017) 35 (4,206) 198
---------- ---------- ---------- ---------
Net income (loss) $ (6,047) $ 85 $ (6,307) $ 389
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
Net income (loss) per share:
Primary $(0.37) $ - $(0.38) $ 0.02
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
Fully diluted $(0.37) $ - $(0.38) $ 0.02
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
Shares used in per share computations:
Primary 16,504 17,003 16,382 16,797
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
Fully diluted 16,504 17,003 16,382 16,797
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
See accompanying notes.
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NETWORK COMPUTING DEVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED - IN THOUSANDS)
Six Months Ended June 30,
-------------------------
1996 1995
---------- ---------
Cash flows from operations:
Net income (loss) $ (6,307) $ 389
Reconciliation to cash provided (used) by operations:
Depreciation and amortization 1,799 2,592
Gain on sale of product lines (6,932) -
Changes in:
Accounts receivable, net 5,293 5,859
Inventories (1,074) 4,745
Prepaid expenses and other (2,881) (1,958)
Accounts payable (6,506) (6,140)
Income taxes payable (2,254) 36
Accrued expenses (375) (606)
Deferred revenue 664 1,890
---------- ----------
Cash provided (used) by operations (18,573) 6,807
Cash flows from investing activities:
Short-term investments, net 7,289 (4,718)
Proceeds from sale of product lines 8,625 -
Changes in other assets 973 (591)
Property and equipment purchases (1,599) (1,968)
---------- ----------
Cash provided (used) by investing activities 15,288 (7,277)
Cash flows from financing activities:
Principal payments on capital lease obligations (735) (805)
Repurchases of stock (89) (2,373)
Proceeds from issuance of stock, net of issuance costs 1,728 928
---------- ----------
Cash provided (used) by financing activities 904 (2,250)
Increase (decrease) in cash and equivalents (2,381) (2,720)
Cash and equivalents:
Beginning of period 13,364 7,407
---------- ----------
End of period $ 10,983 $ 4,687
---------- ----------
---------- ----------
Noncash investing and financing activities:
Property and equipment acquired under capital leases $ - $ 482
---------- ----------
---------- ----------
See accompanying notes.
5
NETWORK COMPUTING DEVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
The unaudited condensed consolidated financial information of Network Computing
Devices, Inc. (the "Company") furnished herein reflects all adjustments,
consisting only of normal recurring adjustments, which in the opinion of
management are necessary to fairly state the Company's consolidated financial
position, results of operations and cash flows for the periods presented. This
Quarterly Report on Form 10-Q should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
1995 Annual Report on Form 10-K. The consolidated results of operations for the
three- and six-month periods ended June 30, 1996 are not necessarily indicative
of the results to be expected for any subsequent quarter or for the entire year
ending December 31, 1996. Certain financial statement amounts from 1995 have
been reclassified to conform with current year methods of presentation.
PER SHARE INFORMATION
Per share information is computed using the weighted average number of common
and dilutive common equivalent shares outstanding. For primary and fully
diluted earnings per share, common equivalent shares consist of the incremental
shares issuable upon the assumed exercise of dilutive stock options (using the
treasury stock method). For the second quarter and first six months of 1995,
common equivalent shares were adjusted to assume that all financial performance
objectives had been achieved, the maximum number of contingently issuable shares
had been issued, and the maximum amount of cash contingently payable had been
paid in connection with the Z-Code acquisition. In the second quarter of 1995,
the Company determined that none of such shares or cash payments are issuable or
payable. The effect of common equivalent shares is not included in earnings per
share calculations during periods in which such effect would be antidilutive.
INVENTORIES
Inventories, stated at the lower of standard cost, which approximates actual
cost on a first-in, first-out basis, or market, consisted of (in thousands):
June 30, December 31,
1996 1995
------- -------
Purchased components and
sub-assemblies $13,131 $ 9,548
Work in process 499 1,814
Finished goods 1,675 3,036
------- -------
$15,305 $ 14,398
------- -------
------- -------
BUSINESS RESTRUCTURING
In the third quarter of 1995, the Company determined that it was appropriate to
undertake a strategic restructuring plan intended to realign and consolidate its
software businesses and reduce operating expenses, and to improve the operating
performance of its X-terminal, or "Systems," operations in reaction to intense
competition and slowness in the X-terminal market. The Company began
implementing this plan during the third quarter of 1995, and terminated
approximately fifty employees associated with such operations.
