ITEM 1. BUSINESS
Penril DataComm Networks, Inc. ("Penril" or the "Company") develops and markets network access devices which enable local, remote or mobile users to access network resources located at remote sites, central sites or any other point in the network. The Company possesses each of the technologies needed for a complete network access solution including: remote Local Area Network ("LAN") access, high performance modems and modem channel banks, bridges and routers, host access from asynchronous terminals and multiplexors for efficient access to the Wide Area Network ("WAN").
PENDING TRANSACTION
On June 16, 1996, the Company entered into a Plan and Agreement of Merger, as amended August 5, 1996 (the "Merger Agreement") with Bay Networks, Inc. ("Bay") and a subsidiary of Bay. Under the terms of the Merger Agreement, the Company will transfer (the "Transfer") all of its Access Beyond remote access products business and any other assets unrelated to its modem business to a newly formed subsidiary, Access Beyond, Inc. ("Access Beyond") and then distribute all of the shares of Access Beyond common stock to the Company's shareholders in a spin-off transaction (the "Spin-Off"). Following the spin-off the subsidiary of Bay will merge with and into Penril, whose primary remaining operations will consist of its modem business, with Penril becoming a wholly owned subsidiary of Bay.
Pursuant to the Spin-Off and merger transaction, shareholders of the Company, as of the appropriate record dates, will receive one share of Access Beyond common stock for every share of Penril common stock held, plus $10 in Bay common stock. The dollar value of Bay shares to be paid is fixed according to an exchange value determined by averaging the closing prices of Bay common stock over a specific period prior to closing. In addition to the assets and liabilities related to the Modem business, Bay will assume the outstanding bank debt of Penril up to $4 million. All cash of Penril on the date of the closing of the transactions will be transferred to Access Beyond, Inc.
The transactions are subject to regulatory and Penril stockholders' approval.
RESTRUCTURING OF BUSINESS
As more fully described in Note 2 to the Consolidated Financial Statements, the Company took actions to strategically restructure its business to reduce costs and improve competitiveness for the long term. The Company's wholly owned subsidiary, Access Beyond, Inc., intends to focus its resources on the growing segment of remote access data communications. As a result of this plan, the Company recorded a charge of approximately $9.7 million in the fourth quarter of fiscal 1996. In addition, the Company decided to sell its Electro-Metrics, Inc. ("EMI") subsidiary which specializes in the production of sophisticated high frequency electronic instrumentation equipment.
DISCONTINUED OPERATIONS
As noted above, the Board of Directors made the decision to sell EMI and consequently, EMI has been classified as a discontinued business. The Company continues to operate EMI and expects EMI to at least operate at a break even level through the anticipated disposition date which is expected to occur on or before December 31, 1996. Prior to the end of fiscal 1996, the Company entered into an agreement subject to certain contingencies, to sell the assets of Technipower, Inc. ("TPI"). The sale is expected to be completed during the first quarter of fiscal 1997. The Company recorded a charge of $640,000 in the fourth quarter of fiscal 1996 for the estimated loss on disposal of both these business. See Note 3 to the Consolidated Financial Statements for further discussion of discontinued operations.
MODEM PRODUCTS
The modem family of products includes a variety of products for use in sending data from one point to another via public or private telephone lines. The mainstay of this product grouping is the V.34 modem. Based on proprietary DSP and controller design, Penril's V.34bis modems offer many advanced features including data transmission speeds up to 33,600 bits per second, protocol intelligent compression performance (e.g., Internet Asynchronous PPP and SLIP) and remote software upgradeability for implementation of future standards.
Modems are delivered in several forms including desktop boxes and modem cards which implement many modems on a single board. In addition to a wide variety of modem products and capabilities, Penril's modems support sophisticated modem management capabilities which are sold together with Penril's modem products. Products are sold through a world wide network of resellers, distributors and OEMs. Based on the high end functionality of Penril's products, Penril focuses its sales efforts on large modem installations, including telephone companies and PTTs world wide.
In the last six months, Penril has begun aggressive licensing and OEM development programs involving its advanced modem technology. For semi-conductor manufacturers, such projects involve the portation of Penril's modem software to new custom chip environments and the payment of substantial engineering fees and per chip royalties. For communications companies, projects involve the design of custom high density modem solutions that integrate with existing customer products, with anticipated subsequent high volume purchases of such custom cards.
In addition to high speed modems and modem technology, Penril expects to continue to sell T1 Customer Premise Equipment. Penril offers a system that allows multiple telephone and data communications to be transmitted over one high-speed transmission line at speeds up to 1.54 million bits per second. This product supports network management, voice, data and video communications as well as access to long distance carrier networks.
INTERNETWORKING PRODUCTS
The Company's internetworking product line consists largely of products which serve the LAN and Host Access markets and a new product family called Access Beyond, serving the remote access market.
The LAN and Host Access products currently sold by the Company include statistical multiplexers and host access servers (VCX), Ethernet terminal servers (CSX), Ethernet local and remote bridge routers (BRX), and a line of CSU/DSU wide area products. The Company's new Access Beyond product family is targeted at the remote access market, providing a scaleable, modular platform into which a variety of connectivity options are expected to be offered. The Access Beyond family of products is expected to replicate the function of most of the LAN and Host Access Products, allowing the Company to phase out LAN and Host Access Products models in favor of new Access Beyond models.
The VCX product line of multiplexers ranges from 4-port remote site multiplexers to enterprise solutions providing up to 304 ports or 36 trunk lines and multipurpose communication servers that combine both wide area network ("WAN") and LAN capabilities. These products can function as a data PBX, X.25 PAD, statistical multiplexer, terminal server or any combination of these. Although the market for these products is in decline, the Company continues to serve the installed base and fulfill customer applications.
The CSX Ethernet communications server family provides local and dialup access to Ethernet LANs. Available as either 8-port or 16-port stand alone units or as a modular chassis based solution, the CSX server provides terminal and dialup access for TCP/IP networks. The BRX family includes modular switching routers that provide up to 16 LAN ports and 2 WAN ports. A key element to the BRX product line is in the Constellation software which provides a scaleable router/switching solution. The Company believes that the Constellation software uses an architecture called Logical Bridge Routing, which enables network managers to optimize bridge/router port configurations for efficient high performance. The Constellation software is one of the key elements in the new Access Beyond product line.
The Access Beyond product line is a scaleable, modular family of remote access products that integrate WAN transmission and LAN access technologies into a single modular architecture, while allowing room for growth and investment protection.
The Company anticipates that a wide range of Access Beyond models will be available to meet varying site requirements, with chassis sizes ranging from small 4-port units to completely modular 196-port units, thus allowing the user to customize the chassis-based units to provide a unique mix of local area and wide area network interfaces that meet the specific demands of its network environment. Interface options will include: Ethernet backbone and end user ports, integrated wide area network interfaces, analog modems, digital modems, CSU/DSU and ISDN interfaces. The modularity and scaleability of the Access Beyond product family is intended to give the customer flexibility in network configuration and expansion potential.
The first phase of Access Beyond includes Ram Rack, a high density modem product and Access Beyond 1000 Remote Access Servers, which are now being shipped to customers. These products provide remote users with competitively priced remote access to Novell, TCP/IP and Appletalk networks. The next phase of the Access Beyond rollout is expected to include the Access Beyond 2400 and Access Beyond 4400 modular chassis systems. These products are designed to expand the flexibility of the product line with optional interfaces for direct terminal connections, integrated V.34 modems and integrated ISDN terminal adapters, along with LAN and high speed WAN (T1/E1/PRI) connectivity.
The Company anticipates that future enhancements to its remote access software will provide integration of the remote access capabilities with full multi-protocol routing. This combination is expected to provide additional connectivity options and reduced access costs for corporate remote access networks by allowing a single Access Beyond server to replace several separate competitive devices. The software features of Access Beyond are and will be focused on solving the problems of corporate remote LAN access. With the growth of the Internet and the World Wide Web, corporate telecommuters and traveling employees now require simultaneous support for multiple networking protocols allowing access to a wide variety of applications. Networking security is provided via a collection of security options.
All Access Beyond products will be monitored and configured with a graphical, menu-driven Windows-based management tool that provides real-time management control over the Access Beyond products. This management tool will be based on the industry standard SNMP protocol to ensure interoperability with equipment and management systems from other vendors.
