UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 1997. 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 0-20933 =============================================================================== RASTER GRAPHICS, INC. (Exact name of Registrant as specified in its charter) DELAWARE 94-3046090 (State of Incorporation) (I.R.S. Employer Identification Number) 3025 ORCHARD PARKWAY SAN JOSE, CA 95134 (Address of principal executive office) (408) 232-4000 (Registrant's telephone number) =============================================================================== 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 [_] No [_]* *Registrant has not filed its Annual Report on Form 10-K for the year ended December 31, 1997 nor its Quarterly Report on Form 10-Q for the quarters ended March 31, 1998 and June 30, 1998, but is filing it's Form 10-K current with the filing of this report and the 1998 10-Qs shortly thereafter. As of September 1, 1998, there were 9,599,525 shares of Common Stock outstanding. 1 AMENDED FILING OF FORM 10-Q FOR THE THREE MONTHS ENDED JUNE 30, 1997, RESTATEMENT OF FINANCIAL STATEMENTS AND CHANGES TO CERTAIN INFORMATION Subsequent to the filing with the Commission of its Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, the Company became aware of errors and irregularities that ultimately affected the dollar amount and timing of reported revenues in the nine months ended September 30, 1997, in particular transactions involving undisclosed arrangements or agreements with customers. As a result of its investigation into these errors and irregularities, in February 1998, the Company announced that it would restate its financial statements for the three and nine months ended September 30, 1997. The financial review undertaken by the Company to determine the extent of the restatement ultimately resulted in the restatement of the Company's financial results for each quarter in the nine months ended September 30, 1997. Financial Statement and related disclosures contained in this amended filing reflect, where appropriate changes to conform to the restatement. INDEX ----- Page ---- PART I. FINANCIAL INFORMATION Item 1. Condensed, Consolidated Financial Statements as of June 30, 1997 and December 31, 1996 (Unaudited and Restated) 3 Condensed Consolidated Statements of Operations for the three and six month periods ended June 30, 1997 and June 30, 1996 4 Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30, 1997 and June 30, 1996 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 PART II. OTHER INFORMATION Item 1. Legal Proceedings 15 Item 2. Changes in Securities 15 Item 3. Defaults upon Senior Securities 15 Item 4. Submission of Matters to a Vote of Security Holders 15 Item 5. Other Items 15 Item 6. Exhibits and Reports on Form 8-K 15 SIGNATURE 16 2 PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS RASTER GRAPHICS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) (UNAUDITED) June 30, December 31, 1997 1996 ------------------ ------------------- (Restated)(1) (Restated)(2) ASSETS Current assets: Cash and cash equivalents $ 2,211 $ 2,963 Short-term investments 7,025 13,100 Accounts receivable, net of allowance for doubtful accounts of $785 in 1997 and $606 in 1996 11,520 10,070 Inventories 8,522 6,705 Prepaid expenses 695 506 ------------------ ------------------- Total current assets 29,973 33,344 Property and equipment, net 3,381 2,547 Deposits and other assets 463 687 ------------------ ------------------- Total assets $ 33,817 $ 36,578 ================== =================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 6,181 $ 4,953 Accrued payroll and related expenses 588 1,089 Accrued warranty 929 331 Other accrued liabilities 2,019 1,635 Deferred revenue 1,316 1,162 Current portion of long-term debt 150 303 ------------------ ------------------- Total current liabilities 11,183 9,473 Long-term debt, less current portion 147 178 ------------------ ------------------- Total liabilities 11,330 9,651 ------------------ ------------------- Stockholders' equity: Common stock 10 10 Additional paid in capital 43,065 42,746 Accumulated deficit (20,008) (15,417) Deferred compensation (340) (392) Notes receivable from stockholder -- (20) Cumulative translation adjustment (240) -- ------------------ ------------------- Total stockholders' equity 22,487 26,927 ------------------ ------------------- Total liabilities and stockholders' equity $ 33,817 $ 36,578 ================== =================== See accompanying notes to condensed consolidated financial statements. (1) see footnote 1 (2) restated for the pooling of interests with ColourPass (see footnote 7) 3 RASTER GRAPHICS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) Three Months Ended Six Months Ended June 30, June 30, ------------------------------------------ ------------------------------------------ 1997 1996 1997 1996 ----------------- ----------------- ----------------- ----------------- (Restated)(1) (Restated)(2) (Restated)(1) (Restated)(2) Net revenues $ 11,152 $10,205 $22,717 $19,527 Cost of revenues 10,710 6,040 18,151 11,854 ----------------- ----------------- ----------------- ----------------- Gross profit 442 4,165 4,566 7,673 ----------------- ----------------- ----------------- ----------------- Operating expenses: Research and development 1,181 1,310 2,745 2,244 Sales and marketing 2,595 1,642 4,614 3,224 General and administrative 895 473 1,837 918 Merger expenses -- -- 139 -- ----------------- ----------------- ----------------- ----------------- Total operating expenses 4,671 3,425 9,335 6,386 ----------------- ----------------- ----------------- ----------------- Operating (loss) income (4,229) 740 (4,769) 1,287 Other income, net 108 6 265 3 ----------------- ----------------- ----------------- ----------------- (Loss) income before provision for income taxes (4,121) 746 (4,504) 1,290 Provision for income taxes 81 66 87 158 ----------------- ----------------- ----------------- ----------------- Net (loss) income $( 4,202) $ 680 $(4,591) $ 1,132 ================= ================= ================= ================= Net (loss) income per share - basic $( 0 .45) $0.10 $(0.49) $0.17 ================= ================= ================= ================= Shares used in computing net (loss) income per share - basic 9,392 6,566 9,338 6,525 ================= ================= ================= ================= Net (loss) income per share - diluted $( 0 .45) $0.09 $(0.49) $0.15 ================= ================= ================= ================= Shares used in computing net (loss) income per share - diluted 9,392 7,650 9,388 7,581 ================= ================= ================= ================= See accompanying notes to condensed consolidated financial statements. (1) see footnote 1 (2) restated for the pooling of interests with ColourPass (see footnote 7) 4 RASTER GRAPHICS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) Six Months Ended June 30, -------------------------------------------- 1997 1996 ----------------- ------------------ (Restated)(1) (Restated)(2) OPERATING ACTIVITIES Net (loss) income $(4,591) $ 1,132 Adjustments to reconcile net (loss) income to net cash used in operating activities: Depreciation and amortization 602 464 Amortization of deferred compensation 52 -- Changes in operating assets and liabilities: Accounts receivable (1,450) (1,086) Inventories (1,817) (1,999) Prepaid expenses and other assets 35 (385) Accounts payable 1,228 2,238 Accrued payroll and related expenses (501) 186 Deferred revenue 154 88 Accrued warranty 598 119 Other accrued liabilities 384 (109) ------------- -------------- Net cash (used in) provided by operating activities (5,306) 648 ------------- -------------- INVESTING ACTIVITIES Capital expenditures (1,436) (581) Net decrease in short-term investments 6,075 -- ------------- -------------- Net cash provided by (used in) investing activities 4,639 (581) ------------- -------------- FINANCING ACTIVITIES Proceeds from bank line of credit -- 250 Repayment of term loan (184) (180) Repayment of note from shareholder 20 -- Proceeds from issuance of common stock 319 88 ------------- -------------- Net cash provided by (used in) financing activities 155 158 ------------- -------------- Effect of exchange rate changes on cash and cash equivalents (240) -- ------------- -------------- Net (decrease) increase in cash and cash equivalents (752) 225 Cash and cash equivalents at beginning of period 2,963 1,550 ------------- -------------- Cash and cash equivalents at end of period $ 2,211 $ 1,775 ============= ============= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid for interest $ 56 $ 37 Cash paid for taxes $ 67 $ 80 See accompanying notes to condensed consolidated financial statements. (1) see footnote 1 (2) restated for the pooling of interests with ColourPass (see footnote 7) 5 RASTER GRAPHICS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) RESTATEMENT OF FINANCIAL STATEMENT Subsequent to the filing with the Commission of its Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, the Company became aware of errors and irregularities that ultimately affected the dollar amount and timing of reported revenues in the nine months ended September 30, 1997. The irregularities took numerous forms and were primarily the result of lack of compliance with the Company's procedures and controls. The Company undertook and completed extended procedures related to revenue recorded in each of the three month periods in the nine months ended September 30, 1997. As a result of these findings and other relevant information now disclosed, the Company has determined that a significant number and dollar amount of revenue transactions were improperly reported as earned revenue for these interim periods, including the three months and six ended June 30, 1997. The Company has concluded that the earnings process for a significant number of printer sales was not complete at the time of product shipment. Further, the Company has determined that arrangements with a number of resellers resulted in significant concessions or allowances that were not accounted for when the revenue was originally reported as earned. Because of the pervasiveness of these irregularities, for the nine months ended September 30, 1997, the Company has determined that revenue from printer sales should only be recognized in the quarter that shipment took place where the Company received payment for the product by the end of the following quarter, provided that the earnings process was complete. For transactions that do not meet this criteria, revenue has been recognized on the receipt of payment from the customer. In addition, the Company has determined that its allowances for doubtful accounts for each quarter in the nine months ended September 30, 1997 was incorrectly estimated. The company has reviewed actual receipts since March 31, 1997 and has revised its estimated doubtful accounts. The Company has also determined that its reserve for obsolete and excess inventory for each quarter in the nine months ended September 30, 1997 was incorrectly estimated. The Company has revised its estimate of expected printer sales and accordingly has revised its estimate of excess and obsolete inventory. As a result of this restatement, the financial statements shown under Item 1 in the Index of this Form 10-Q/A have been restated. Three Months Ended June 30, 1997 ------------------------------------ (In thousands except per share data) ------------------------------------ As reported Restated ---------------- ------------- Net revenues $ 14,114 $ 11,152 Operating income (loss) 1,375 (4,229) Income tax expense (benefit) 163 81 Net income (loss) 1,320 (4,202) Net income (loss) per share $0.13 ($0.45) Retained earnings (deficit) (13,128) (20,008) Accounts Receivable, net 15,393 11,520 Inventory, net 10,597 8,522 Accounts payable 5,724 6,181 Other accrued liabilities 1,513 2,019 Deferred revenue 1,347 1,316 6 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared by Raster Graphics, Inc. (the "Company" or "Raster Graphics") pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the audited financial statements included in the Company's Annual Report and Form 10-K for the fiscal year ended December 31, 1996. In the opinion of management the accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited financial statements and include all recurring adjustments necessary for a fair presentation of the interim periods presented. The operating results for the six months ended June 30, 1997 are not necessarily indicative of the results for any other interim period or the full fiscal year ending December 31, 1997. The unaudited condensed consolidated financial statements also include adjustments that eliminated all significant intercompany transactions and balances between the Company and ColourPass, which was merged into the Company's wholly owned subsidiary, Raster Graphics Systems Limited effective March 18, 1997, for relevant periods prior to the merger (see Note 7). All periods presented have been restated to reflect the merger which has been accounted for as a pooling of interests. 2. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 3. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS For financial statement purposes, the Company considers all highly liquid debt instruments with original maturities of ninety days or less and with insignificant interest rate risk to be cash equivalents. The Company classifies all of its investments as "available-for-sale" in accordance with the provisions of Financial Accounting Standards Board Statement No. 115 "Accounting for Certain Investments in Debt and Equity Securities." Accordingly, the Company states its investments at estimated fair value, with material unrealized gains and losses reported in stockholders' equity. The cost of securities sold is based on the specific identification method. Such securities are anticipated to be used for current operations and are, therefore, classified as current assets, even though maturities may extend beyond one year. As of June 30, 1997, the Company has $7.0 million of investments in state and municipal bonds. These state and municipal bonds bear interest at a rate that automatically resets to the prevailing market interest rate at approximately 35-day intervals. At June 30, 1997, substantially all the available-for-sale securities have principal maturity dates of over ten years. The gross unrealized gains and gross unrealized losses at June 30, 1997 were immaterial to the Company and, therefore, no amounts were recorded to stockholders' equity. 7 4. INVENTORIES Inventories are stated at the lower of cost (first in, first out) or fair market value and consist of the following (in thousands): June 30, 1997 (1) December 31, 1996 (2) -------------------- ------------------------- Raw materials $5,344 $ 956 Work-in-progress 1,969 1,708 Finished goods 1,209 4,041 ------------- ---------------- $8,522 $6,705 ============= ================ 5. NET INCOME PER SHARE In 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share. Statement 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods presented have been restated to conform to the Statement 128 requirements. Pro forma net income (loss) per share for the six months ended June 30, 1997 and 1996 have been computed as described above and also gives effect, even if antidilutive, to common equivalent shares from preferred stock that automatically converted upon the closing of the Company's initial public offering (using the as-if-converted method). Three months ended Six months ended June 30, June 30, ------------------------------------------------------------------------- in thousands, except share data ------------------------------------------------------------------------- 1997 (1) 1996 (2) 1997 (1) 1996 (2) ------------------------------------------------------------------------- Numerator for basic and diluted earnings per share $ (4,202) $ 680 $ (4,591) $ 1,132 =================================================================== Denominator for basic earnings per share: Weighted average common stock 9,392 663 9,338 632 Convertible preferred stock (pro forma 1996) -- 5,893 5,893 ------------------------------------------------------------------- Shares used in computing basic earnings per share (pro forma 1996) 9,392 6,566 9,338 6,525 =================================================================== Basic earnings per share (pro forma 1996) $ (0.45) $ 0.10 $ (0.49) $ 0.17 Denominator for diluted earnings per share: Weighted average common shares 9,392 663 9,338 632 Convertible preferred stock -- 5,893 5,893 Stock options and warrants 1,094 1,056 ------------------------------------------------------------------- Shares used in computing diluted earnings per share 9,392 7,650 9,338 7,581 =================================================================== Diluted earnings per share $ (0.45) $ 0.09 $ (0.49) $ 0.15 =================================================================== (1) see footnote 1 (2) restated for the pooling of interests with ColourPass (see footnote 7) 8 6. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board issued Statement Number 130, "Reporting of Comprehensive Income". This Statement requires that all items that are to be required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This Statement is effective for fiscal years beginning after December 15, 1997, and will be adopted by the Company for the year ended December 31, 1998. In June 1997, the Financial Accounting Standards Board issued Statement Number 131, "Disclosures About Segments of an Enterprise and Related Information". This Statement replaces Statement Number 14 and changes the way public companies report segment information. This Statement is effective for fiscal years beginning after December 15, 1997 and will be adopted by the Company for the year ended December 31, 1998. In June 1988, the Financial Accounting Standards Board issued Statement Number 133, "Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards for derivative instruments, inducing certain derivative instruments embedded in other contracts (collectively referred to as derivative) and for hedging activities. This statement is effective for fiscal years beginning after June 30, 1999 and will be adopted by the Company for the year ended December 31, 2000. 7. MERGER On March 18, 1997, the Company completed a merger with ColourPass, a business in the United Kingdom, in which ColourPass was merged into Raster Graphics System Limited, a wholly owned subsidiary of the Company. The combination was accounted for as a pooling of interests. Accordingly, the condensed consolidated statements of operations for the three and six months ended June 30, 1997, and June 30, 1996, respectively, the balance sheets as of June 30, 1997 and December 31, 1996, respectively, and all related footnotes presented herein have been restated to include the accounts of Raster Graphics, Inc. and ColourPass. The table below sets forth the composition of combined revenues and net income (loss) for the periods indicated (in thousands). Merger related expenses of $105,000 and $34,000 incurred in the first quarter of 1997 were included in the Raster Graphics, Inc. and ColourPass net income, respectively. Three months ended Six months ended --------------------------------- ----------------------------------- June 30, June 30, June 30, June 30, 1997 (1) 1996 1997 (1) 1996 --------------------------------- ----------------------------------- Revenues Raster Graphics, Inc $10,325 $ 9,560 $21,316 $18,151 ColourPass 827 645 1,401 1,376 --------------------------------- ----------------------------------- Combined $11,152 $10,205 $22,717 $19,527 ================================== =================================== Net Income (loss) Raster Graphics, Inc $(4,312) $ 712 $(4,804) $ 1,201 ColourPass 110 (32) 213 (69) --------------------------------- ----------------------------------- Combined $(4,202) $ 680 $(4,591) $ 1,132 ================================== =================================== (1) see footnote 1 8. PENDING LITIGATION Commencing in March 1998 several class action lawsuits were filed in both state and federal courts purportedly on behalf of shareholders who purchased the Company's stock during various periods in 1997 through early 1998. The complaints name as defendants the Company and its Chairman, Chief Executive Officer and President, and certain other officers and directors. The complaints allege, among other things, violation of federal securities laws and that defendants made false and misleading statements in press releases, SEC filings and/or other public statements and seek unspecified damages. The litigation could result in substantial costs and a diversion of management's attention and 9 resources, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is a party to a number of legal claims arising in the ordinary course of business. The Company believes the ultimate resolution of the claims will not have a material adverse effect on its financial position, results of operation, or cash flow. 9. SUBSEQUENT EVENTS The Company has entered into an Agreement and Plan of Merger with Gretag Imaging Group, Inc. ("Gretag") for the acquisition of the Company for approximately $1.30 per share (the "Merger"). The Company has also entered into a Loan and Pledge Agreement and Asset and Subsidiary Stock Option Agreement and certain of its stockholders have entered into a Stockholders Agreement with Gretag. Pursuant to the Loan and Pledge Agreement, Gretag is providing the Company a loan facility secured by 100% of the issued stock of Onyx, a wholly owned subsidiary of the Company. The Company may draw down amounts together with accrued interest of up to $5,000,000. The first installment of $500,000 was received by the Company on September 23, 1998. In addition, Gretag has the option to purchase up to $5,000,000 of the Company's Common Stock in exchange for forgiving the loan and paying the balance in cash. Pursuant to the Asset and Subsidiary Stock Option Agreement, (i) if the Agreement and Plan of Merger is terminated, Gretag has the option to acquire Onyx for $5,000,000 less the amount drawn down under the loan facility, or (ii) if the Company's stockholders do not vote in favor of the Merger, if the Company accepts a superior offer to sell the Company or upon certain other events, Gretag has the option to acquire the Company's inkjet technology for $6,000,000 less the amount drawn down under the loan facility. Pursuant to the terms of the Stockholders Agreement, stockholders of the Company holding approximately 20% of the Company's outstanding Common Stock have agreed to vote in favor of the Merger and against any other proposal to acquire the Company. The Merger and the Agreement and Plan of Merger requires stockholder approval and consummation of the Merger is conditioned upon settlement of the class action lawsuits against the Company. In August 1998 the Company entered into a mutual release agreement with Marc Willard, an officer of the Company. In consideration for Mr. Willard's full release relating to the Company's acquisition of ColourPass (of which Mr. Willard was an 80% partner), the parties agreed to a cash bonus of $70,000, a cash payment of $200,000 upon the acquisition of the Company, and a stock option grant of 175,000 shares. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Part I -- Item 1 of this Quarterly Report and the audited financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's Annual Report and Form 10-K for the fiscal year ended December 31, 1996. As a result of the restatement of the Company's financial statements for each quarter in the nine months ended September 30, 1997 certain information contained in this item has been changed from that which appeared in the Company's originally filed form 10-Q for the quarterly period ended June 30, 1997. OVERVIEW Raster Graphics was established in 1987 initially to develop low-cost electrostatic raster printers for the computer-aided design ("CAD") market. Raster Graphics commenced shipments of its first printer, a 22-inch printer, in 1989, followed by a 24-inch printer in 1990 and a 36-inch printer in 1992. In 1993, the Company identified the on-demand production large format digital printing ("LFDP") market as a new opportunity to develop a product based on its proprietary high-speed printhead technology. As a result, in 1993 the Company shifted its product focus and began to develop the DCS 5400, an electrostatic printer, specifically for the LFDP market. The Company began shipping the DCS 5400 in July 1994. The Company began commercial production of the DCS 5442 in January 1996 as a second generation to the DCS 5400. By September 1996, the DCS 5442 substantially replaced the DCS 5400. In December 1996, the Company introduced the PiezoPrint(TM) 1000, an inkjet printer manufactured by a third party, that is targeted at the lower priced entry level production market. In March 1997, the Company introduced the PiezoPrint(TM) 5000 as a mid-range, price/performance inkjet printer to complement the affordable PiezoPrint(TM) 1000 inkjet printer and the high production DCS 5442. Although the Company has no current plans to replace any printer in its current line of products, the future success of the Company will likely depend on its ability to continue to develop market leading products for the production segment of the LFDP market. In order to provide a complete digital printing solution to its customers, the Company began shipping Onyx's image processing software with its digital printers in July 1994. Onyx develops and markets image processing software for the Company's digital printers as well as printers manufactured by companies such as CalComp, Encad, Hewlett-Packard and ColorgrafX. In August 1995, the Company acquired Onyx. Onyx supplies its software to Raster Graphics and also sells its software products to OEMs, VARs, systems integrators and other printer manufacturers. Onyx's current 10 image processing software product, PosterShop, was introduced in April 1996 as a replacement for Onyx's Imagez image processing software product, which Onyx had been shipping since May 1991. Although the Company has no current plans to replace its PosterShop product, the Company will likely introduce new versions of its image processing software in the future. Raster Graphics also sells related consumables, including specialized inks and papers that it acquires from third party suppliers and resells under the Raster Graphics name for use in the Company's digital printers. The sale of consumables generates recurring revenues, which the Company believes will continue to increase to the extent that the installed base of printing systems expands. As the Company develops new printers, it may need to develop new consumables to be used by its new printer products. In the United States, Raster Graphics also derives revenues from maintenance contracts on installed systems and printers, including the Company's installed base of 22-inch, 24-inch and 36-inch printers. Revenue is also generated from the sale of spare parts. Raster Graphics' end user customers, OEMs, VARs, and international distributors submit purchase orders that generally require product shipment within two to eight weeks from receipt of order. Accordingly, the Company does not use order backlog as a primary basis for management planning for longer periods. Revenues are not recognized until products have been shipped and all contingencies have been removed. As a result of the discovery of irregularities, the Company has assumed that for the three months ended in March 31, 1997, such contingencies exist on printer shipments unless payment was received by the end of the following quarter, provided that the earning process was completed. For transactions that do not meet this criteria, revenue has been recognized on the receipt of payment (see footnote to the Condensed Consolidated Financial Statements). Cost of revenues includes materials, labor, overhead and software royalties. Cost of revenues as a percentage of revenue varies depending upon the revenue mix generated through end user, OEM, VAR and distributor sales, and the revenue mix generated from Onyx software license fees, printing systems sales, consumables sales and service fees. Raster Graphics expenses research and development costs as incurred. Research and development expenses have increased from year to year. Raster Graphics believes that research and development expenses will continue to increase in absolute dollar amounts and may increase as a percentage of revenues. Raster Graphics' sales and marketing expenses and general and administrative expenses have also increased to support the revenue growth of the Company. The Company's strategy is to distribute its products through a direct sales force and independent representatives in selected markets, as well as through OEMs, VARs and distributors. Raster Graphics also incurs sales and marketing expenses in connection with product promotional activities. The Company intends to continue to develop its domestic and international sales and marketing