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NETWORK COMPUTING DEVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The plan's major components include:
- - modifying the method of manufacturing and materials management to a "build-
to-order" paradigm in order to increase the efficiency with which the
Company receives product orders and manufactures and delivers products to
its customers;
- - phasing out X-terminal products that were currently yielding, or were
anticipated to yield, profit margins that did not meet certain minimum
requirements of the Company;
- - reducing and consolidating facilities devoted to the conduct of the Systems
business through a combination of sublease activities or negotiating early
exits to existing lease agreements; and
- - reducing the number of employees engaged in Systems business activities to
a level deemed to be essential to reengineer the business for improved
operating performance.
A description of the types and amounts (in thousands) of accruals made for
restructuring costs in 1995, and the cumulative amounts charged against such
accruals, is presented below.
Initial June 30,
Amounts Asset Cash 1996
Accrued Write-offs Payments Balance
------------------------------------------------
Reserve for the write-down of
phase-out inventories $2,706 ($2,706) $ - $ -
Employee termination benefits 1,580 - (1,147) 433
Exiting facilities -related
obligations 2,256 - (1,171) 1,085
Asset impairment & other 996 (815) - 181
------ ------------ ------------ ------------
Total $7,538 ($3,521) ($2,318) $1,699
------ ------------ ------------ ------------
------ ------------ ------------ ------------
It is anticipated that the restructuring plan will continue through 1996.
INTEREST AND TAX PAYMENTS
Interest payments, primarily related to interest on capital lease liabilities,
were $41,000 and $65,000 for the second quarter and first six months of 1996,
respectively, and were $81,000 and $148,000 for the second quarter and first six
months of 1995. Income tax payments were $130,000 and $164,000 for the second
quarter and first six months of 1995. There were no income tax payments for the
second quarter and first six months of 1996.
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NETWORK COMPUTING DEVICES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
THIS DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS, INCLUDING BUT NOT LIMITED
TO STATEMENTS WITH RESPECT TO THE COMPANY'S FUTURE FINANCIAL PERFORMANCE,
OPERATING RESULTS, PLANS AND OBJECTIVES. ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE CURRENTLY ANTICIPATED DEPENDING UPON A VARIETY OF FACTORS, INCLUDING
THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "FUTURE PERFORMANCE AND RISK
FACTORS."
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE UNAUDITED
CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED
IN PART I -- ITEM 1 OF THIS QUARTERLY REPORT AND THE AUDITED CONSOLIDATED
FINANCIAL STATEMENTS AND NOTES THERETO AND MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31,
1995 CONTAINED IN THE COMPANY'S 1995 ANNUAL REPORT ON FORM 10-K.
The Company designs, develops, manufactures and markets hardware and software
products that provide information access to networks of heterogeneous computers.
During 1995, the Company took various actions to reorganize the two basic
components of its business into two separate business units: the Systems
business, consisting of the Company's network computers and related software;
and the Software business, consisting of its lines of PC connectivity software,
electronic messaging software and, initially, its Mariner Internet access
software. In addition, the Company took steps to consolidate the management and
sales organizations of the geographically separated segments of its Software
business and reoriented its software sales strategy toward the increased use of
distributors, value added resellers ("VARs") and other resellers. These efforts
continued in the first six months of 1996. In June 1996, the Company determined
to recombine its Systems and Software business units.
During the third quarter of 1995, the Company began implementing a plan to
restructure its Systems business in order to improve its operating performance.
The plan included substantial modifications to the Company's manufacturing
processes, phasing out lower margin products, a reduction in the amount of
leased space devoted to the conduct of the Systems business, and a reduction in
the number of employees engaged in Systems business activities. During the
third quarter of 1995, the Company recognized charges totaling $7.5 million for
the implementation of this plan, which will continue into 1996. Included in
these restructuring charges were amounts related to the severance of personnel,
phase-out of certain products, and costs associated with the termination of
lease obligations.
