UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1998
Commission File Number 0-21369
VITECH AMERICA, INC
(Exact name of registrant as specified in its charter)
FLORIDA 65 041 9086
- ------------------------ ------------------------
(State of incorporation) (I.R.S. Employer ID No.)
8807 Northwest 23rd Street
Miami, Florida 33172-2419
(Address of principal executive offices, zip code)
(305) 477-1161
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. _X_
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of March 31, 1999 was approximately $25 million.
As of March 31, 1999 there were 14,635,655 shares of the Common Stock
of the Company, no par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Specifically identified portions of the Company's Proxy Statement to be
filed for the registrant's 1998 Annual Meeting of Shareholders are incorporated
by reference into Part III of this report.
<PAGE>
PART I
ITEM 1. BUSINESS
The Company
Vitech America, Inc. and subsidiaries (the "Company") are engaged in
the manufacture and direct marketing of PCs and related products, business
systems integration products and turn-key business solutions, as well as the
financing of the purchase thereof, in the Federal Republic of Brazil. The
Company's principal operations are conducted in Brazil by its Brazilian
subsidiaries. The parent company, Vitech America, Inc., is based in Miami,
Florida and sources components in the United States and throughout the world and
engages in the distribution of those components to its subsidiaries'
manufacturing operations in Brazil. Substantially all of the Company's revenues
have been recognized in Brazil by the Company's subsidiaries. The Company's
products, which include desktop PCs, notebooks, workstations, network servers,
peripherals, software, business systems integration products and turn-key
business solutions, are marketed under brand names owned or licensed by the
Company directly to end-users through a variety of channels in the Brazilian
marketplace. In addition, the Company maintains an engineering support service
dedicated to assisting customers in effecting networking and systems integration
solutions, and to providing technical support to the end-users of the Company's
products.
Industry Overview
With a population of 160 million people and a GDP of over $750 billion,
Brazil is the fifth largest country in the world (by population) and the largest
in Latin America, measured by both its population and the size of its economy.
As a result of the increasing stability of the economy and the growth of a
middle class in Brazil, demand for PCs and business systems integration products
in Brazil has increased significantly over the last five years. Prior to 1993,
the market for computer products in Brazil was closed to foreign competition,
protected from foreign imports and reserved for Brazilian companies. During this
period of protection, the demand for computers was left largely unfulfilled,
resulting in pent-up demand for computers and other technology products. In
1993, with the opening of the market to foreign competition and the continued
expansion of the middle class, the market for computers in Brazil expanded at
the average annualized rate of approximately 30% on a unit basis through 1998.
The Company believes that the market for PCs and business systems integration
products in Brazil is expected to continue to for at least the next 5 years.
The market for computer products in Brazil is challenged by a basic
lack of infrastructure which prevents the pure "U.S. style" build-to-order
tele-marketing model or "PCs by mail" model from being an efficient distribution
strategy for Brazil. With the direct sales model in the United States, a
customer sees an advertisement in a periodical or on television, calls the
manufacturer or marketer, gives a credit card number, and the machine is shipped
direct via express freight within several days. In Brazil, there are several
infrastructure barriers which prevent the pure U.S. model from being
successfully implemented, including:
o Telecommunications. The telecommunication infrastructure in Brazil is both
inefficient and underdeveloped. With only approximately 12 million
telephone lines for the 160 million inhabitants in Brazil, the lack of
telephone lines is a primary barrier for direct selling in Brazil. This
barrier makes it challenging for a seller of information technology
solutions to maintain the necessary relationships with end-users from a
single centralized location.
o Consumer Credit. The lack of available credit to consumers is a significant
barrier for selling PCs in the consumer markets. There is very low
penetration of credit cards in Brazil, and even less penetration with
sufficiently high credit limits to allow the purchase of major items such
as PCs. In addition, there is a lack of a central credit-reporting bureau
which encompasses factors relating to an individual's credit history which
would allow for a rapid and high-quality credit decision in light of the
lack of credit cards.
o Low installed base of PCs. The installed base of PCs in Brazil is
approximately 40 per 1,000 inhabitants, as compared to approximately 550
per 1,000 in the U.S. and approximately 160 per 1,000 in the countries of
Southern Europe. With such a low installed base, the majority of the growth
of PC sales in Brazil is coming from the first time PC buyer as opposed to
the U.S. where the majority of the growth is coming from the second or
third generation PC buyer. First time PC buyers generally require more
"hand-holding" at the time of sale in order to get comfortable with the
purchase. Direct personal contact at retail shops or by internal sales
persons and external representatives through office or home visits allows
the Company to overcome this barrier. As the market develops, and the
installed base increases, and as credit cards become more widely used, the
pure "U.S. style" build-to-order tele-marketing model will become more
successful in Brazil. The Company allocates sales and marketing resources
on each of its channels according to their
2
<PAGE>
relative success in generating sales. In the future, as one channel such as
telemarketing becomes more effective, the Company will allocate more
resources to that effort.
o Logistics. The underdeveloped transportation infrastructure and the
bureaucratic importation processes in Brazil pose a logistical challenge
for operating in the Brazilian market. Due to the geographic size of Brazil
and its transportation infrastructure, there are not efficient express
delivery services available for delivering products to customers from a
centralized distribution point. Additionally, since principally all of the
Company's components for its products are sourced directly from component
manufacturers located in the U.S. and in Asia, the transit times and the
bureaucratic importation procedures make it very difficult to operate a
just-in-time manufacturing operation.