The Company believes that it will deliver the industry's first unified approach to remote access, with one comprehensive product line that can supply both LAN and WAN technologies required in a single architecture, with complete management control, and new levels of investment protection for end users. Existing applications will be changed from dedicated services to faster, lower cost and more flexible services such as Frame Relay and Ethernet. Access Beyond is intended to provide a migration path from these older networks to the remote access networks of the future.
SUPPLIERS
Material and components for the Company's products are purchased from outside suppliers. While most components are available from several suppliers, a few are provided from sole-source vendors. The Company believes that in most cases alternative sources of supply could be obtained within a reasonable time period; however, an interruption in the supply of such components could have a temporary adverse effect on the Company's operations.
PATENTS, COPYRIGHTS AND LICENSES
The Company owns, or is licensed or otherwise possesses legally enforceable rights to use, several patents, patent applications, trademarks, trade names, service marks, copyrights, schematics, technology, know-how, computer software programs or applications, and tangible or intangible proprietary information or material essential and necessary to the business of the Company. The Company may desire in the future to obtain additional licenses related to its products and believes, based on industry practice, that any necessary licenses could be obtained. The costs of such licenses may vary significantly depending on the nature of the technology involved.
The patents owned by Penril include patents entitled "Precoding Scheme for Transmitting Data Using Optimally-Shaped Constellations over Intersymbol-Interference Channels" (jointly owned with the University of Maryland pursuant to a certain Patent Ownership Agreement, dated April 3, 1996), "Modem and Method for Eight Dimensional Trellis Code Modulation" and "Radio Frequency Apparatus for Measuring Moisture Content of Materials as a Function of Dielectric Constant" (expired on November 3, 1992). The trademarks, trade names, and service marks, owned by Penril include BIAX, PENRIL, PENRIL CORP., PENRIL DATABILITY NETWORKS, AND THE PENRIL DATABILITY DESIGN, PENRIL DATACOMM, and PENRIL DATA COMMUNICATIONS.
Penril has historically licensed technology, which helps to support Company developed designs, including multiplexer base system technology channel bank system technology, quad voice card technology, quad analog card technology, high speed data card technology, logic redundancy technology, uninterruptible power supply technology, drop and insert arrangement technology, networking technology, V.34 data/fax modem technology, bridge routers and remote access servers technology, router software technology, V.42bis modem technology, license under MNP Link protocol technology, and various software licenses.
On June 16, 1996, Penril and Bay entered into a Perpetual License Agreement whereby Penril licensed Bay certain intellectual property, software, and technical know-how relating to certain V.34+Xylogics Octal Modem Cards. The effective date of this Perpetual License Agreement is contingent on certain terms contained in the Merger Agreement. Should Penril or Bay terminate the Merger Agreement, this Perpetual License Agreement will become effective under certain circumstances upon the payment by Bay of $50 million within 10 business days of giving notice of such termination to Penril, but no earlier than December 16, 1996. The Perpetual License Agreement contemplates that Penril will develop an 8 port Digital Modem Card for Bay, train Bay's personnel in the underlying technology, and provide technical assistance where necessary to permit Bay to market this digital technology. In addition, in order to practice the licensed technology, a license under a certain patent must be granted by Penril to Bay. Penril and Bay will negotiate the terms and conditions of such license. Such license will be subject to the following conditions: (a) if Bay makes the payment of $50 million should the Merger Agreement be terminated, the royalty rate for modems covered by such patent will not exceed the lesser of $.30 per modem or the lowest rate being charged to any other licensee of such patent, and (b) if no such payment of $50 million is made, the royalty rate will not exceed that being charged to any other licensee manufacturing a comparable volume of modems under such license. The Perpetual License Agreement also grants Bay the right to hire, within 90 days of its effective date, up to five designated Penril employees, which employees are important to the modem business. Also on June 16, 1996, Penril and Bay entered into a License Agreement whereby Penril licensed to Bay certain intellectual property, software and technical know-how relating to certain V.34+ Xylogics Octal Modem Cards. The License Agreement terminates December 15, 1996. Bay paid Penril a fee of $4.5 million upon execution of the License Agreement.
The patents which are associated with EMI and TPI include patents entitled "Fiber Optic Connector", "Uninterruptible Power Supply", and "Guard Time Elimination in a TimeDivision Multiplexed, Active Star-coupled, Half-duplex Mode, Synchronous Communications Network." These patents will be sold as part of the assts of EMI and TPI. If the sale of these subsidiaries are not consummated prior to the Transfer, then these patents will be contributed to Access Beyond as part of the assets of EMI and TPI.
The United States trademarks, trade names and service marks which will be owned by Access Beyond after the Transfer include ELECTRO-METRICS, TECHNIPOWER, ACCESS BEYOND, CONSTANT POWER, MULTIVERTER, FORSITE, MUX/ROUTER, and SUNUPS. The foreign trademarks, trade names and service marks which will be owned by Access Beyond include TECHNIPOWER in France, the United Kingdom and Italy.
Access Beyond will license much of its technology including integrated access software; CSU/DSU technology; frame relay assembler disassembler technology; PC/TCP SNMP technology; terminal emulation software; remote access software; router card technology and software; network management software; and basic frame relay software for LAN interconnect products.
On June 16, 1996, Penril and Bay entered into a Development and License Agreement on behalf of Access Beyond whereby Bay licensed to Penril on behalf of Access Beyond certain intellectual property, software, and technical know-how related to certain 24-port Digital Modem Cards. The agreement contemplates that Bay will develop a 24-port Digital Modem Card for Access Beyond, train Access Beyond's personnel in the underlying technology, and provide technical assistance where necessary to permit Access Beyond to market this digital technology.
Finally, the consummation of the spin-off transaction is conditioned upon a transfer of a license for intellectual property, software and technical know-how pursuant to the terms of that certain Technology License Agreement to be executed between Penril and Access Beyond. In connection with the Transfer, Penril and Access Beyond will enter into a Technology License Agreement whereby Penril will license to Access Beyond certain intellectual property, software and technical know-how, including those relating to a patent jointly owned by Penril and the University of Maryland. The Technology License Agreement will also obligate Penril to use its best efforts to obtain for Access Beyond all rights obtained by Penril pursuant to cross licensing agreements involving such jointly owned patent.
BACKLOG
A significant portion of data communications revenues are based on customer purchase orders with immediate shipment requirements. Backlog, which tends not to be significant in data communications products, is a result of the occasional customer order with future scheduled shipment requirements or misalignment of demand and production of a particular product. Because data communications revenues constitute such a significant portion of the revenues of the Company, it is the opinion of the Company's management that the dollar amount of backlog at any given time is not indicative of the actual level of revenues which will ultimately be realized during future periods. Consequently, the Company's management believes that the amount of backlog is not a material consideration in understanding the Company's business operations.
COMPETITION
The Company encounters substantial competition in the marketing of its products and many of its competitors have greater financial, marketing and technical resources. Important competitive factors in the markets for the Company's products are established customer base, product performance and features, service and support as well as price. The Company believes that it competes favorably with respect to these factors. There can be no assurance that the Company's products will compete successfully with competitive products that may be offered in the future or that aggressive pricing will not negatively impact the profitability of the Company.
RESEARCH AND DEVELOPMENT
Under its own sponsorship, the Company is continuously engaged in the development of new products as well as the development and enhancement of its existing products. The Company expensed approximately $7,389,000 (19% of consolidated revenues) for product development and engineering during fiscal 1996 compared to $7,438,000 (14% of consolidated revenues) in fiscal 1995 and $8,817,000 (14% of consolidated revenues) in fiscal 1994.
ENVIRONMENTAL MATTERS
The Company's compliance with federal, state and local environmental laws has had no material effect upon the Company's capital expenditures, earnings or competitive position.
EMPLOYEES
As of July 31, 1996, EMI had 71 employees, TPI had 46 employees and Penril Datability division had 276 employees. The Company believes that its future success will depend largely on its ability to retain certain key personnel and to recruit and retain additional highly skilled employees who are in great demand. The Company has employment contracts with certain officers, but does not have employment contracts with its other employees. The Company has experienced no work stoppages and believes that its employee relations are satisfactory. It is currently anticipated that employees working at EMI and TPI will remain as employees of these entities when the entities are sold. As part of the restructuring of the Company, and the spin-off of Access Beyond and the subsequent merger with Bay, 66 employees have been notified that their employment will be terminated, approximately 170 employees will be employed by Access Beyond and approximately 41 employees will remain with Penril after the merger.
INTERNATIONAL OPERATIONS
The Company has subsidiaries located in the United Kingdom and Hong Kong. Reference is made to Note 10 of the Notes to Consolidated Financial Statements contained in Part II, Item 8.