In 1994, the Company began the development of Mariner, an Internet access and
navigation tool which it intended to market to large enterprises, as well as to
OEMs and VARs. In January 1995, the Company entered into a software development
and licensing agreement with AT&T to develop a custom version of Mariner for
AT&T (the "AT&T Agreement"). The AT&T Agreement provided for total minimum
royalties of $15 million through 1998, and contemplated the development of
additional Internet access products by NCD for license to AT&T. In September
1995, the AT&T Agreement was amended to provide that the additional products
would not be developed and that NCD would be paid fees totaling $9 million
through 1996 for development work completed at the time of the amendment and for
a license to evaluate the Mariner product. In 1995, the Company recognized
license fees totaling $6.8 million under the AT&T Agreement and received
$500,000 in fees for non-recurring engineering costs that offset research and
development expenses. In 1995, the Company also recognized revenues of $300,000
from customers other than AT&T related to the Mariner product line. In light of
the Company's inability to develop a long-term relationship with AT&T, as well
as other changes in the Internet market, including the development of intense
price competition among vendors of Internet access products, the Company in late
1995 determined to sell the Mariner product line and focus its attention on
providing desktop information access solutions for network computing
environments. In February 1996, the Company sold the Mariner product line to FTP
Software, Inc. ("FTP") for $9.8 million. NCD paid FTP a one-time license fee of
$2.5 million for the right
8
NETWORK COMPUTING DEVICES, INC.
to incorporate Mariner technology into future versions of NCD's hardware and
software products. The net gain recognized on this transaction was $7.0
million.
In February 1994, the Company acquired all of the outstanding stock of Z-Code
Software Corp., a developer of electronic mail and messaging application
products for open system environments. The Company's Z-mail electronic
messaging product was a part of the Company's Software business unit. The
initial consideration for the acquisition was approximately $3.2 million in cash
and 3,000,000 shares of the Company's Common Stock (including approximately
269,000 shares issuable upon the exercise of options). Of these shares,
approximately 1,183,000 (the "Performance Shares") were held in escrow and
subject to release in whole or in part upon the achievement of certain financial
performance objectives over a 15-month period that ended in the second quarter
of 1995. Additional cash of up to $3.2 million was contingently payable based
on the achievement of these objectives. In July 1994, the Company repurchased
1,361,802 shares of its Common Stock from the former principal shareholder of Z-
Code for approximately $5.0 million and paid approximately $2.5 million for his
contingent rights to an additional 1,041,378 Performance Shares that were held
in escrow as well as his contingent right to receive up to approximately $2.5
million in cash. In light of disappointing recent operating results,
intensifying competition in this market, and other related factors, the Company
determined during the second quarter of 1996 to sell or discontinue this product
line. In June 1996, the Company sold its Z-Mail product line to NetManage, Inc.
for a total sales price of $1.3 million. The net loss recognized on this
transaction was $27,000.
In June 1996, the Company announced an agreement with International Business
Machines Corporation ("IBM") for the joint development of a network
application terminal for resale by IBM. Under the agreement, IBM will fund a
portion of NCD's development efforts. Subject to successful completion of the
development effort, including satisfaction of certain design and
manufacturing requirements, the agreement states that IBM will purchase a
substantial portion of its requirements from NCD during 1997 and 1998,
although IBM will be under no obligation to make such purchases until the
development phase has been successfully completed and IBM has commenced
volume shipments of such devices.
RESULTS OF OPERATIONS
TOTAL NET REVENUES
Total net revenues for the second quarter and first six months of 1996 were
$29.3 million and $59.8 million, respectively, representing decreases of 16%
and 18%, respectively, when compared with the same periods of 1995. The
proportion of international revenues to total net revenues has remained
relatively comparable for the periods presented.
Sales to Motorola Inc. ("Motorola"), which is deemed to be a related party due
to its ownership of approximately 9% of the Company's common stock, accounted
for 7% and 10% of the Company's total net revenues in the second quarters of
1996 and 1995, respectively, and accounted for 6% and 9% of the total net
revenues for the six-month periods ended June 30, 1996 and 1995, respectively.
Motorola is the Company's largest OEM customer, and also purchases the Company's
products as an end user customer. The Company does not have a long-term sales
contract with Motorola, which purchases products on an as-needed basis to
satisfy the requirements of its own customers as well as internal requirements.