Company Strengths
The Company believes that it is particularly well-positioned to
capitalize upon the anticipated growth in Brazil based upon:
o The Company's significant experience in the Brazilian market, including
substantial managerial participation by Brazilian nationals at all levels
of the organization. The Company has successfully used Brazilian nationals
to assist in the adaptation of the direct selling model for the
infrastructure realities of Brazil.
o The Company's knowledge of prevailing customs, importation practices,
technology and labor bases, regional and national tax policies, marketing
dynamics, and economic conditions in Brazil.
o The Company's low-cost manufacturing and quality engineering capabilities
in Brazil. As the market becomes more efficient in Brazil, the Company
believes that its dedication to a low-cost quality manufacturing operation
will become an increasingly important competitive advantage for the
Company.
o The Company's national direct distribution network in Brazil, which enables
the Company to maintain a direct relationship with the end-user in Brazil,
thus overcoming significant infrastructure barriers.
o The Company's ability to provide installment financing alternatives to
customers and generate quality consumer receivables through its established
credit policies and procedures. The Company believes that this program
augments its direct relationship with the end-users of its products and
enables it to expand the market for its products by overcoming a
significant barrier in the market.
o The Company's strong base of corporate and governmental customers resulting
from its acquisition of Microtec Sistemas Industria e Comercio S.A.
("Microtec") in July 1997. The Company's penetration into these markets has
allowed it to diversify its sales and has provided additionally opportunity
for expanding sales in these markets with the Company's business systems
integration solutions.
o The Company's ability to integrate acquisitions as part of its growth
strategy. To date, the Company has successfully integrated acquisitions
that complement the Company's business strategy.
Business Strategy
The Company's business strategy comprises the following:
o Direct Marketing. The Company's strategy is centered around attaining a
direct relationship with the end-users of its products through various
channels including commissioned sales agents, Company owned retail outlets,
focused account teams in government and corporate markets, telemarketing,
and internet commerce. The Company believes that this strategy offers
several competitive advantages. First, the direct sales strategy helps the
Company maintain competitive pricing by avoiding the additional markups and
inventory carrying and occupancy costs associated with traditional third
party distribution and retail channels. Second, working directly with
end-users promotes customer loyalty and fosters brand awareness. Third, the
direct end-user relationships allow the Company to maintain, monitor and
update database information about customers and their current and future
products and service needs, which can be used to shape future product
offerings and support services.
3
<PAGE>
o Brand Development. The Company intends to continue to develop its brand and
trade names in support of its direct marketing efforts. The Company
believes that such efforts will enhance the awareness of the Company's
products among the end-users of information technology and enable the
Company to expand the penetration of its products.
o Consumer Financing. The Company believes that its ability to provide
financing arrangements for its customers has enabled it to expand its
market penetration by overcoming a significant infrastructure barrier in
Brazil. The Company also believes its consumer financing program enhances
the Company's direct relationship with the consumer and provides a
competitive advantage.
o Systems Integration. The Company is dedicated to expanding its market by
providing integrated turn-key business solutions (including computer
hardware, software, networking, and support services) for its corporate and
government customers. In doing so, the Company seeks to widen its market in
Brazil from the estimated $2.5 billion annual market for PCs to the
estimated $8 billion annual market for all information technology
expenditures.
o Leading-Edge Technology. The Company is dedicated to providing leading-edge
information technology solutions to its customers. The Company has
established non-exclusive strategic relationships with the world's leading
information technology developers, including Intel Corp., Microsoft and
Cisco Systems. The Company is currently one of 25 "Vendors of Choice" for
Intel in the world. The Company is one of two companies in Brazil which, in
addition to being a direct Original Equipment Manufacturer ("OEM") supplier
of Microsoft products, is a Microsoft Solutions Provider for database,
network and connectivity solutions utilizing Microsoft technology. The
Company has recently established an international service provider
relationship with Cisco to represent Cisco products in the Brazilian
market. The Company believes that these relationships, together with market
information obtained from its direct relationship with end-users, will
continue to allow the Company to bring leading-edge technology to the
Brazilian market on a timely basis.
o Acquisitions. In an effort to continue to grow its market penetration in
Brazil and elsewhere, the Company will continue to look for strategic
acquisition candidates that complement the Company's strategy.
o New Market Expansion. The Company's growth initiatives include identifying
other countries that have similar infrastructure characteristics to the
Brazilian market. The Company believes that there are opportunities for
adaptation of the Company's business model in the countries of Argentina,
Paraguay, and Uruguay, which, together with Brazil, make up the Mercosul
trade region.