ITEM 2.
ITEM 2. PROPERTIES
The Company and its subsidiaries lease manufacturing, warehouse and office facilities as follows:
Each location has separate space as required for manufacturing, engineering, marketing and administrative activities adequate for present purposes. The Company's executive offices are located in the Gaithersburg, Maryland facility. In addition to the facilities mentioned above, the Company also leases several sales offices throughout the United States.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is party to several material legal proceedings as summarized below. With the exception of the proceeding against Rockwell International Corporation, et. al., and one other legal proceeding incurred in connection with the modem business, all costs, expenses, liabilities and obligation of the litigation will be assumed by Access Beyond in connection with the spin-off transaction and all recoveries from such litigation will be realized by Access Beyond; provided, however, that Penril may be deemed to have remained contingently liable for satisfaction of the obligations.
On June 1, 1993 Penril initiated a lawsuit against Standard Microsystems Corp., ("SMC") Massachusetts, Inc., Ashraf M. Dahad and Kwabena Akufo (the "SMC Defendants") in the Circuit Court of Maryland for Montgomery County for breach of contract including, among other things, failure to transfer technology, unfair competition and false representations. Penril sought relief in an aggregate amount of approximately $50 million. The SMC Defendants subsequently brought a counterclaim alleging fraud and breach of contract and sought recovery of amounts due under the contract which were alleged to be approximately $1,650,000 in compensatory damages plus unspecified punitive damages. In September 1996, the Company and the SMC Defendants agreed to drop the fraud charges and to settle the contractual dispute. The Company will receive from SMC, in settlement of litigation, $3.5 million, net of legal payments, in the first quarter of fiscal 1997.
On December 24, 1994, Penril filed a complaint against Network Systems Corporation of Minneapolis, Minnesota ("NSC") in the Circuit Court of Maryland for Montgomery County. The litigation arises out of a contract in which Penril agreed to develop certain computer hardware and software to NSC's specifications. Penril alleges breach of contract, fraudulent inducement and defamation and is seeking specific performance, compensatory damages of $2,000,000 and punitive damages of $5,000,000. On March 28, 1995, NSC filed an answer and counterclaim in which NSC alleges negligent misrepresentation, fraud and breach of contract by Penril. NSC is seeking rescission of the contract, restitution of monies paid by NSC to Penril, compensatory damages of $5,000,000 and punitive damages in an unspecified amount. As of September 24, 1996, the litigation was in the discovery stage.
Digital Equipment Corporation ("DEC") has claimed, through a series of written communications, that Penril has violated DEC patents related to DEC LAT technology. Penril has taken the position that Datability, Inc., prior to its acquisition by Penril, had a relationship with DEC that involved the development of LAT for which Datability has not collected. Both DEC and Penril have taken the position that it is in the best interests of both parties to work toward a fair resolution. As of September 24, 1996 no formal claims have been filed.
On December 6, 1995, Penril filed a lawsuit against Rockwell International Corporation and U.S. Robotics Access Corporation seeking declaratory, injunctive, and money damage relief by reason of an alleged patent infringement by the defendants. The action was filed in the United States District Court for the District of Maryland. In September 1996, the Company agreed to settle its lawsuit with U.S. Robotics.
The Company is involved in other routine litigation.
Management believes none of the litigation will have a material adverse effect on the Company's financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded over-the-counter and quoted on the NASDAQ National Market System under the symbol PNRL. The following table sets forth the high and low sales prices as reported by NASDAQ for the fiscal quarters indicated.
The current quoted price of the stock is listed daily in the Wall Street Journal in the NASDAQ National Market System section. The number of holders of record of the Company's Common Stock as of August 31, 1996 was 936. The Company has not paid a dividend during the preceding two fiscal years and there can be no assurance that it will pay a dividend.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL BUSINESS DEVELOPMENTS
Beginning in fiscal year 1994, Penril began to focus its business on remote access connectivity products. Out of this strategy came the Company's new remote access product line. The first phase of the new remote access product line includes the Ram Rack and the Access Beyond 1000 Remote Access Server.
As noted above, the Board of Directors made the decision to sell EMI and consequently, EMI has been classified as a discontinued business. The Company continues to operate EMI and expects EMI to at least operate at a break-even level through the anticipated disposition date which management believes will be completed by December 31, 1996. Prior to the end of fiscal 1996, the Company entered into an agreement, subject to certain contingencies, to sell TPI. The completion of the sale is expected during the first quarter of fiscal 1997. The Company recorded a charge of $640,000 in the fourth quarter of fiscal 1996 for the estimated loss on disposal of both these businesses. No assurance can be given that either or both of EMI and TPI will be sold or that the timing or terms of any such sale will be favorable to and as anticipated by the Company.
On June 16, 1996, as amended on August 5, 1996, the Company entered into the Merger Agreement with Bay and a subsidiary of Bay. Under the terms of the Merger Agreement, the Company will transfer all of its remote access products business and any other assets unrelated to its modem business to a newly formed subsidiary, Access Beyond, Inc. ("Access Beyond") and then distribute all of the shares of Access Beyond common stock to the Company's stockholders in a spin-off transaction (the "Spin-Off"). Following the Spin-Off, the subsidiary of Bay will merge with and into the Company, whose primary remaining operations will consist of its modem business, with the Company becoming a wholly owned subsidiary of Bay.
As a result of all of the above items, in the fourth quarter of fiscal 1996, the Company took actions to strategically restructure the business to focus on the remote access connectivity products, to reduce costs and improve competitiveness for the long term. This restructuring plan included the elimination of the VCP and BRX product lines and the introduction of the new remote access product line. The decision to restructure and refocus is not dependent upon consummation of the Merger. As described more fully in Note 2 to the Consolidated Financial Statements, the Company recorded a restructuring charge in the fourth quarter of fiscal 1996 of $9.7 million. This charge consisted of a write-down of costs in excess of net assets acquired ($5.0 million), a provision for the write-down of inventories and fixed assets ($2.3 million), a provision for costs associated with contractual obligations for leased facilities in Hong Kong and Carlstadt, New Jersey ($1.0 million), a provision for the write-down of purchased technology ($1.0 million), and a provision for costs associated with termination of approximately 90 employees ($400,000). On an annualized basis this plan is expected to reduce labor costs by approximately $3 million, reduce amortization and depreciation expenses by approximately $700,000, and reduce facilities expenses by approximately $300,000. The Company anticipates completion of the employee terminations and consolidation of leased facilities by the end of the second quarter of fiscal 1997, and does not anticipate any additional costs associated with this restructuring plan.
With the exception of historical information, the matters discussed in this document may include forward-looking statements that involve risks and uncertainties. The Company wishes to caution readers that a number of important factors, including those identified in this section as well as factors discussed elsewhere in this filing and in other filings with the Commission, could affect the Company's actual results and cause actual results to differ materially from those in the forward-looking statements.
NEW ACCOUNTING PRONOUNCEMENTS
During fiscal 1996, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121 (SFAS 121), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of", which requires the Company to review long-lived assets, certain identifiable intangibles, and goodwill related to those assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. As a result of events occurring in the fourth quarter of fiscal 1996, the Company decided to restructure and refocus its remaining businesses. Due to these events, the Company determined that the excess of costs over net assets acquired would not be recoverable, and a charge of $4,952,000 was taken in the fourth quarter of fiscal 1996 against the carrying value of this asset. This charge was the remaining balance in the account "Excess of Costs over Fair Value of Net Assets Acquired" (See Note 2).
During fiscal 1996, Statement of Financial Accounting Standard No. 123 ("SFAS 123"), "Accounting for Stock Based Compensation," which establishes a fair value based method for stock-based compensation plans, was issued. SFAS 123 includes both recognition and measurement provisions and disclosure requirements for stock based compensation. The Company has elected not to adopt the recognition and measurement provisions of SFAS 123. The effect of adopting this statement in fiscal 1997 is not deemed to be material.
RESULTS OF OPERATIONS
As a result of the Merger Agreement with Bay and the Spin-Off of the LAN and remote access products business, the following discussion is based on the Penril historical financial statements, with revenue and expenses which could be specifically identified with the modem products shown separately from the LAN and remote access ("Host Access") products. All revenue and expenses which could not be specifically identified with the modem products were included with the LAN and Host Access products, consequently the expenses for the LAN and Host Accss products are in excess of those that would have been incurred had the Company been a stand alone company. As noted above, TPI and EMI subsidiaries are classified as discontinued operations and are not included in this discussion unless otherwise noted. Dollar amounts are reported in thousands.