The Company believes that sales to Motorola will continue to decline during
1996, but is unable to predict future levels of sales to Motorola over the
longer term. Substantial reductions in such sales levels could have a material
adverse effect on the Company's operating results in future periods.
SYSTEMS REVENUES
Systems revenues consist primarily of revenues from the sale of network
computers, including X-terminals, and to a lesser extent revenues from the
licensing of related network computing system software, and the sale of
related customer support services. Systems revenues were $25.4 million for
the second quarter of 1996, compared to $28.8 million for the second quarter of
1995, and $52.1 million for the first six months of 1996, compared to $61.4
million for the first six months of 1995. The decline in Systems revenues was
due to a combination of factors, including 1.) a decline in the overall market
demand for Unix-based X-terminals, offset to a degree by demand for the
Company's recently introduced network computer product line, the
Explora-Registered Trademark-, and 2.) a decline in the average selling
prices ("ASPs") of the Company's Systems products due to lower-priced network
computers and intense price competition. The above-mentioned negative effects
on Systems revenues were offset to a degree by higher revenues related to
WINCENTER,-Registered Trademark- the Company's multi-user
WindowsNT-Registered Trademark- application server software for network
computers.
9
NETWORK COMPUTING DEVICES, INC.
SOFTWARE REVENUES
Software revenues consisted primarily of revenues from software products not
directly related to network computers, including the licensing of PC
connectivity software and electronic mail and messaging software. Prior to
the first quarter of 1996, Software revenues also included revenues from the
development and licensing of the Company's Mariner Internet connectivity
software (which product line was sold in the first quarter of 1996).
Software revenues were $3.9 million for the second quarter of 1996, a
decrease of 37% compared to the second quarter of 1995, and $7.7 million for
the six months ended June 30, 1996, a decrease of 31% compared to the same
period of 1995. The decline in software revenues was primarily attributable
to a decline in shipments of the Z-Mail product, as the Z-Mail product line
was sold during the second quarter of 1996. Revenues related to Z-Mail were
$352,000 and $1.1 million for the second quarter and first six months of
1996, respectively. Such Z-Mail revenues will not continue in future periods,
as the Z-Mail product line was sold during the second quarter of 1996. Net
revenues for the first quarter of 1996 also included $426,000 associated with
the AT&T Agreement, while no such revenues were recognized during the second
quarter of 1996. The Company will recognize the remaining $1.3 million in
revenues associated with the AT&T Agreement as its obligations thereunder are
satisfied through the filling of such orders as may be placed by AT&T or upon
expiration of the Company's obligations under the Agreement in the third
quarter of 1997. The Company cannot predict with any certainty whether AT&T
will place any such orders under the Agreement.
GROSS MARGIN ON SYSTEMS REVENUES
The Company's gross profit margin on Systems revenues was 13% and 26% for the
second quarters of 1996 and 1995, respectively, and 17% and 28% for the six
months ended June 30, 1996 and 1995, respectively. The decline in Systems gross
margin was primarily due to a charge of approximately $3.0 million incurred in
the second quarter of 1996 to reduce the value of certain inventories to market
price. This value reduction was related to the recent price decline in the DRAM
memory component market. Other factors which contributed to the decline in the
gross profit margin percentage were heavier price discounting as a result of
intense price competition, the increased sale of lower priced EXPLORA network
computers, and decreased manufacturing efficiencies caused by lower volumes
in the second quarter and first six months of 1996 when compared to the
corresponding periods of 1995.
GROSS MARGIN ON SOFTWARE REVENUES
The Company's gross profit margin on Software revenues was 84% for the second
quarter of 1996 compared to 88% for the second quarter of 1995, and 81% for the
first six months of 1996 compared to 88% for the same period of 1995, reflecting
lower revenues, offset slightly by a more favorable mix of different types of
OEM revenue.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development ("R&D") expenses were $4.0 million for the second
quarter of 1996 compared to $3.0 million for the second quarter of 1995, and
$8.1 million for the six-month period ended June 30, 1996 compared to $6.0
million for the first six months of 1995. The quarter-to-quarter increases were
primarily related to increased software development efforts during the 1996
periods in both the PC Connectivity and Z-Mail product lines. The second
quarters of both 1995 and 1996 include R&D expenses incurred by the Z-Mail
product line, and the first six months of 1995 and 1996 include R&D expenses for
both the Mariner and Z-Mail product lines. Because the Company has sold these
two product lines, the related R&D expenses will not be incurred in future
periods. However, the Company plans to increase its efforts in
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NETWORK COMPUTING DEVICES, INC.
research and development, primarily in the area of network computers and
related software. As a percentage of net revenues, R&D expenses increased to
14% for the second quarter and first six months of 1996 from 8% for
the second quarter and first six months of 1995, reflecting the combined impact
of increased spending and lower net revenues.