In July 1997, the Company acquired 94.4% of the outstanding capital
stock of Microtec. Based in Sao Paulo, Brazil, Microtec is engaged in the
manufacture and sale of PCs and servers in Brazil. Microtec sells directly to
corporate and government clients and through a nationwide network of over 300
channel partners who represent Microtec's products. Microtec participates
heavily in all levels of governmental bids and public solicitations in Brazil.
As the oldest computer manufacturer in Brazil (founded in 1983), Microtec has
established a brand name recognized for quality products and services in the
Brazilian market. Microtec has extensive experience in the engineering and
design of PCs, and its facility has been granted ISO-9001 process certification
as well as other technical and quality certifications necessary to compete in
governmental bids and public solicitations in Brazil. With a nationwide network
of technical assistance and service centers, Microtec has one of the most
extensive post-sale support systems in Brazil. With Microtec's strong
penetration in the corporate and government markets and the Company's prior
strength in the consumer market, the acquisition has enabled the Company to
broaden its customer base and diversify its sales. In September of 1998, the
Company acquired an additional 4.1% of the outstanding capital of Microtec to
bring the Company's total ownership up to 98.5%.
In furtherance of its business strategy to develop direct relationships
with the end-users of its products, the Company acquired a majority interest in
Tech Shop Holdings, USA, Inc., the parent of Tech Shop, Ltda. and Tech Stock,
Ltda. ("Techshop"), located in Belo Horizonte, Brazil, in November 1997. During
the same month, the Company also acquired a majority interest in Recife
Holdings, USA, Inc., the parent of Rectech-Recife Tecnologia, Ltda. ("Rectech").
The operations of Techshop and Rectech include regional distribution and retail
sales of computers and related equipment in the corporate and consumer markets
in Brazil. The companies are well suited to the Company's strategy of selling
directly to individual consumers as well as corporate clients and governmental
entities, and these subsidiaries add strength to the Company's direct marketing
and support services in the central and northeastern regions of Brazil. In
December of 1998, the Company increased its ownership position of Techshop and
Rectech to 99%.
Products
Computer Systems
The market for the sale of computer products is significant and growing
in Brazil, reflecting an increasing demand for PCs and related products. Until
1993, the market for computer products in Brazil was closed to foreign
competition,
4
<PAGE>
protected from foreign imports and reserved for Brazilian companies. During this
period of protection, the demand for computers in Brazil was left largely
unfulfilled, resulting in pent-up demand for computers and other technology
products. In 1993, however, import restrictions were lifted resulting in the
expansion, at an annualized rate in excess of 30%, of the market for computers
in Brazil. The Company, as a vertically integrated computer manufacturer and
direct marketer based in Brazil, has established a full line of computer
products using Intel processors and Microsoft Windows software, from low-end
workstations to high-end multimedia workstations and powerful multi-processor
servers, in order to meet the increasing demand in Brazil for information
technology solutions. The Company's products include desktop PCs, notebooks,
workstations, network servers, peripherals, software, business systems
integration equipment and turn-key business solutions. The Company offers its
products under the Vision, Mythus, Quest, Spalla and Vesper names.
Business Systems Integration; Client-Server Applications
The Company has created a family of products and services in response
to the need for client-server distributed computing solutions in Brazil. The
Company offers a range of powerful symmetrical multi-processor super-servers.
The Company markets a full line of local area network and wide area network
parts, including bridges, multiplexors, DSU/CSU, buffers, modems, bridges,
routers and wide area networks for system integrators and their customers. As a
developing country migrating from a mainframe system-dominant environment,
Brazil has a large demand for distributed computing solutions through the
establishment of client-server networks in an effort to become more competitive
in the world markets. Many of the Company's system integration customers do not
yet have the expertise to design complex systems. In response, the Company
assembled its own dedicated business systems integration team that supplies
technical expertise to design turn-key business solutions including local area
network or wide area network systems for the Company's corporate and
governmental customers.
Customer Financing
Financing is an important component of the Company's operations. Before
extending credit to a prospective customer, the Company thoroughly analyzes the
credit history and ability to pay of such prospective customer. The Company only
extends credit after performing such credit analysis with respect to each
prospective customer on a case-by-case basis. The Company has developed specific
credit analysis procedures with respect to each individual, business and
government customer.
All installment sales to individual customers are conducted in
accordance with a credit manual (the "Credit Manual") that has been developed by
the Company based upon the Company's experience in the Brazilian market. The
Credit Manual sets forth guidelines and procedures for gathering and confirming
information related to a prospective customer and his, her or its credit
history, and for deciding whether and in what amounts to extend credit to such
customer.