Fiscal 1996 Compared to Fiscal 1995
July 31, July 31, 1996 1995 CHANGE --------- --------- --------
Revenues: LAN and Host Access products............. $19,916 $33,637 $(13,721) Modem products........................... 19,519 18,974 545 --------- --------- -------- $39,435 $52,611 $(13,176) ======== ======== ========
The decrease in revenues for Penril's LAN and Host Access products was primarily attributable to the continued decline in market demand for terminal servers and multiplexers which resulted in lower volumes and more competitive pricing. The Company intends to phase out these products, which represent older technology, and introduce its new remote access product line. The new remote access product line is designed to meet the growing demand for remote access technology. The Company believes that its new remote access product line has a unique product architecture that combines both remote access and internetworking capabilities which will offer expanded and fully compatible capabilities to the existing customer base as well as offering new customers a product line which will be state of the art in remote access. The Company believes that this new product line will be competitively priced and will generate revenues over the next fiscal year to offset the decline in revenue from its older LAN and Host Access product line.
In the fourth quarter of fiscal 1996, the Company and Bay entered into a License Agreement whereby Bay acquired a license to certain intellectual property rights related to its modem technology, and the Company was paid $4.5 million. Revenue for the modem business without this license agreement would have been $15,019,000 in fiscal 1996 compared with $18,974,000 in fiscal 1995. The decrease in revenue from the sale of modem products was due to slower than expected sales of Penril's V.34 modems, and a decline in sales of older modem products. The Company believes that more competitive pricing of its new V.34 modems will result in higher revenues for fiscal 1997 compared to fiscal 1996, and that these higher revenues should offset the continued decline in sales of older modem products.
As shown in Note 10 to the Consolidated Financial Statements, exports represented 44% of the Company's total revenues in fiscal 1996 and 45% of the Company's revenues in fiscal 1995. Approximately 60% of the Company's exports related to Modem products in both fiscal 1996 and fiscal 1995. Revenues from the Company's foreign subsidiaries, which are primarily sales and marketing operations (in England and Hong Kong) represented 7% of the Company's total revenues in fiscal 1996 and 5% of the Company's total revenues in fiscal 1995 and over 95% of those revenues were generated from the subsidiary in England. Due to the growing demand worldwide for data communications products, the Company believes it will continue to generate revenue from exports of both its LAN and Host access products and its modem products. Because of the location of its primary foreign subsidiary, the Company does not believe it has any significant exposure to exchange rate risk.
As a result of the restructuring plan, the Company will phase out its Hong Kong subsidiary in fiscal 1997, and relocate its sales and marketing operations to the U.S. The Company does not anticipate that the restructuring plan will have a material effect on revenues for either the Modem products or the LAN and Host access products.
July 31, July 31, 1996 1995 CHANGE --------- --------- ------ Gross Profit Margin: LAN and Host Access products............... 37% 46% (9%) Modem products............................. 49% 41% 8%
The decrease in the gross profit margin for LAN and Host Access products was due to reductions in product pricing in order to remain competitive in the marketplace, and increases in manufacturing inefficiencies due to lower sales volumes. As noted above, the Company entered into a License Agreement with Bay in the fourth quarter of fiscal 1996 for $4.5 million. Gross profit margins without this License Agreement would have been 34% in fiscal 1996 compared to 41% in fiscal 1995. The decrease in gross profit margins for modem products was due to higher costs of materials in the V.34 modem product line as well as pricing competition and lower manufacturing efficiencies related to the lower sales volume.
July 31, July 31, 1996 1995 CHANGE --------- --------- ------- Selling, general and administrative expenses: LAN and Host Access products............... $16,417 $16,479 $ (62) Modem products............................. 2,694 2,286 408 --------- --------- ------ $19,111 $18,765 $ 346 ========= ========= ======
Selling, general and administrative expenses decreased for the LAN and Host Access products primarily from lower commissions paid due to lower sales volume. There was also a reduction in personnel costs as a result of eliminating several administrative positions in the Gaithersburg, Maryland facilities during fiscal 1995. This reduction was partially offset by an charge of $500,000 during the fourth quarter of fiscal 1996, for costs incurred related to the Merger Agreement with Bay. All expenses which could not be specifically identified with the modem products were included with the LAN and Host Access products, consequently the expenses for the LAN and Host Access products are in excess of those that would have been incurred had the LAN and Host Access products been a stand alone company.
July 31, July 31, 1996 1995 CHANGE --------- --------- ------ Product development expenses: LAN and Host Access products............... $ 5,624 $ 5,520 $ 104 Modem products............................. 1,765 1,918 (153) --------- --------- ------ $ 7,389 $ 7,438 $ (49) ======== ======== =====
Product development expenses in the LAN and Host Access products increased because of an increase in personnel costs related to development of the new Access Beyond product line. Modem product development expenses decreased because of reductions in personnel costs as a result of Penril's cost reduction efforts in fiscal 1995. All expenses which could not be specifically identified with the modem products were included with the LAN and Host Access products, consequently the expenses for the LAN and Host Access products are in excess of those that would have been incurred had the LAN and Host Access products been a stand alone company.
July 31, July 31, 1996 1995 CHANGE --------- --------- ------- Interest expense............................. $ 698 $ 1,228 $(530)
During fiscal 1996, Penril sold common stock in private placements which generated approximately $14.7 million in cash. A portion of the proceeds was used to repay all term debt during fiscal 1996, which resulted in decreased interest expense.
Fiscal 1995 Compared to Fiscal 1994
July 31, July 31, 1995 1994 CHANGE --------- --------- ------- Revenues: LAN and Host Access products............... $33,637 $39,011 $(5,374) Modem products............................. 18,974 22,827 (3,853) --------- --------- ------- $52,611 $61,838 $(9,227) ======== ======== ========
The decrease in revenues for Penril's LAN and Host Access products was primarily attributable to the declining market for terminal servers and multiplexers as these products were reaching the end of the product life cycle, and to a decrease in orders from some of Penril's OEM customers. The decrease in revenues from modem products was due to unexpected delays in shipment of the V.34 and V.34bis modems. As shown in Note 10 of the Consolidated Financial Statements, the Company had total exports of $23.6 million in fiscal 1995 compared with $25.6 million in fiscal 1994.
July 31, July 31, 1995 1994 CHANGE --------- --------- ------ Gross Profit Margin: LAN and Host Access products............... 46% 54% (8%) Modem products............................. 41% 45% (4%)
The decrease in gross profit margins for LAN and Host Access products was due to lower manufacturing efficiencies. The decrease in gross profit margins for modem products was due to costs associated with the initial production of the V.34 modem product line, lower manufacturing efficiencies and pricing competition related to the decrease in sales.
July 31, July 31, 1995 1994 CHANGE --------- --------- ------- Selling, general and administrative expenses: LAN and Host Access products............... $16,479 $16,965 $ (486) Modem products............................. 2,286 1,850 436 --------- --------- ------- $18,765 $18,815 $ (50) ======== ======== =======
Selling, general and administrative expenses decreased for LAN and Host Access products primarily because of a reduction in personnel costs as a result of eliminating several administrative positions in the Gaithersburg, Maryland facilities during fiscal 1995 as part of the Company's cost reduction program. Selling, general and administrative expenses for modem products increased primarily due to additional allowances for bad debts.
July 31, July 31, 1995 1994 CHANGE --------- --------- ------- Product development expenses: LAN and Host Access products............... $ 5,520 $ 6,797 $(1,277) Modem products............................. 1,918 2,020 (102) --------- --------- ------- $ 7,438 $ 8,817 $(1,379) ======== ======== =======
Product development expenses decreased because of reductions in personnel costs as a result of Penril's cost reduction efforts in fiscal 1995 and 1994.
July 31, July 31, 1995 1994 CHANGE --------- --------- ------- Interest expense............................. $ 1,228 $ 908 $ 320
Interest expense increased because of the increase in the prime rate from 7% in fiscal 1994 to 9% in fiscal 1995, and because the rate charged the Company by its principal bank was raised from prime plus 1/2% to prime plus 2%.
LIQUIDITY AND CAPITAL RESOURCES
During fiscal 1996, the Company sold 2,607,000 shares of its common stock in two unrelated series of private placements which generated aggregate proceeds of $14,744,000. These proceeds were used to repay all of the Company's bank term debt and all its outstanding subordinated debt which combined totaled $4.8 million and to fund general working capital needs including the loss of $11.1 million (excluding restructuring charges) for fiscal 1996.