MARKETING AND SELLING
Marketing and selling expenses were $9.4 million and $8.2 million for the second
quarters of 1996 and 1995, respectively, and $19.0 million and $17.1 million for
the six-month periods ended June 30, 1996 and 1995, respectively. The increases
in 1996 compared to the corresponding periods of the previous year were
primarily related to higher staffing, facilities and promotional costs
associated with the division of the Systems and Software businesses into
separate business units. In June 1996, the Company determined to recombine
its remaining business units. As a percentage of total net revenues,
marketing and selling expenses were 32% and 23% for the second quarters of
1996 and 1995, respectively, and 32% and 24%, for the six months ended June
30, 1996 and 1995, respectively, and resulted from the combined effects of
increased spending and lower net revenues.
GENERAL AND ADMINISTRATIVE
General and administrative ("G&A") expenses were $3.5 million and $2.0 million
for the second quarters of 1996 and 1995, respectively and $6.0 million and $4.0
million for the first six months of 1996 and 1995, respectively. When compared
to 1995, the increase in expenses for the same periods of 1996 was largely due
to both severance costs associated with the elimination of certain positions
within the Company and to increased personnel costs that resulted from the
division of the Systems and Software businesses into separate business units.
As mentioned above under "Marketing and Selling," in late June 1996 the
Company determined to recombine its remaining business units. As a percentage
of net revenues, G&A expenses increased to 12% in the second quarter of 1996
from 6% in the second quarter of 1995, and to 10% in the first six months of
1996 from 6% in the same period of 1995, the combined impact of increased
expenses and lower revenues.
OTHER INCOME
Other income primarily includes interest income, net of interest expense. The
slight increase in interest income, net, in the second quarter and first six
months of 1996 over the comparable periods of 1995 was due primarily to lower
interest expense incurred on declining capital lease obligation balances offset
by lower interest earned on lower cash and investment balances at declining
interest rates.
GAIN (LOSS) ON SALE OF PRODUCT LINE(S)
The loss on the sale of the product line for the second quarter 1996 represents
the net loss on the Company's sale of the Z-Mail division. The gain on the sale
of product lines for the first six months of 1996 represents the net gain on the
sale of the Mariner product line in February 1996, offset slightly by the net
loss on the sale of Z-Mail in June 1996.
INCOME TAXES
The Company recorded an income tax benefit of $4.0 million on pretax losses
incurred during the second quarter of 1996. This compared to an income tax
provision of $35,000 during the second quarter 1995.
FINANCIAL CONDITION
Total assets as of June 30, 1996 decreased by $13.4 million, or 14%, from
December 31, 1995. The change in total assets predominantly reflects
significant decreases in combined cash and short-term investments and accounts
receivable of $9.7 million and $5.3 million, respectively. The decline in
combined cash and short-term investments was primarily the result of cash used
in operations ($18.6 million) partially offset by cash received from the sale
of product lines ($8.6 million). The reduction in accounts receivable was
primarily caused by a reduction in sales volumes during the quarter. The
aforementioned decreases were partially
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NETWORK COMPUTING DEVICES, INC.
offset by an increase in prepaid expenses and other of $2.9 million, which was
primarily related to income tax refunds receivable generated by net operating
loss carrybacks.
Total liabilities as of June 30, 1996 decreased by $8.9 million, or 30%, from
December 31, 1995. The decrease was primarily associated with lower accounts
payable and income taxes payable balances. The reduction in accounts payable
was associated with lower inventory receipts occurring beyond the middle of the
second quarter, while reductions in accrued income taxes payable was caused by a
significant operating loss in the second quarter of 1996.