organizations. As a result, the Company believes that sales and marketing expenses will continue to increase in absolute dollar amounts and may increase as a percentage of revenues. The Company has established a customer finance program to provide customers with financing options for Raster Graphics printing systems. Third party financial partners will take title of the equipment and manage the financial portfolio. The Company has a limited operating history upon which an evaluation of the Company and its prospects can be based. The Company's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in the early stages of development, particularly companies in new and rapidly evolving markets. To address these risks, the Company must, among other things, respond to competitive developments, attract, retain and motivate qualified persons, and continue to upgrade its technologies and commercialize products and services incorporating such technologies. There can be no assurance that the Company will be successful in addressing these risks. As of June 30, 1997, the Company had an accumulated deficit of $20.0 million. Although the Company was marginally profitable in 1995 and 1996, there can be no assurance that the Company will be profitable in the future. RESULTS OF OPERATIONS 11 ColourPass merged into Raster Graphics Systems Limited, a wholly owned subsidiary of the Company, on March 18, 1997. The merger has been accounted for as a pooling of interest, and accordingly, the financial results presented have been restated to include ColourPass. The following table sets forth certain restated consolidated statements of operation data as a percentage of net sales for the periods indicated. Three Months Ended Six Months Ended June 30, June 30, --------------------------------- --------------------------------- 1997 1996 1997 1996 -------------- -------------- --------------- -------------- Net revenues 100.0% 100.0% 100.0% 100.0% Cost of revenues 96.0 59.2 79.9 60.7 -------------- -------------- --------------- -------------- Gross profit 4.0 40.8 20.1 39.3 -------------- -------------- --------------- -------------- Operating expenses: Research and development 10.6 12.8 12.1 11.5 Sales and marketing 23.3 16.1 20.3 16.5 General and administrative 8.0 4.6 8.1 4.7 Merger expenses - - 0.6 - -------------- -------------- --------------- -------------- Total operating expenses 41.9 33.5 41.1 32.7 -------------- -------------- --------------- -------------- Operating (loss) income (37.9) 7.3 (21.0) 6.6 Other income, net 0.9 - 1.2 - -------------- -------------- --------------- -------------- (Loss) income before provision for income (37.0) 7.3 (19.8) 6.6 taxes Provision for income taxes 0.7 0.6 0.4 0.8 -------------- -------------- --------------- -------------- Net (loss) income (37.7) 6.7 (20.2) 5.8 ============== ============== =============== ============== Net Revenues. Net revenues for the three and six months ended June 30, 1997 were $11.2 million and $22.7 million, respectively, an increase of 9.3% and 16.3%, respectively, over the comparable periods of fiscal 1996. The increase can be attributed to the growth in sales of printer systems following the introduction of the PiezoPrint(TM) 1000 in December 1996, and the PiezoPrint(TM) 5000 in March 1997, increased sales by the Company's United Kingdom and German subsidiaries, and the increase in sales of consumables. Future revenue growth will depend on a number of factors, including the Company's ability to develop, manufacture, market and sell innovative and reliable new products, customer satisfaction, market growth, competitive developments, product mix, vendor performance and the Company's ability to manage growth, if any. International sales, which include export sales and direct sales of the Company's German and United Kingdom operations, were $6.0 million and $13.0 million for the three and six months ended June 30, 1997, respectively. These sales represented 53.6% and 57.3% of net revenue for the three and six months ended June 30, 1997, respectively. The increase in international sales was a result of increased international customer acceptance of the Company's printer systems, and increased sales made by the Company's German and United Kingdom subsidiaries. Sales made by the Company's German and United Kingdom subsidiaries are denominated in local currencies. The Company is subject to transaction exposure that arises from foreign exchange movements between the dates foreign currency sales are recorded and the dates cash is received in the foreign currency. To date, the Company has not found it appropriate to hedge the risks of foreign sales subject to fluctuations in exchange rates. Future international revenues will depend on the factors set forth above, and will be subject to unexpected changes in regulatory requirements and tariffs, longer customer payment cycles, fluctuation in currency exchange rates, seasonal factors and risks associated with managing business operations in geographically distant locations. No assurance can be given that international revenues will continue to grow at current rates, or at all. Gross Profit. The Company's gross profit for the three and six months ended June 30, 1997 was $442,000 and $4.6 million, respectively, a decrease of 89.4% for the three month period and a decrease of 40.5% over the comparable periods of fiscal 1996. The decrease in gross profit for the three and six months ended June 30, 1997 as compared to the same period in 1996 was primarily the result of an increase in obsolete and excess inventory reserve balances following a revision in the Company's estimate of future printer sales. Gross profit represented 4.0% and 20.1% of net revenue for 12 the three and six months ended June 30, 1997, respectively, decreasing from 40.8% and 39.3% for the comparable periods of fiscal 1996, respectively. The