Certain procedures must be followed before the Company may extend
credit. Individuals wishing to make a purchase utilizing installment sale
agreements must fill out a standard form wherein the applicant must specify
certain information, including income, taxpayer registration number, address and
age. The Company also requires that the applicant provide bank references in the
application form. In addition to the information provided in the application,
the Company requires the applicant to provide proof of income or employment,
residence and the identity information issued by the Brazilian government. The
Credit Manual also provides for alternative requirements based on the
applicant's profession and income stream. No credit will be extended to
individuals under the age of 21, or to any applicant that does not produce
evidence that he or she has been employed in the same job and has resided in the
same place for at least one year.
Business entities seeking to finance the purchase of computers and
related products are subject to a credit analysis similar to that undergone by
individual consumers. As with individual consumers, credit applications are
processed and reviewed directly by the Company in accordance with the Credit
Manual. Business customers seeking to make a purchase on credit are required to
fill out a standard form in which they must disclose organizational information,
such as the nature of business, taxpayer registration number, commercial and
banking references and business address. Furthermore, business customers must
also submit copies of various documents to be examined by the credit analysts,
such as financial statements, corporate organizational documents and taxpayer
registration card.
Information about individual and business customers' credit history is
obtained in several ways. The credit analyst will verify the accuracy of the
information provided by the individual or business in the application. Further,
the credit analyst will consult with the local office of the Sistema de Protecao
ao Credito ("SPC"), a credit history database organized by commercial
associations throughout Brazil containing information on local sales. The credit
analyst will also consult SERASA, a centralized database developed by Brazilian
financial institutions that gathers credit history information obtained
5
<PAGE>
through banks, notaries and some commercial associations. To date, however,
there is no centralized credit history database in Brazil that gives a complete
picture of a customers' overall credit history, nor is there any means in Brazil
for independently verifying a consumer's level of indebtedness.
After the information provided by an individual consumer or business
customer has been verified, a credit analyst will have to prepare a report
indicating whether or not credit should be extended to the prospective client.
Depending on the amount of credit being sought by a client, it may be extended
directly by the analyst or it may require additional review by a senior analyst
or a credit committee consisting of senior management.
According to Brazilian law, most of the purchases made by governmental
entities must be conducted through a bidding process. The Company is an active
participant in bidding processes in order to obtain contracts with governmental
entities. Due to the fact that each bidding process is conducted in connection
with a specific invitation to bid, the decision to extend credit to such a
governmental entity and, thus, to present a bid proposal, will vary from case to
case. Because credit history databases generally do not provide extensive credit
information on governmental entities, prior to the presentation of the bid
proposal, the Company will often informally exchange credit information with
companies that had previously extended credit to the governmental entity
conducting the bidding process. Depending on the type of governmental entity,
some limited credit history information may also be available through SERASA.
Finally, the Company will examine whether the payments to be made as a result of
the bidding process are to be included in the budget of such a governmental
entity. The Company will not extend credit to a governmental entity if the
budget of such entity does not expressly include the payments under the bidding
process.
Logistics and Materials Management
Virtually all of the products that the Company purchases are received
and consolidated in containers at the Company's U.S. facility for sea or air
freight to the Company's facilities in Ilheus or Salvador, Brazil. These
destinations contain deep-water ports with modern handling and storage
facilities. The Company is highly-sophisticated in Brazilian customs matters and
is knowledgeable in producing appropriate documentation to expedite customs
clearance and importation of components. Upon receipt in Brazil, the goods are
expedited through customs by Company personnel so that goods spend a minimum
amount of time at the port facility. The Company maintains a fleet of eight
tractor-trailers and a larger fleet of vans and trucks for final delivery to the
Company's distribution points and to end-users.
Operating in the Brazilian market requires dedicated logistics and
materials handling experience in order to overcome the infrastructure challenges
of Brazil and in order to take advantage of the tax incentives afforded to local
manufacturers. The Company maintains an integrated manufacturing requirements
planning system in order to achieve the Company's objective of fulfilling its
manufacturing needs while optimizing its investments in inventory. The Company
sources components directly from major technology manufacturers and distributors
in Asia and the United States. Components are then shipped to the Company's
manufacturing facilities in Brazil on a coordinated basis to allow production
goals to be met in accordance with its sales objectives. The Company's material
requirements planning system allows it to track and control components
throughout the entire procurement process.
Engineering and Manufacturing
The Company has an experienced engineering department comprised of 20
engineers at its facilities in Brazil. The engineering department is responsible
for designing products, producing the technical specifications for components
required for manufacture, training personnel, line engineering, and quality
control/quality assurance programs. The engineering group constructs the bill of
materials of components that are required for manufacture and designs the
manufacturing line so that the tasks can be undertaken reliably within the
capabilities of the Company's specially trained labor force. The group also
supports the sales force and is responsible for the design of local area network
or wide area network systems for the Company's customers and their end users.
The Company's manufacturing facilities consist of a modern 160,000
square-foot leased facility in Ilheus. Management believes that these facilities
will allow the Company to continue to operate at its anticipated capacity levels
for at least the next 12 months. In 1996, the Company began the development of a
new 70,000 square foot manufacturing plant and administrative center in Ilheus.