LIQUIDITY
At June 30, 1996, the Company's primary sources of liquidity consisted of
combined cash and equivalents and short-term investments totaling $26.4 million.
Although the Company also had a $7.0 million bank line of credit in place, as
a result of its loss for the year ended December 31, 1995, the Company was in
default under certain financial covenants in its agreement as of June 30,
1996, and accordingly, its line of credit was unavailable. This line of
credit was never utilized and was terminated in July 1996. The Company
believes that its existing sources of liquidity are sufficient to meet
operating cash requirements and capital lease repayment obligations at least
through the next twelve months.
FUTURE PERFORMANCE AND RISK FACTORS
THE COMPANY'S FUTURE BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION ARE
SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES, INCLUDING THOSE DESCRIBED BELOW.
EVOLVING NETWORK COMPUTING MARKET
The Company derives a majority of its revenues from the sale of network computer
products, or X-terminals, and related software. During the past several years,
the Company and other manufacturers of network computing systems and products
have experienced intense competition from alternative desktop computing
products, particularly personal computers, which has slowed the growth and
development of the network computing market. Until recently, the absence of X
protocol support from Microsoft Corporation ("Microsoft"), combined with the
proliferation of off-the-shelf Windows-based application software, constituted
an obstacle to the expansion of the network computing model into Windows-based
environments. The introduction of the Company's WinCenter Pro multi-user Windows
application server software and new, lower-priced network computers have allowed
the Company to offer network computing systems that provide users with access to
Windows applications, although sales of these new products have been limited to
date. The Company's future success will depend in substantial part upon
increased acceptance of the network computing model and the successful marketing
of the Company's new network computing products. There can be no assurance that
the Company's new network computing products will compete successfully with
alternative desktop solutions or that the network computing model will be widely
adopted in the rapidly evolving desktop computer market. The failure of new
markets to develop for the Company's network computing products would have a
material, adverse effect on the Company's business, operating results and
financial condition. See "Item 1. Business - Industry Background" and "Business
- - Markets and Applications" in the Company's Annual Report on Form 10-K for the
year ended December 31, 1995.
COMPETITION
The desktop computer and information access markets are characterized by rapidly
changing technology and evolving industry standards. The Company experiences
significant competition from other network computer manufacturers, suppliers of
personal computers and workstations and software developers. Competition within
the network computing market has intensified over the past several years,
resulting in price reductions, reduced profit margins and the loss of the
Company's leading market share position in the X-terminal market. This
competition has adversely affected the Company's operating results. In addition,
intense competition from alternative desktop computing products, particularly
personal computers, has
12
NETWORK COMPUTING DEVICES, INC.
resulted in a reduction in demand for X-terminal products. The Company expects
this intense competition to continue and there can be no assurance that the
Company will be able to continue to compete successfully against current and
future competitors as the desktop computer market evolves and competition
increases. The Company's software products also face substantial competition
from software vendors that offer similar products, including several large
software companies. See "ltem 1. Business - Competition" in the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
FLUCTUATIONS IN OPERATING RESULTS
The Company's operating results have varied significantly, particularly on a
quarterly basis, as a result of a number of factors, including general economic
conditions affecting industry demand for computer products, the timing and
market acceptance of new product introductions by the Company and its
competitors, the timing of significant orders from and shipments to large
customers, periodic changes in product pricing and discounting due to
competitive factors, and the availability and pricing of key components, such as
DRAMs, video monitors, integrated circuits and electronic sub-assemblies, some
of which require substantial order lead times. The Company's operating results
may fluctuate in the future as a result of these and other factors, including
the Company's success in developing and introducing new products, its product
and customer mix, the level of competition which it experiences and its ability
to develop and maintain strategic business alliances. In addition, the Company
operates with a relatively small backlog. Revenues and operating results
therefore generally depend on the volume and timing of orders received which are
difficult to forecast and which may occur disproportionately during any given
quarter or year. The Company's expense levels are based in part on its forecast
of future revenues. If revenues are below expectations, the Company's operating
results may be adversely affected. The Company has experienced an increasingly
disproportionate amount of shipments occurring in the last month of its fiscal
quarters. This trend increases the risk of material quarter-to-quarter
fluctuations in the Company's revenues and operating results. In the past, the
Company has experienced reduced orders during the first and third quarters due
to buying patterns common in the computer industry. In addition, sales in Europe
have been adversely affected in the third calendar quarter, when many European
customers reduce their business activities.