Company's future level of gross profit will depend on a number of factors, including its ability to manage product mix, control variable expenses relative to revenue levels, maintain a revenue base over which to allocate fixed costs, and continue to develop, manufacture, market and sell innovative and reliable new products. Research and Development. Research and development expenses for the three months ended June 30, 1997 were $1.2 million, a decrease of 9.8% in comparison to the three months ended June 30, 1996. This decrease is attributed to a significant level of material purchases for prototype development of the PiezoPrint(TM) products during the second quarter of fiscal 1996. Research and development expenses for the six months ended June 30, 1997 were $2.7 million, an increase of 22.3% in comparison to the six months ended June 30, 1996. This increase in research and development expenses for the first six months was primarily due to product development expenses associated with the launch of the new PiezoPrint(TM) 5000 inkjet printer during the first quarter of fiscal 1997. The Company intends to continue to dedicate substantial resources to research and development activities to maintain its leadership in the LFDP market. The Company intends to expand its product lines, including printers, to achieve lower price points and higher image quality, and to enhance its PosterShop image processing software. Accordingly, the Company believes that research and development expenses will continue to increase in the future. Sales and Marketing. Sales and marketing expenses for the three months ended June 30, 1997 were $2.6 million, an increase of 58.0% in comparison to the three months ended June 30, 1996. Sales and marketing expenses for the six months ended June 30, 1997 were $4.6 million, an increase of 43.1% in comparison to the six months ended June 30, 1996. As a percentage of net revenues, sales and marketing expenses were 23.3% and 20.3% for the three and six months ended June 30, 1997, respectively, as compared to 16.1% and 16.5% for the comparable period of fiscal 1996. The increase in sales and marketing expenses was primarily a result of tradeshow expenses associated with the promotion of the new PiezoPrint(TM) products and the expansion of the Company's domestic and international sales force. The Company expects to continue to increase its sales and marketing expenses in an effort to expand domestic and international markets, introduce new products, and establish and expand new distribution channels. General and Administrative. General and administrative expenses for the three months ended June 30, 1997 were $895,000, an increase of 89.2% in comparison to the three months ended June 30, 1996. General and administrative expenses for the six months ended June 30, 1997 were $1.8 million, an increase of 100.1% in comparison to the six months ended June 30, 1996. As a percentage of net revenues, general and administrative expenses were 8.0% and 8.1% for the three and six months ended June 30, 1997, respectively, as compared to 4.6% and 4.7% for the three and six months ended June 30, 1996. The increase in absolute dollars reflected the increased cost of operating as a public company, an increased reserve for bad debt, and an increase in staffing. The Company believes that its general and administrative expenses will increase as the Company continues to build its infrastructure. Merger Expenses. On March 18, 1997, the Company completed a merger with ColourPass, a business in the United Kingdom. Approximately $139,000 of expense was incurred in connection with this transaction. Provision for Income Taxes. The Company's effective tax rate on the consolidated pretax loss for the three and six month periods ended June 30, 1997 is (2%), compared to an effective rate of 9% and 12% on consolidated pretax income for the three and six month periods ended June 30, 1996, respectively. The tax provision for the three and six months ended June 30, 1997 results from taxes on income in foreign jurisdictions despite an overall loss. The effective tax rates for the three and six months ended June 30, 1996 differ from the statutory rate primarily due to the tax benefit of utilizing net operating loss carryforwards. LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company has financed its operations primarily through its initial public offering of common stock, private sales of preferred stock and common stock, issuance of convertible debt, bank loans, equipment lease financing and private loans. At June 30, 1997, the Company had $9.2 million of cash, cash equivalents and short-term investments, a decrease of $6.9 million from the December 31, 1996 balance of $16.1 million. The Company also had available a $5.0 million bank line of credit that expires on December 14, 1997, which is secured by the tangible assets of the Company. At June 30, 1997, there were no borrowings outstanding under the bank line of credit. 13 Net cash used in operating activities during the first six months of fiscal 1997 was $5.3 million due primarily to increases in accounts receivable of $1.5 million and inventory of $1.8 million. Accounts receivable increased because of the high volume of shipments made towards the end of the quarter. Inventory levels, specifically consumables and finished goods, were increased to support the potential shift in product mix following the introduction of the PiezoPrint(TM) 1000 in December 1996 and the PiezoPrint(TM) 5000 in March 1997. During the six month period ended June 30, 1997 the Company paid approximately $1.4 million for capital expenditures compared to $581,000 for the same period of the prior year. To finance the working capital needs and the purchase of capital equipment, the Company reduced its short-term investments. Other financing activities principally