As a result of the strategic business plan to restructure the Company, the Company recorded a restructuring charge of $9.7 million in the fourth quarter of fiscal 1996. This restructuring charge included non-cash items for the write-down of costs in excess of net assets acquired of approximately $5.0 million, a provision for the write-down of purchased technology of approximately $1.0 million, a provision for the write-down of inventory of $2.2 million. This restructuring charge also included items that will require future cash expenditures for employee severance of approximately $400,000, and obligations for leased facilities of $1.0 million. The severance payments to employees will occur in the fiscal 1997 second quarter and the payments under the leased facilities obligations will occur over the remaining life of the lease with $282,000 due in fiscal 1997, $289,000 due in fiscal 1998 and $440,000 due after fiscal 1998.
As a result of lower than expected sales and the build up of inventory to support the new remote access product line, inventory levels of the Company increased $1.3 million during the first nine months of fiscal 1996. Consequently, the Company started a program to reduce inventories that resulted in a fourth quarter reduction of approximately $750,000. In addition, as noted above, the Company recorded an inventory write-down provision of $2.2 million as part of the restructuring charge. These actions resulted in the Company inventory levels of $9.7 million at July 31, 1996, or a reduction of $1.7 million below the July 31, 1995 inventory level of $11.4 million.
Contributing to the Company's cash flow in fiscal 1996 was the reduction in accounts receivable of $6.5 million. This reduction was the result of the lower sales volumes in fiscal 1996 compared to fiscal 1995 and an aggressive collection effort that reduced the average collection time from 94 days in fiscal 1995 to 65 days in fiscal 1996.
The Company's accounts payable also declined by $2.1 million as result of the lower level of business.
As part of the Transfer, Access Beyond is to receive all the cash and cash equivalents of the Company. As of September 25, 1996, the Company had cash and cash equivalents of approximately $3.8 million. In addition, the Company is expected to generate cash from several non-operating sources. These anticipated sources include the following:
The Company settled a law suit with Standard Micro Systems Corp on September 24, 1996. This settlement will result in the Company receiving in October 1996, $3.5 million in cash after all related expenses have been paid.
The Company is in discussions with a potential buyer of EMI. Although there can be no assurance that a sale of EMI wil occur, the Company's management believes that the sale of EMI will be completed by December 31, 1996 with expected net cash proceeds of $3.0 million to $3.5 million after transaction expenses.
The Company has entered into a contract to sell TPI, for $4.3 million, subject to various contingencies. The Company expects this transaction to close during the first quarter of fiscal 1997 with the payment of to the Company $1.5 million in cash. The remaining $2.8 million payment is due, pursuant to the terms of the contract, on or before December 31, 1996.
As part of the Merger Agreement with Bay, Access Beyond will receive $1.5 million at the closing pursuant to the Transitional Services Agreement with the Company.
Prior to the Spin-Off, the Company also anticipates receiving approximately $5 million ($2.6 million is expected from officers of the Company and $300,000 from directors of the Company) from the exercises of employee and director stock options. The cash generated from these exercises is expected to be used for the expenditures related to the Merger and the Spin-Off. These expenditures include legal and accounting fees (estimated to be $700,000), investment banker fees (estimated to be $1.3 million) and change of control payments due to certain officers of the Company (estimated to be $1.3 million).
The Company currently has a line of credit with its principal bank. The agreement provides a maximum working capital facility of $5.5 million with borrowing based on qualified accounts receivable and secured by substantially all of the Company's assets. Interest accrues at the bank's prime rate plus 2% with a commitment fee of 3/8% on the unused portion of the facility. In the event the facility is canceled prior to its expiration, there is a fee due the bank equal to 3% of the total facility. As of July 31, 1996, the Company had borrowed $4 million under the line and had utilized another $90,000 in connection with a standby letter of credit. Pursuant to the Merger Agreement, the Company after the merger will retain bank debt up to a maximum of $4 million.
Currently there are discussions with lending institutions regarding a line of credit for Access Beyond after the Spin-Off. Although there can be no assurances, management believes Access Beyond will be able to secure a line of credit after the Spin-Off. There can be no assurances such a line of credit will be on economic terms favorable to Access Beyond.
The management of the Company believes that Access Beyond expenditures, during the first 12 months following the Spin-Off, for fixed assets and capitalized technology purchases will be approximately $2.2 million, and $700,000 for cash expenditures related to the employee severance and lease obligations noted above.
Immediately following the Spin-Off, management believes Access Beyond could have as much as $7.8 million in cash as well as the right to receive a payment of $2.8 million from the sale of TPI and possibly proceeds from the sale of EMI. Based on the Company's expectations with respect to Access Beyond's product development and production, cash from operations alone will not satisfy Access Beyond's cash requirements during the first 12 months following the Spin-Off. However, management expects that cash on hand as noted above, cash from operations and cash from the sources discussed above, will satisfy Access Beyond's cash requirements during the first 12 months after the Spin-Off. There can be no assurance that product development will proceed at the expected pace, that Access Beyond sales will achieve expected levels, that staffing and facilities required will be able to be maintianed at the reduced levels expected under the restructuring plan referred to above, or that other competitive factors will not result in cash from operations being less that expected by management. However, Access Beyond has the ability to defer product development and marketing expenditures if necessary, to match with cash flow. The deferral of these expenditures could have a negative impact on future sales of the Access Beyond products. The Company believes, based on its expected cash on hand, cash from operations, cash from the sources discussed above and anticipated bank line of credit, that there will be adequate cash flow to fund operations of Access Beyond.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders Penril DataComm Networks, Inc. Gaithersburg, Maryland
We have audited the accompanying consolidated balance sheets of Penril DataComm Networks, Inc. and subsidiaries as of July 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ending July 31, 1996. These financial statements are the responsibility of the Penril's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Penril DataComm Networks, Inc. and subsidiaries as of July 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 1996 in conformity with generally accepted accounting principles.
\s\Deloitte & Touche LLP - ------------------------
Washington, D.C. September 6, 1996 (September 20, 1996 as to the sixth and ninth paragraphs of Note 7)
PENRIL DATACOMM NETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED July 31, 1996, 1995 AND 1994
1. Summary of Significant Accounting Policies
Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have been eliminated.
Cash and Cash Equivalents: The Company considers cash on hand, deposits in banks, and highly liquid investments with an original maturity of three months or less as cash and cash equivalents.
Fair Value of Financial Instruments: The carrying values of cash and cash equivalents, accounts receivable, and accounts payable approximate fair value due to the short maturities of such instruments. Long-term debt is carried at amounts approximating fair values based on current rates offered to the Company for debt with similar collateral and guarantees, if any, and maturities.
Inventories: Inventories are stated at the lower of cost (first-in, first-out method) or market. The inventories include the cost of material and, when applicable, labor and manufacturing overhead. The following table shows the detail in the inventory account (in thousands): July 31, 1996 1995 ------ ------ Inventories: Raw material $ 5,823 $ 6,381 Work in process 541 452 Finished goods 3,320 4,594 ------ ------ Total inventories $ 9,684 $11,427 ====== ======
Property, Equipment and Depreciation: Additions to property and equipment are recorded at cost. The Company provides depreciation for financial reporting purposes using primarily the straight-line method over the estimated useful lives of the assets which range from 3 to 10 years. Leasehold improvements are amortized over the term of the related lease or their estimated useful lives, whichever is shorter. The following table shows the detail in the property, equipment and depreciation (in thousands): July 31, 1996 1995 ------ ------ Machinery, and equipment $10,875 $ 9,952 Purchased software and technology 5,486 5,486 Leasehold improvements 879 865 ------ ------ Total property and equipment, at cost 17,240 16,303
Less accumulated depreciation and amortization (14,783) (13,655) ------ ------ Total property and equipment, net $ 2,457 $ 2,648 ====== ======
Revenue Recognition: Revenues are recognized at the time of shipment of the product or performance of product-related services. Revenues from the license of product technology is recorded upon delivery of the technology specification and the fulfillment of other material obligations.
Accounting Estimates: The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Excess of Cost Over Fair Value of Net Assets Acquired: During fiscal 1996, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121 (SFAS 121), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of", which requires the Company to review long-lived assets, certain identifiable intangibles, and goodwill related to those assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. As a result of events occurring in the fourth quarter of fiscal 1996, the Company decided to restructure and refocus its remaining businesses. Due to these events, the Company determined that the excess of costs over net assets acquired would not be recoverable, and a charge of $4,952,000 was taken in the fourth quarter of fiscal 1996 against the carrying value of this asset. This charge was the remaining balance in the account "Excess of Costs over Fair Value of Net Assets Acquired" (See Note 2).