NEW PRODUCT DEVELOPMENT AND TIMELY INTRODUCTION OF NEW AND ENHANCED PRODUCTS
The markets for the Company's products are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and short product life cycles. The Company's future results will depend to a
considerable extent on its ability to continuously develop, introduce and
deliver in quantity new hardware and software products that offer its customers
enhanced performance at competitive prices. The development and introduction of
new products is a complex and uncertain process requiring substantial financial
resources and high levels of innovation, accurate anticipation of technological
and market trends and the successful and timely completion of product
development. Once a hardware product is developed, the Company must rapidly
bring it into volume production, a process that requires accurate forecasting of
customer requirements in order to achieve acceptable manufacturing costs. The
introduction of new or enhanced products also requires the Company to manage the
transition from older, displaced products in order to minimize disruption to
customer ordering patterns, avoid excessive levels of older product inventories
and ensure that adequate supplies of new products can be delivered to meet
customer demand. As the Company is continuously engaged in this product
development and transition process, its operating results may be subject to
considerable fluctuation, particularly when measured on a quarterly basis. The
inability to finance important research and development projects, delays in the
introduction of new and enhanced products, the failure of such products to gain
market acceptance, or problems associated with new product transitions could
adversely affect the Company's operating results. See "Item 1. Business -
Industry Background" and "Business - Research and Development" in the Company's
Annual Report on Form 10-K for the year ended December 31, 1995.
RELIANCE ON INDEPENDENT DISTRIBUTORS AND RESELLERS
13
NETWORK COMPUTING DEVICES, INC.
The Company relies substantially on independent distributors and resellers for
the marketing and distribution of its products, particularly its Software
products. During 1995, the Company consolidated its Software sales operations by
creating a single organization devoted to the sale of the Company's PC
connectivity and messaging software and re-oriented its Software sales strategy
toward the increased use of distributors, VARs and other resellers. In late 1995
and early 1996, the Company experienced significant returns of its Software
products from its distributors. There can be no assurance that the Company will
not continue to experience similar levels of returns. In addition, there can be
no assurance that the Company's distributors and resellers will continue their
current relationships with the Company or that they will not give higher
priority to the sale of other products, which could include products of the
Company's competitors. A reduction in sales effort or discontinuance of sales of
the Company's products by its distributors and resellers could lead to reduced
sales and could adversely affect the Company's operating results. In addition,
there can be no assurance as to the continued viability or the financial
stability of the Company's distributors and resellers, the Company's ability to
retain its existing distributors and resellers or the Company's ability to add
distributors and resellers in the future. See "Item 1. Business - Marketing and
Sales" in the Company's Annual Report on Form 10-K for the year ended December
31, 1995.
RELIANCE ON INDEPENDENT CONTRACTORS
The Company relies on independent contractors for virtually all of the sub-
assembly of the Company's network computer products. The Company's reliance on
these independent contractors limits its control over delivery schedules,
quality assurance and product costs. In addition, a number of the Company's
independent suppliers are located abroad. The Company's reliance on these
foreign suppliers subjects the Company to risks such as the imposition of
unfavorable governmental controls or other trade restrictions, changes in
tariffs and political instability. The Company currently obtains all of the sub-
assemblies used for its network computer products (consisting of all major
components except monitors and cables) from a single supplier located in
Thailand. Any significant interruption in the supply of sub-assemblies from this
contractor would have a material adverse effect on the Company's business and
operating results. Disruptions in the provision of components by the Company's
other suppliers, or other events that would require the Company to seek
alternate sources of supply, could also lead to supply constraints or delays in
delivery of the Company's products and adversely affect its operating results.
The operations of certain of the Company's foreign suppliers were briefly
disrupted during 1992 due to political instability in Thailand. See "Item. 1.
Business - Manufacturing and Supplies" in the Company's Annual Report in Form
10-K for the year ended December 31, 1995.