In 1997, the Company suspended the ground breaking of the new manufacturing
plant, and is currently reevaluating such construction and whether or not it
purchases its present facility in Ilheus. The 160,000 square-foot leased
facility in Ilheus that the Company currently occupies may be available for
purchase through auction and the Company is currently evaluating the purchase
thereof. See "Management's Discussion and Analysis of Financial Condition and
Results of Operation" and See "Item 2. Properties".
6
<PAGE>
Work Force and Training Program
The Company has elected to locate its principal manufacturing
facilities in remote regions of Brazil in order to capitalize on lower costs.
Many of the cities and states in which the Company operates, especially those in
remote regions, do not have sufficient technical educational facilities and,
where such facilities do exist, they are located in areas with higher labor
costs. In response to this lack of technical education, the Company has created
its own technical training program to create a technically adept labor force by
training workers in various technical phases of assembly line manufacturing. The
Company believes that this training will often confront and mitigate cultural
differences that may interfere with an employee's motivation and productivity.
The Company has designed internal training programs that build
technical skills for entry level employees. Entry level employees engage in
assembly work, packing, shipping, and cleaning, and require a great deal of
training and supervision. All of the Company's entry level employees are
compensated at a level in excess of the national minimum wage which is
approximately R$130 per month (or approximately US$76). Technical personnel have
had either technical school or university level training. These workers are
usually upwardly mobile and are recruited either from other companies or
technical schools. Although these technical personnel must be taught specific
work-related skills, they usually come to the Company well-trained. Engineers
are university trained and are generally paid between 5 and 10 times the minimum
wage. See "Item 1. Business - Employees".
Quality Assurance and Service
The Company addresses quality assurance at all stages of the production
process. First, components considered for use in standard systems are tested for
compatibility by the Company's engineering staff. Second, incoming components
receive a physical damage inspection on receipt and again at the start of the
production process. A statistical sampling of components in every category is
electronically tested prior to assembly. Each complete unit is then functionally
tested at the end of the production process to demonstrate that all components
are engaged and fully operational. Thereafter, each complete unit is "burned-in"
for at least three hours. This process involves running a test program which
sequentially tests each component to verify prescribed operation. The Company
has implemented a total quality program at its manufacturing facility in Ilheus,
Bahia and has an ISO-9001 process certification. This program includes training
employees company wide on the processes and methods involved in achieving the
Company's goal of zero defects.
In addition to the total quality control procedure in its production
process, the Company provides post sales technical support for its products.
Such technical support is provided by the Company's national network of sales
agents and by making available engineers and technicians who perform in-house
and local on-site servicing for corporate and government clients. Additionally,
the Company offers, through its newly established call center, its Vision Plus
toll-free telephone support service providing personalized attention to its
customers.
Consumer Electronics
During the years ended December 31, 1997 and 1996, the Company, through
a subsidiary, was engaged as a contract manufacturer of televisions and video
cassette recorders for Casas Bahia, a leading retailer of consumer electronic
products in Brazil. Such sales accounted for approximately 9% and 30% of the
Company's sales during such periods, respectively. The Company also had sales of
PCs to Casas Bahia for the year ended December 31, 1996 which accounted for
approximately 8% of sales. The Company initiated the contract manufacturing of
consumer electronic products in order to utilize excess capacity in its
manufacturing facility. As the Company has expanded the production and sales of
PCs, it has elected to phase out the contract manufacturing of consumer
electronics. As a result, such contract manufacturing business ceased by the end
of the second quarter of 1997. The Company has continued, however, to
manufacture consumer electronics on a limited basis for direct sale to
consumers. The Company has used consumer electronics as an entry product for the
direct sales of PCs to end-users in certain markets.
Distribution and Marketing
The Company's marketing strategy is centered around attaining a direct
relationship with the end-users of its products through various channels
including commissioned sales agents, Company owned retail outlets, focused
account teams in government and corporate markets, telemarketing, and internet
commerce. The Company believes that this strategy offers several competitive
advantages. First, the direct sales strategy helps the Company maintain
competitive pricing by avoiding the additional markups and inventory carrying
and occupancy costs associated with traditional third party
7
<PAGE>
distribution and retail channels. Second, working directly with end-users
promotes customer loyalty and fosters brand awareness. Third, the direct
end-user relationships allow the Company to maintain, monitor and update
database information about customers and their current and future products and
service needs, which can be used to shape future product offerings and support
services. The Company, operating through its sales and marketing teams, has
built a national direct distribution network for Brazil. This distribution
network includes access to large markets in Brazil for computer systems and
business systems integration products. Customers include small and medium-sized
businesses, large corporations, government agencies, major retailers, and
consumers.