Excess of Cost Over Fair Value of Net Assets Acquired (in thousands):
July 31, 1996 1995 ------ ------ Cost $ -- $ 8,090 Less accumulated amortization -- 2,401 ------ ------ $ -- $ 5,689 ====== ======
Income Taxes: Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. A valuation allowance is established to reduce deferred tax assets to the amount expected to be realized.
Earnings Per Share: Earnings per share for fiscal 1996 and 1995 are calculated based on the weighted average common shares outstanding. Earnings per share for fiscal 1994 year are calculated using the modified treasury stock method, which limits the assumed purchase of treasury shares to 20% of the outstanding common shares. Any remaining proceeds are assumed first to retire debt, with any remaining proceeds invested in commercial paper. The difference between fully diluted and primary earnings per share was not significant in any year.
Software Development Costs: Certain acquired software development costs are being amortized over their estimated economic life, principally five years, commencing when each product is available for general release. Internal software development and any other costs of development are expensed as incurred, except those costs applicable to third party contracts.
New Accounting Pronouncements: During fiscal 1996, Statement of Financial Accounting Standard No. 123 ("SFAS 123"), "Accounting for Stock Based Compensation," which establishes a fair value based method for stock-based compensation plans, was issued. SFAS 123 includes both recognition and measurement provisions and disclosure requirements for stock based compensation. The Company has elected not to adopt the recognition and measurement provisions of SFAS 123. The effect of adopting this statement in fiscal 1997 is not deemed to be material.
Reclassifications: Certain reclassifications have been made to prior period consolidated financial statements to conform to the July 31, 1996 presentation.
2. Restructuring
In the fourth quarter of fiscal 1996, the Company took actions to strategically restructure its business to improve the Company's financial performance. The restructuring included a plan to focus the Company's business operations on the remote access server and remote connectivity markets ("Remote Access") and away from the data transmission markets. As a result of this plan the Company recorded a charge of $9,718,000 in the fourth quarter of fiscal 1996. This charge was for the following costs.
a. The excess of costs over the fair value of net assets acquired through the Datability, Inc. acquisition in fiscal 1993, was related to data transmission techniques and, due to the restructuring plan, has no net realizable value. Accordingly the remaining book value of $4,952,000 was written off.
b. A charge of $2,339,000 was taken for the write-off of inventory and fixed assets related to the data transmission business.
c. A charge of $1,012,000 was taken for contractual obligations and settlement costs incurred for leased facilities in Carlstadt, New Jersey, Hong Kong and Malaysia, which will be vacated under the restructuring plan.
d. A charge of $979,000 was taken for computer software related to the data transmission business that was capitalized in accordance with FAS86, which has no realizable value under the restructuring plan.
e. A charge of $436,000 was taken for severance costs associated with employees terminated in connection with the restructuring plan. No such costs were paid as of July 31, 1996.
3. Discontinued Operations
As part of the Company's decision to restructure its business, the Board of Directors decided to sell Electro-Metrics, Inc. ("EMI"), a wholly owned subsidiary which manufactures test equipment and systems for analysis of electromagnetic interference and communications security including applications in satellite communications. As a result of this decision, previously reported financial statements have been restated to reflect EMI as a discontinued operation.
During fiscal 1995, the Board of Directors decided to sell Technipower, Inc ("TPI"), a wholly-owned subsidiary manufacturing uninterruptible power supplies and power regulating equipment. The divestiture of TPI is expected to be completed in fiscal 1997 for $4,300,000. The following table sets forth the selected financial data of both Discontinued OperationS (in thousands):
Year Ended July 31, 1996 1995 1994 ----- ----- ----- Revenues $ 10,469 $ 8,960 $ 11,995 ====== ====== ====== Income (Loss) from operations net of income taxes 404 (1,661) (828) Loss on disposal net of income taxes (640) (1,400) -- ------ ------ ------ Total loss from discontinued operations $ (236) $ (3,061) $ (828) ====== ====== ====== Depreciation and Amortization $ 431 $ 415 $ 472 ====== ====== ====== Capital Expenditures $ 275 $ 245 $ 441 ====== ====== ====== Identifiable Assets at year end $ 10,210 $ 7,950 $ 8,112 ====== ====== ======
Because the Company expects to retain the tax benefits associated with the discontinued operations, no income tax benefit has been recorded for any year.
Net assets of the discontinued operations consist of the following (in thousands):
July 31, 1996 1995 ----- ----- Current assets $ 9,135 $ 6,803 Current liabilities (2,229) (1,395) ----- ----- Net current assets 6,906 5,408
Property, plant and equipment, net 783 849 Other non-current tangible assets, net 60 42 Non-current liabilities (4) (10) ----- ----- Net tangible assets 7,745 6,289 Intangible assets, net 232 256 ----- ----- 7,977 6,545 Estimated loss on disposal (640) (1,400) ----- ----- Net Assets of Discontinued Operations $ 7,337 $ 5,145 ===== ===== 4. Acquisitions
On May 6, 1993, the Company acquired all of the outstanding stock of Datability, Inc. ("Datability") The acquisition was accounted for by the purchase method, and accordingly, the results of operations of Datability are included in the Consolidated Statements of Operations from the date of acquisition. Datability has been consolidated with the Company's data communications operations located in Gaithersburg, Maryland.
The acquisition was accomplished through the issuance of 1,050,000 shares of the Company's common stock ("Common Stock"). The purchase price totaled $4,980,000 including acquisition costs of $386,000. At the acquisition date, the purchase price exceeded the fair value of net assets acquired by $8,169,000. Under terms of the agreement, the final purchase price was dependent upon the valuation of the net assets acquired. During fiscal 1994, a valuation adjustment of $829,000 resulted in 124,388 shares of Common Stock being returned to the Company thereby reducing the excess of cost over the fair value of net assets acquired. During the fourth quarter of fiscal 1996, the Company expensed the remaining portion of excess of cost over the fair value of net assets acquired.
5. Financing
Bank Financing: On March 15, 1996 the Company amended the credit agreement with its principal bank. The new agreement provides for a maximum working capital facility of $5,500,000 with borrowings based on qualified accounts receivable and secured by substantially all the Company's assets. Interest accrues at the bank's prime rate plus 2% with a commitment fee of 3/8% assessed on the unused portion of the facility. In the event the facility is canceled prior to its expiration, there is a fee due the bank equal to 3% of the total facility. The agreement expires March 31, 1997. As of July 31, 1996, the Company had $5,412,000 available of which the Company had utilized $4,000,000 for working capital loans and $90,000 for a letter of credit. On June 16, 1996, the Company entered into a Plan and Agreement of Merger, as amended August 5, 1996 (the "Merger Agreement") with Bay Networks, Inc. ("Bay") and a subsidiary of Bay. As part of the Merger Agreement with Bay, outstanding bank debt up to $4,000,000 remains with the Company after the Transfer. Average monthly borrowings and weighted average interest rate for the three years ended July 31, 1996 are as follows (amounts in thousands):
1996 1995 1994 ------- ------- ------- Average monthly borrowings under working capital facility (in thousands) $ 4,353 $ 4,621 $ 1,475
Weighted average interest rate 10.47% 9.6% 7.2%
As of March 7, 1996, the Company had repaid all outstanding term debt with its principal bank.
Subordinated debt: In April 1995, as part of the bank financing arrangements, the Company was permitted to make principal payments on the subordinated debt only after the bank term loans had been reduced by $3,000,000. This reduction was accomplished by December 1995 at which time the Company made a subordinated debt principal payment of $174,000 as required by the amended subordinated debt agreement. The remaining outstanding balance of $805,000 was repaid in May 1996.