consisted of cash received from the exercises of incentive stock options and employee stock purchase plan in the amount of $319,000 offset by the repayment of term loans in the amount of $184,000 for the six months ended June 30, 1997. The Company may require additional funds to support its working capital requirements or for other purposes and may seek to raise such additional funds through bank borrowings and public or private sales of its securities, including equity and debt securities. The company is also evaluating other options including mergers and acquisitions. The Company's future capital requirements, however, depend on numerous factors, including, without limitation, the success of marketing, sales and distribution efforts; the progress of its research and development programs; the costs involved in preparing, filing, prosecuting, defending and enforcing intellectual property rights; competition; competing technological and market developments; and the effectiveness of product commercialization activities and arrangements. There can be no assurance that additional funds, if required, will be available to the Company on favorable terms or at all. As part of its business strategy, the Company expects to make acquisitions of businesses that offer complementary products, services and technologies. Future acquisitions will be accompanied by the risks commonly encountered in acquisitions of businesses. Such risks include, among other things, the difficulty of assimilating the operations and personnel of the acquired businesses, the potential disruption of the Company's ongoing business, the inability of management to maximize the financial and strategic position of the Company, the maintenance of uniform standards, controls, procedures and policies and the impairment of relationships with employees and clients as a result of any integration of new management personnel. These factors could have a material adverse effect on the Company's business, results of operations or financial condition. Consideration paid for future acquisitions, if any, could be in the form of cash, stock, rights to purchase stock or a combination thereof. Dilution to existing stockholders and to earnings per share may result to the extent that shares of stock or other rights to purchase stock are issued in connection with any such future acquisitions. FORWARD LOOKING STATEMENTS The Company notes that certain of the foregoing statements in this report are forward-looking, the accuracy of which is necessarily subject to risks and uncertainties. Actual results may differ materially from the statements made due to a variety of factors including, but not limited to, (i) fluctuations in quarterly results, (ii) risk related to international operations, (iii) competitive products and technologies, (iv) ability of the Company to upgrade its technologies and commercialize products, and (v) other risk factors described in the Company's Annual Report and Form 10-K for the year ended December 31, 1996, and such other documents that are filed from time to time with the Securities and Exchange Commission. 14 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Commencing in March 1998 several class action lawsuits were filed in both state and federal courts purportedly on behalf of shareholders who purchased the Company's stock during various periods in 1997 through early 1998. The complaints name as defendants the Company and its Chairman, Chief Executive Officer and President, and certain other officers and directors. The complaints allege, among other things, violation of federal securities laws and that defendants made false and misleading statements in press releases, SEC filings and/or other public statements and seek unspecified damages. The litigation could result in substantial costs and a diversion of management's attention and resources, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is a party to a number of legal claims arising in the ordinary course of business. The Company believes the ultimate resolution of the claims will not have a material adverse effect on its financial position, results of operation, or cash flow. ITEM 2. CHANGES IN SECURITIES Not applicable ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 1. The 1997 Annual Meeting of Stockholders of the Company was held pursuant to notice at 1:30 p.m., Pacific time on June 3, 1997 at the Company's offices in San Jose, California. There were present at the meeting, in person or represented by the proxy, the holders of 6,620,244 shares of Common Stock. The matters voted on at the meeting and the votes cast are as follows: (a) As listed below, all the Management's nominees for Class I Directors were elected at the meeting: No. of Common No. of Common Name of Nominee Votes in Favor Votes Withheld --------------- -------------- -------------- Rakesh Kumar 6,600,944 19,300 Delbert W. Yocam 6,600,889 19,355 (b) The appointment of Ernst & Young LLP as independent public accountants of the company for the fiscal year ending December 31, 1997 was ratified and approved with 6,610,635 Common shares voting in favor, 2,600 Common shares voting against and 7,009 Common shares abstaining. ITEM 5. OTHER ITEMS Not applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: See exhibit index on page 17 (b) Reports on Form 8-K: None 15 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. RASTER GRAPHICS, INC. By: /s/ Rak Kumar --------------------------------- Rak Kumar Chief Executive Officer Date: October 2, 1998 16 EXHIBIT INDEX ------------- EXHIBITS - -------- 10.14 Assignment of Lease, dated June 27, 1997, by and between Kaman Music Corporation, Coast Wholesale Music Division, and the Registrant (1) 27.1 Financial Data Statement ___________ (1) Incorporated by reference to exhibits of the Registrant 10-Q for the quarter ended June 30,1997. 17