The Company's primary channels of distribution are as follows:
o Sales Agents. Sales agents located throughout Brazil represent the
Company's products to end-users for a commission equal to approximately 12%
of the sales price of the product. These former value added resellers are
consigned merchandise which in turn is billed to the end-user directly by
the Company, after credit approval process is completed by the Company's
central credit processing operation. The agent is responsible for providing
a full-coverage service warranty for the Company for the duration of the
warranty on the product. As a result of this synergistic relationship, the
sales agent is incentivised to work with the Company and its products
because (i) a layer of valued added tax and federal sales tax is eliminated
to allow for a more competitively priced product, (ii) the sales agent's
inventory carrying cost is eliminated, allowing for more working capital
for selling activities, and (iii) the agent avoids most credit risk. The
Company, in turn, benefits from this relationship because (i) it allows for
a direct relationship for the Company with the end-user, (ii) it allows for
Company controlled inventory, (iii) it allows the Company to control its
credit quality and reduce its credit exposure, and (iv) it allows for a
reduction of value added and sales taxes thereby reducing the end-user
price and increasing margins for the Company. The resulting network of
agents make up the Company's national network of warranty service centers,
able to support the end-users in nearly all locations in Brazil. The
Company currently has 70 active sales agents.
o Network Representatives. Network representatives, working through regional
managers who control 60 regions covering all of Brazil, sell house-to-house
and office-to-office. This strategy enables the Company to have direct
contact with end-users, and allows for the efficient gathering of credit
information and administration of the sales process in remote areas where
the 70 active sales agents do not have adequate penetration. These network
representatives work on a strict commission basis and use the 70 active
sales agents as sources of stock for immediate delivery as well as for
technical assistance and warranty service. There are currently in excess of
500 active network representatives. Prior to becoming active, all of the
Company's network representatives participate in a sales and technical
training program administered by the Company and designed to insure a
marketing presentation that is consistent with the Company's quality and
standards.
o Direct Sales Teams. The Company has established a systems integration sales
team that is focused on selling the Company's products directly to
corporate and governmental customers. Systems integration is one of the
leading growth areas in the country. The Company has invested in creating a
staff of 48 internal sales, support, technical, and engineering
professionals to handle the design, quotation, build, installation and
support of high-end network systems and turn-key business solutions based
on the Windows-NT Cluster applications, Intel symmetrical processing server
technology, and Cisco IP networking technology. In addition, the Company
participates in a wide variety of government and corporate bids. The
Company also uses outside consultants to administer such bid processes.
With the addition of Microtec, which participates heavily in this market,
the Company expects to expand its activities in this area.
o Company Owned Retail Stores. In order to enhance the Company's relationship
with the end-user, the Company has established its own retail stores in
important strategic markets in Brazil. The Company believes that these
stores are an important part to overcoming the infrastructure barriers in
Brazil and establishing a direct relationship with the end-users of the
Company's products. The Company currently owns 15 stores within its retail
network in Brazil and has a further ten stores operated by independent
agents of the Company and where the principal products sold are the
Company's products. In addition to facilitating direct sales to end-users,
these stores serve as important regional distribution and support centers.
o Telemarketing. Telemarketing is a program established in 1997 to sell the
Company's products direct to consumer end-users and to market the Company's
products to small resellers. In addition to generating sales to end-users,
this channel also serves as a lead-generator for sales agents, network
representatives, and the corporate sales staff. The Company is also using
this program as a test-bed for specific sales programs and promotions. The
telemarketing call center, which currently has 30 telephone operators, is
also integrated with the Company's technical assistance hotlines.
8
<PAGE>
o Internet Sales. In 1998, the Company launched its Internet site for selling
its computers. The web site was designed specifically for the Brazilian
market allowing for high speed interactive information research and product
purchases over the existing telecommunications infrastructure in Brazil.
The web site offers clear informational product presentations, fast page
download and site navigation considering the bandwidth limitations in
Brazil, security for online purchases, and online post-sales technical
support.
o Third Party Retail and Franchising. Retail is the traditional method used
to penetrate a consumer product market. The Company currently has
approximately 300 active clients, including the 10 largest department
stores in Brazil. This channel, as a percentage of the Company's total
sales, is expected to play a smaller role in the Company's sales as the
Company's strategy of implementing direct channels is developed and
enhanced. The Company has developed a concept for a small scale PC and
information technology retail store called Mr. Micro. The Company is
currently exploring the opportunity for franchising such concept nationally
in Brazil.
The Company presently has 25 employees in its Sao Paulo facility with
the responsibility of marketing new product lines, receiving input on existing
product lines and making sales calls. In addition, they are responsible for
accepting, processing and administering sales orders and coordinating
advertising and logistics of product shipment.