Long-Term Debt: Long-term debt at July 31, 1996 and 1995 consisted of (in thousands):
1996 1995 ------ ------ Term Loans $ -- $ 3,848 Subordinated Debt -- 979 ------ ------ -- 4,827 Capital leases and other 905 854 ------ ------ 905 5,681 Less current portion (272) (5,164) ------ ------ Long-term debt $ 633 $ 517 ====== ======
Future maturities of long-term debt are as follows:
Year Ending July 31, 1997 $ 272 1998 261 1999 190 2000 146 2001 36 ------ Total $ 905 ====== 6. Income Taxes
The following table sets forth the differences between the tax provision (benefit) from continuing operations calculated at the statutory federal income tax rate and the actual tax benefit for the three years ended July 31, 1996 (in thousands):
1996 1995 1994 ------ ------ ------ Tax provision at federal statutory rate $ (7,027) $ (1,724) $ 644 Amortization of non- deductible intangibles 1,931 283 283 State & foreign taxes, net of federal benefit (1,137) (218) 236 Utilization of net operating loss carryforward -- -- (1,195) Change in valuation allowance 6,093 1,134 (538) Other 140 (53) 57 ------ ------ ------ Income tax benefit $ -- $ (578) $ (513) ====== ====== ======
The primary components of temporary differences which give rise to the Company's net deferred tax asset are shown in the table below. At July 31, 1996 the Company had consolidated federal net operating loss carryforwards (including EMI and TPI) of approximately $17,200,000 which expires in 2007 through 2011, and general business and other tax credits of $1,248,000 to reduce future tax liabilities through 2009 (in thousands):
As of July 31, 1996 1995 ---- ---- Deferred tax assets: Reserves and other contingencies $ 1,500 $ 1,462 Depreciation and amortization 65 34 Restructuring Reserve 1,859 -- Net operating loss 6,780 2,615 General business and other tax credits 1,248 1,248 Loss on discontinued operations 546 546 Valuation reserve (9,837) (3,744) ------ ------ Total deferred tax assets 2,161 2,161
Deferred tax liabilities: Amortization of technologies (461) (461) ------ ------ Net deferred tax assets $ 1,700 $ 1,700 ====== ======
The deferred tax assets will remain with the Company after the Transfer.
7. Commitments and Contingencies
Pending Transaction: Under the terms of the Merger Agreement, the Company will Transfer all of its remote access products business and any other assets unrelated to its modem business to a newly formed subsidiary, Access Beyond, and then distribute all of the shares of Access Beyond common stock to the Company's stockholders in the Spin-Off. Following the Spin-Off, the subsidiary of Bay will merge with and into Penril, whose primary remaining operations will consist of its modem business, with Penril becoming a wholly owned subsidiary of Bay.
Pursuant to the Spin-Off and merger, stockholders of the Company, as of the appropriate record dates, will receive one share of Access Beyond common stock for every share of Penril common stock held, plus $10 in Bay common stock. The dollar value of Bay shares to be paid is fixed according to an exchange value determined by averaging the closing prices of Bay common stock over a specific period prior to consumation of the merger. In addition to the assets and liabilities related to the modem business, Bay will assume the outstanding bank debt of Penril up to $4,000,000. All cash of Penril on the date of the closing of the transactions will be transferred to Access Beyond.
The transactions are subject to regulatory and the Company's stockholders' approval and certain conditions to closing as set forth in the Merger Agreement. At the time of the consummation of the merger, the Company is responsible for payment of the investment banking fees of approximately $1,300,000 and for change of control payments of approximately $1,300,000 due to certain officers of the Company.
Leased Facilities: The Company leases office and manufacturing facilities and equipment under lease agreements, certain of which are renewable at the Company's option and/or provide for increases in rent related to increases in the Consumer Price Index and other factors. Rent expense for the fiscal years 1996, 1995 and 1994 was $1,673,000, $1,941,000 and $1,754,000 respectively. Approximate aggregate future minimum rentals applicable to operating leases in effect at July 31, 1996 without consideration of the effects of the Spin-Off and Merger are as follows (in thousands):
Year Ending July 31, 1997 $1,720 1998 1,758 1999 1,729 2000 775 2001 633 Beyond 2001 135 ------ Total minimum rentals $6,750 ======
Legal Proceedings: The Company is a party to several material legal proceedings as summarized below. With the exception of the proceeding against Rockwell International Corporation, et. al., and one other legal proceeding incurred in connection with the modem business, all costs, expenses, liabilities and obligations of the litigation will be assumed by Access Beyond in connection with the Spin-Off and all recoveries from such litigation will be realized by Access Beyond; provided, however, that Penril may be deemed to have remained contingently liable for satisfaction of the obligations.
On June 1, 1993 Penril initiated a lawsuit against Standard Microsystems Corp., ("SMC") Massachusetts, Inc., Ashraf M. Dahad and Kwabena Akufo (the "SMC Defendants") in the Circuit Court of Maryland for Montgomery County for breach of contract including, among other things, failure to transfer technology, unfair competition and false representations. Penril sought relief in an aggregate amount of approximately $50,000,000. The SMC Defendants subsequently brought a counterclaim alleging fraud and breach of contract and sought recovery of amounts due under the contract which were alleged to be approximately $1,650,000 in compensatory damages plus unspecified punitive damages. In September 1996, the Company and the SMC Defendants agreed to drop the fraud charges and to settle the contractual dispute. The Company will receive from SMC, in settlement of litigation, $3,500,000, net of legal payments, in the first quarter of fiscal 1997.
On December 24, 1994, Penril filed a complaint against Network Systems Corporation of Minneapolis, Minnesota ("NSC") in the Circuit Court of Maryland for Montgomery County. The litigation arises out of a contract in which Penril agreed to develop certain computer hardware and software to NSC's specifications. Penril alleges breach of contract, fraudulent inducement and defamation and is seeking specific performance, compensatory damages of $2,000,000 and punitive damages of $5,000,000. On March 28, 1995, NSC filed an answer and counterclaim in which NSC alleges negligent misrepresentation, fraud and breach of contract by Penril. NSC is seeking rescission of the contract, restitution of monies paid by NSC to Penril, compensatory damages of $5,000,000 and punitive damages in an unspecified amount. As of July 31, 1996, the litigation was in the discovery stage.
Digital Equipment Corporation ("DEC") has claimed, through a series of written communications, that Penril has violated DEC patents related to DEC LAT technology. Penril has taken the position that Datability, prior to its acquisition by Penril, had a relationship with DEC that involved the development of LAT for which Datability has not collected. Both DEC and Penril have taken the position that it is in the best interests of both parties to work toward a fair resolution. As of July 31, 1996 no formal claims have been filed.
On December 6, 1995, Penril filed a lawsuit against Rockwell International Corporation and U.S. Robotics Access Corporation seeking declaratory, injunctive, and money damage relief by reason of an alleged patent infringement by the defendants. The action was filed in the United States District Court for the District of Maryland. In September 1996, the Company agreed to settle its lawsuit with U.S. Robotics.
The Company is involved in other routine litigation.
Management believes none of the litigation will have a material adverse effect on the Company's financial position or results of operations.
8. Stockholders' Equity
On September 22, 1995, the Company issued an aggregate of 1,465,000 shares of its unregistered common stock to Pequot Partners Fund, L.P., Pequot Endowment Fund, L.P and Pequot International Fund, Inc. (collectively the "Investors") for $7,325,000 in a private transaction. As required by the Purchase Agreement between the Investors and the Company, a shelf registration was filed with the Securities and Exchange Commission which became effective on February 28, 1996. The investors may request one public shelf registration after the three years until the later of September 22, 1999 or 30 days after the Company files its annual report on Form 10-K for the fiscal year ended July 31, 1999. If the Company does not keep the shelf registration effective for the required three years, the Investors are entitled to require the Company to effect up to two public registrations during that time. As part of the transaction, the Company has agreed to increase the Board of Directors of Penril by one and, so long as the Investors collectively own in the aggregate not less than 10% of the issued and outstanding common stock of Penril, the Investors are entitled to fill such vacancy by designating one person to the Board of Directors. In addition, on October 5, 1995, the Company completed the sale of 50,000 shares of its unregistered common stock to Cramer Partners, L.P. for $250,000.
In the second half of fiscal 1996, the Company issued 1,092,267 shares of its unregistered common stock in an unrelated series of private placements which generated $7,425,000.
Serial Preferred Stock: The Company's Serial Preferred Stock may be issued in one or more series. The shares of any series may be convertible into Common Stock, may have priority over Common Stock in the payment of dividends and in the distribution of assets in the event of liquidation or dissolution of the Company, and may have preferential or other voting rights, all as determined by the Board of Directors at the time it approves the series.