INTERNATIONAL SALES
A majority of the Company's international sales are denominated in U.S. dollars,
and an increase in the value of the U.S. dollar relative to foreign currencies
could make the Company's products less competitive in those markets. Over the
past two years, a significant portion of international revenues have been
derived from sales to a customer in the United Kingdom that have been
denominated in pound sterling and sales denominated in foreign currencies may
increase in the future. These sales are subject to exchange rate fluctuations
which could affect the Company's operating results negatively or positively,
depending on the value of the U.S. dollar against the other currency. Where the
Company believes foreign currency-denominated sales could pose significant
exposure to exchange rate fluctuations, the Company acquires forward exchange
contracts in an effort to reduce such exposure. International sales and
operations may also be subject to risks such as the imposition of governmental
controls, export license requirements, restrictions on the export of technology,
political instability, trade restrictions, changes in tariffs and difficulties
in staffing and managing international operations and managing accounts
receivable. In addition, the laws of certain countries do not protect the
Company's products and intellectual property rights to the same extent as the
laws of the United States. There can be no assurance that these factors will not
have an adverse effect on the Company's future international sales and,
consequently, on the Company's operating results.
DEPENDENCE ON KEY PERSONNEL
14
NETWORK COMPUTING DEVICES, INC.
The Company's success depends to a significant degree upon the continuing
contributions of its senior management and other key employees. Recently, the
Company experienced turnover of certain senior management positions. Robert G.
Gilbertson was appointed to the position of President and Chief Executive
Officer and Rudolph G. Morin was appointed as Executive Vice President of
Operations and Finance. Moreover, partially as a consequence of the
restructuring of its business in 1995, the Company has experienced significant
turnover of management personnel, particularly in its finance, procurement,
manufacturing, and sales organizations. The Company believes that its future
success will depend in large part on its ability to attract and retain highly-
skilled engineering, managerial, sales and marketing personnel. Competition for
such personnel is intense, and there can be no assurance that the Company will
be successful in attracting, integrating and retaining such personnel. Failure
to attract and retain key personnel could have a material adverse effect on the
Company's business, operating results or financial condition.
VOLATILITY OF STOCK PRICE
The market price of the Company's common stock has fluctuated significantly over
the past several years and is subject to material fluctuations in the future in
response to announcements concerning the Company or its competitors or
customers, quarterly variations in operating results, announcements of
technological innovations, the introduction of new products or changes in
product pricing policies by the Company or its competitors, general conditions
in the computer industry, developments in the financial markets and other
factors. In particular, shortfalls in the Company's quarterly operating results
from historical levels or from levels forecast by securities analysts could have
an adverse effect on the trading price of the common stock. The Company may not
be able to quantify such a quarterly shortfall until the end of the quarter,
which could result in an immediate and adverse effect on the common stock price.
In addition, the stock market has, from time to time, experienced extreme price
and volume fluctuations that have particularly affected the market prices for
technology companies and which have been unrelated to the operating performance
of the affected companies. Broad market fluctuations of this type may adversely
affect the future market price of the Company's common stock.
15
NETWORK COMPUTING DEVICES, INC.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Reference is made to "Item 3. Legal Proceedings" in the Company's Annual Report
on Form 10-K for the year ended December 31, 1995 for a description of
litigation pending against the Company and certain of its officers and
directors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed herewith:
Exhibit 10.42 Alliance Agreement dated June 27, 1996 by and between the
Registrant and International Business Machines
Corporation.(1)(2)
Exhibit 10.43 Asset Purchase Agreement dated June 3, 1996 by and among
the Registrant and NetManage, Inc.(2)
Exhibit 11.1 Statement Regarding Computation of Shares Used in Per Share
Earnings Computations.
Exhibit 27 Financial Data Schedule.
(1) Confidential treatment has been requested as to a portion of this
exhibit.
(2) Other exhibits to this agreement not filed herewith are identified in
this agreement. The Company will furnish supplementally any omitted
exhibit to the Commission upon request.
(b) The Company filed no reports on Form 8-K during the three-month period
ended June 30, 1996.
16
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Network Computing Devices, Inc.
(Registrant)
Date: August 12, 1996
By:
/s/ Rudolph G. Morin
------------------------------------------------
Rudolph G. Morin
Executive Vice President, Operations and Finance
(Duly Authorized and Principal Financial and
Accounting Officer)
17