Tax-Exempt Status
The government of the State of Bahia, Brazil has issued a decree that
exempts companies such as the Company's subsidiary, Bahiatech - Bahia Tecnologia
Ltda. ("Bahiatech"), from the payment of state import duties, state sales tax,
and state services tax. Bahiatech has received an exemption from such taxes
through and including the year 2003. Additionally, Bahiatech is exempted from
the payment of Brazilian federal income tax through and including the year 2004,
provided that the Company meets certain budgeted production goals. Based upon
the Company's experience in Brazil, it believes that it will be able to renew
both its state and federal tax incentives, although no assurances can be give
that the Company will be able to successfully renew such initiatives. The
Company is not exempted from the payment of a federal social contribution tax of
approximately 8% of pre-tax income. The normal rate of federal taxation on a
non-exempt basis is 33%. In the event that the Company is unable to extend such
tax-exempt status, the Company's after-tax earnings as a percentage of sales
would decline by the amount of the tax benefit, which may be substantial. See
"Risk Factors - Expiration of Tax-Exempt Status".
In December of 1997, as a result of the Company's plan to consolidate
the manufacturing operations of Microtec by relocating it to the State of Bahia,
Microtec applied with the State of Bahia and the federal government of Brazil
for the same tax incentives that have been granted to Bahiatech. Microtec has
been granted the state tax incentives from the state of Bahia and will enjoy
such state tax holiday through 2005. Should Microtec be granted the federal
incentive, it would enjoy the federal income tax holiday through 2007. While the
Company believes that Microtec will be granted such incentive, there is no
assurance that Microtec's eligibility will be approved.
Competition
The manufacturing and distribution of computer equipment and related
products is highly competitive and requires substantial capital. The Company
competes with, and will compete with, numerous international, national, and
regional companies, many of which have significantly larger operations and
greater financial, marketing, human, and other resources than the Company, which
may give such competitors competitive advantages, including economies of scale
and scope. Competitors include internationally recognized companies such as IBM,
Acer, Dell, Hewlett Packard and Compaq. Additionally, the Company competes with
internationally recognized systems integrators such as IBM, EDS and Unisys.
Competition is based on price, product quality, customer support and the ability
to deliver products in a timely fashion. No assurance can be given that the
Company will successfully compete in any market in which it conducts or may
conduct operations.
In addition, the Company competes with other small manufacturers of
computer equipment sold on what is known as the "gray market" in Brazil. Such
manufacturers are able to sell such equipment at prices that are often
significantly lower than those offered by the Company and other legitimate
manufacturers. Gray market manufacturers are able to offer lower prices because
of the avoidance of import duties and other taxes, and the avoidance of
necessary software licensing fees. There can be no assurance that gray market
activity will not continue to flourish putting downward pressures on the
Company's profit margins as result of low pricing strategies.
9
<PAGE>
Technology Acceptance Corp.
In April 1998, the Company entered into an accounts receivable
financing program with Technology Acceptance Corp. ("TAC"), an independently
owned special purpose corporation, whereby Bahiatech may sell certain of its
accounts receivable to TAC. The program is a $150 million collateralized global
medium term note program whereby TAC may issue notes which are collateralized by
the purchased accounts receivable. TAC is an exempted company incorporated under
the laws of the Cayman Islands. One hundred percent (100%) of TAC's voting
shares are held by a Cayman Islands trust. TAC is a special purpose company that
was established solely to participate in the securitization, to acquire and hold
the designated receivables and to issue collateralized notes under a note
program. TAC has covenanted in the indenture pursuant to which the notes are
issued, not to engage in any activities other than those contemplated by the
indenture. The receivables constitute the principal asset of TAC.
During the year ended December 31, 1998, the Company completed the sale
of an aggregate face amount of approximately $140 million of its accounts
receivable to TAC at a discount of approximately $7.5 million for cash and a
subordinated debenture. The subordinated debenture is a revolving,
non-interest bearing, bearer note, which constitutes the Coompany's retained
interest in the program
The receivables arise out of sales of computer equipment and related
products, and, to a lesser extent, from the sale of consumer electronics
products by Bahiatech and by other Brazilian subsidiaries of the Company. The
receivables consist of installment sale agreements, in which the originator
retains a security interest in the equipment until the final installment has
been paid in full, and trade acceptance bills arising from sales to corporate
and governmental customers in the Brazilian market. In the case of installment
sale agreements, each installment constitutes a separate receivable. For
purposes of the TAC program, the receivables are classified into three
categories: (i) installment sale agreements accompanied by the delivery of
post-dated checks signed by the obligor, corresponding to each scheduled
installment with maturities up to twenty-four months; (ii) installment sale
agreements, accompanied by a promissory note, in which the obligor receives
payment coupons prior to each due date, such coupons payable over a period of up
to twenty-four months; and (iii) trade acceptance bills of corporate and
governmental obligors, with an average maturity of 60-70 days. The Company's
other Brazilian subsidiaries have other classes of receivables not relevant to
the issuance of the notes or the TAC program. Before extending credit to a
prospective customer, the Company's Brazilian subsidiaries thoroughly analyze
the credit history of such prospective customer. Credit is extended only after
performing such credit analysis with respect to each prospective customer on a
case-by-case basis. Bahiatech has developed specific credit analysis procedures
with respect to each of the three categories of customers described above.