Employee Stock Options and Stock Awards: On December 13, 1995, the Company adopted the 1995 Long-Term Stock Option Incentive Plan (the "1995 Plan") to replace the 1986 Incentive Plan which expires on October 8, 1996. The stockholders of the Company approved the 1995 Plan at the Annual Meeting held April 10, 1996. Under the 1995 Plan, which will terminate December 13, 2005, key employees of the Company and its subsidiaries may be granted awards consisting of non-qualified stock options, incentive stock options, and restricted stock awards. The option price of shares of Common Stock will not be less than 100% (110% in the case of incentive stock options granted to optionees holding more than 10% of the voting stock of the Company at the date of grant) of the fair market value of shares of Common Stock on the date of grant. No option will be exercisable more than ten years (five years in the case of incentive stock options granted to optionees holding more than 10% of the voting stock of the Company on the date of grant) from the date it is granted. The Company has reserved 1,000,000 shares for issuance under the 1995 Plan. At July 31, 1996, employees had been granted awards for 70,000 shares.
In the case of a "change in control" of Penril, an option holder will generally have the right, commencing at least five days prior to the "change in control" and subject to any other limitation on the exercise of the option in effect on the date of exercise, to immediately exercise any options in full to the extent not previously exercised, without regard to any vesting limitations. On July 2, 1996 the Company's Stock Option/Compensation Committee (the "Committee") took action which caused all of the outstanding Penril options held by directors and executive officers of Penril to vest.
The terms of restricted stock awards granted under the 1995 Plan are determined at the time of the award. The Company will hold the shares of Common Stock under restricted stock awards until all restrictions lapse and such shares of Common Stock may not be sold or transferred by the employee until such time. The employee must be employed by the Company when the restrictions lapse in order to receive the shares of Common Stock when the restriction's lapse.
On October 8, 1986, the Company adopted the 1986 Incentive Plan (the "1986 Plan"). Under the 1986 Plan, which will terminate on October 8, 1996, key employees of the Company and its subsidiaries may be granted awards consisting of incentive stock options non-qualified stock options, and restricted stock awards. The option price of shares of Common Stock subject to options granted under the 1986 Plan will not be less than 100% (110% in the case of incentive stock options granted to optionees holding more than ten percent of the voting stock of the Company at the date of grant) of the fair market value of shares of Common Stock at the date of grant. No option will be exercisable more than ten years (five years in the case of incentive stock options granted to optionees holding more than ten percent of the voting stock of the Company on the date of grant) from the date it is granted. At July 31, 1996 an aggregate of 964,538 shares of Common Stock were reserved for issuance under the 1986 Plan, of which employees have been awarded grants for 962,951 shares of Common Stock.
In the case of a "change in control" of Penril, an option holder will generally have the right, commencing at least five days prior to the "change in control" and subject to any other limitation on the exercise of the option in effect on the date of exercise, to immediately exercise any options in full to the extent they previously have not been exercised, without regard to any vesting limitations. On July 2, 1996 the Committee took action which caused all of the outstanding Penril options held by directors and executive officers of Penril to vest.
The terms of restricted stock awards ("Stock Awards") granted under the 1986 Plan are determined at the time of issuance and are evidenced by a written restricted stock agreement. Any Stock Awards granted are subject to approval by a majority of all "disinterested directors" as defined in Rule 16b-3 of the General Rules and Regulations under the Securities Exchange Act of 1934.
On October 1, 1992, the Company granted Stock Awards, under the 1986 Plan for an aggregate of 71,220 Common Stock to all employees of the Gaithersburg, Maryland facility. The Stock Awards granted vested over two years and employees had to be employed by the Company when the vested shares of Common Stock were issued. Of the total shares of Common Stock awarded, 53,020 were issued. The Company issued 29,560 shares of Common Stock in October, 1993 which represented 50% of the Stock Awards outstanding on that date and the remaining 23,460 shares of Common Stock on October 1, 1994. Compensation related to the Stock Award Program was amortized over the vesting period.
Non-Employee Director Stock Options: On December 9, 1987, the Company adopted the Non-Employee Directors' Stock Option Plan ("Directors Plan"). Under the Directors Plan an option to purchase 24,000 shares is automatically granted to each non-employee director on the first day of his initial term. In addition, options to purchase shares are automatically granted to each non-employee director on the fifth business day after the Annual Report on Form 10-K is filed with the Securities and Exchange Commission as follows: in each of the first two successive years after the initial grant an option to purchase 6,000 shares is granted, and in each of the next five successive years an option to purchase 3,000 shares is granted. The option price per share of any option granted under the Directors Plan is the fair market value of a share of Common Stock on the date the option is granted. No option will be exercisable more than ten years from the date of grant. An aggregate of 125,333 shares were reserved for issuance under the Directors Plan at July 31, 1996, of which (5) directors have been granted awards for 92,000 shares of Common Stock. On July 2, 1996 the Committee took action which caused all of the outstanding Penril options held by directors and executive officers of Penril to vest.
(1) Number of shares granted under the 1986 Incentive Plan and 1995 Long-Term Incentive Plan. The options are exercisable at prices ranging from $2.31 to $7.875 per share, the fair market value at the date of grant. The Company does not grant SARs.
(2) Includes for fiscal 1996, $300 paid for the benefit of each of the named executives pursuant to the Company's 401(k) Plan, except for Mr. Johnson. Also includes for Mr. Epstein, Mr. Howard, Mr. Johnson, and Mr. Rose, $4,260, $274, $809, and $274 respectively, paid under the Company's Split-Dollar Life Insurance Program and for each of the named executives, $8,515, $210, $2,611, $4,172 and $1,749, respectively, paid to the Exec-U-Care Medical Insurance Trust.
(3) Mr. Johnson resigned from the Company in January 1996.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth, as of August 31, 1996, based in part on information provided to the Company by the persons named in the table, the number of shares of Common Stock beneficially owned by each director, each executive officer named in the Summary Compensation Table in Item 11
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
NONE
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements --------------------
Included in Part II of this report:
Independent Auditors' Report
Consolidated Statements of Operations for each of the three years in the period ended July 31, 1996
Consolidated Balance Sheets as of July 31, 1996 and 1995
Consolidated Statements of Cash Flows for each of the three years in the period ended July 31, 1996
Consolidated Statements of Shareholders' Equity for each of the three years in the period ended July 31, 1996
Notes to Consolidated Financial Statements for the years ended July 31, 1996, 1995, and 1994
(a) 2. Financial Statement Schedule -----------------------------
Included in Part IV of this report:
Independent Auditors' Report on Schedule Schedule II -Valuation and Qualifying Accounts
Other schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the Financial Statements or notes thereto.
3. Exhibits
The exhibits are set forth on the attached Exhibit Index which is incorporated by reference. Exhibits are included only in the copies of this Form 10-K filed with the Securities and Exchange Commission and NASDAQ.
4. Reports on Form 8-K
On June 18, 1996 the Company filed a report on Form 8-K reporting on plans to Spin-Off the Access Beyond unit to stockholders and the signing of a definitive merger agreement with Bay Networks, Inc. and Beta Acquisition Corp.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Penril DataComm Networks, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PENRIL DATACOMM NETWORKS, INC.
By:\s\Henry D. Epstein ------------------------------ Henry D. Epstein President, Chief Executive Officer, and Chairman of the Board of Directors Date: October 7, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated:
\s\Norman G. Einspruch \s\Henry D. Epstein - --------------------------- ------------------------------ Norman G. Einspruch, Henry D. Epstein, Director Chief Executive Officer and Date: October 7, 1996 Chairman of the Board of Directors Date: October 7, 1996
\s\John P. Lowe, Jr. - --------------------------- John P. Lowe, Jr., Director \s\Ronald A. Howard Date: October 7, 1996 ------------------------------ Ronald A. Howard, Director and Executive Vice President Date: October 7, 1996 \s\Richard D. Margolis - --------------------------- Richard D. Margolis, Director \s\Richard D. Rose Date: October 7, 1996 ------------------------------ Richard D. Rose Vice President and Chief Financial Officer \s\Michael H. Newlin Date: October 7, 1996 - --------------------------- Michael H. Newlin, Director Date: October 7, 1996
\s\Howard M. Schneider - --------------------------- Howard M. Schneider, Director Date: October 7, 1996
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders Penril DataComm Networks, Inc. Gaithersburg, Maryland
We have audited the consolidated financial statements of Penril DataComm Networks, Inc. and subsidiaries as of July 31, 1996 and 1995, and for each of the three years in the period ended July 31, 1996, and have issued our report thereon dated September 6, 1996 (September 20, 1996 as to the sixth and ninth paragraphs of Note 7), which report is included herein. Our audits also included the financial statement schedule of Penril DataComm Networks, Inc., listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
\s\Deloitte & Touche LLP
Washington, D.C. September 6, 1996 (September 20, 1996 as to the sixth and ninth paragraphs of Note 7)