The purchased receivables are subject to the following concentration
limits: (i) the sum of outstanding stated amounts of receivables in the
receivables pool due from any individual consumer may not exceed $5,000, (ii)
the sum of the outstanding stated amount of receivables in the receivables pool
from any single corporation, partnership or governmental entity may not exceed
five percent (5%) of the aggregate outstanding stated amount of the receivables,
and (iii) the sum of the outstanding stated amounts of receivables in the
receivable pool due from corporate, partnership and governmental interests or
corporations may not exceed fifty percent (50%) of the aggregate outstanding
stated amount.
The notes were offered by TAC with maturities ranging from three months
to three years. Each series of notes will have terms as may be specified in a
supplement relating to such series. Such terms will include (i) the issue date
and maturity date, (ii) the principal amount of such series, (iii) the interest
rate, (iv) the interest payment dates, and (v) a sinking fund payment schedule.
Maturities may range from sixty days to three years. The notes may be issued on
a discounted, non-interest bearing basis or on a fixed rate basis or any
combination thereof.
There is a repurchase provision whereby Bahiatech is required to
repurchase the receivables sold to TAC under certain circumstances, including
default under the program, delinquencies or violations of certain concentration
limits. The repurchase obligation may be satisfied by transferring to TAC, for
no additional consideration, an aggregate amount of additional receivables the
net present value of which is equal to the repurchase price. If the net present
value of the receivables available to Bahiatech to affect such substitution is
less than the repurchase price thereof, then Bahiatech will be required to pay
in cash the excess of the repurchase price over the net present value of the
additional receivables transferred to TAC pursuant to such substitution. Vitech
serves as guarantor of the repurchase obligation. If Bahiatech fails to comply
in full with its repurchase obligation on or prior to the required repurchase
date, Vitech is required to deposit, within twenty-four hours of the expiration
of the required repurchase date, the amount of the repurchase price not paid by
Bahiatech.
Unibanco-Uniao de Bancos Brasileiros S.A., the arranger of the sale and
notes program, is the third largest private bank in Brazil. The Bank of New York
is the trustee, paying and transfer agent and registrar for the notes, and Banco
10
<PAGE>
Credibanco S.A. is the Brazilian collateral agent. See "Management's Discussion
and Analysis of Financial Condition and Results of Operation - Liquidity and
Capital Resources".
In January 1999, the Brazilian government allowed its currency, the
Real, to trade freely against other foreign currencies, which resulted in an
immediate devaluation of the Real against the U.S. dollar. With the post
devaluation exchange rates of the Real to the U.S. dollar the overcollateral
ratio fell below its required minimum which caused trigger and default events,
as defined, of the TAC program. As a result, the Company is currently not
selling any of its accounts receivable to TAC, and may not, other than pursuant
to its repurchase obligation.
TAC has made a proposal to the holders of TAC notes for temporary and
permanent adjustments to the structure of the TAC program inorder to allow the
TAC program to operate more effectively in the post devaluation environment.
While the Company continues to believe that TAC could continue to be a viable
financing source, should TAC fail to gain consensus among the holders of TAC
notes concerning its proposal or should the macroeconomic conditions fail to
recover, then the Company may choose not to sell any additional accounts
receivable to TAC, other than pursuant to its repurchase obligation.
Backlog; Unfulfilled Contract Manufacturing Obligations
The Company's backlog through fiscal year end as of December 31, 1998
was approximately $13.4 million. The Company expects to ship its entire current
backlog within the Company's current fiscal year. Variations in the magnitude
and duration of contracts received by the Company and customer delivery
requirements may result in substantial fluctuations in backlog from period to
period. Since customers may cancel or reschedule deliveries, backlog may not be
a meaningful indicator of future financial results.
Regulation and Environmental Matters
The Company believes that its facilities and practices for controlling
and disposing of the limited amount of wastes it produces are in compliance with
applicable environmental laws and regulations in Brazil.
Trademarks
The Company's products are marketed and sold under Company-owned
trademarks, including Vision and Microtec's Mythus, Quest, Spalla, Vesper and
Mr. Micro.
Employees
As of December 31, 1998, the Company employed approximately 900
persons, including 3 executive officers, 20 executive personnel, 20 engineering
personnel, and 120 administrative personnel. The Company believes that its
employee relations are satisfactory. See "Item 1. Business - Work Force and
Training Program".
ITEM 2. PROPERTIES
The Company's corporate headquarters are located in Miami, Florida. The
Company leases, from an unaffiliated landlord, approximately 16,000 square feet
of office and warehouse space in Miami. The office and warehouse space lease
expires in August 1999, and the Company is currently securing a lease on a new
facility. The Company pays annual rent of approximately $102,000 plus its
allocable share of real estate taxes, insurance, and other assessments.
The Company's Brazilian operations are centered in the states of Sao
Paulo and Bahia. The Company leases approximately 15,000 square feet of office
space in Sao Paulo for an annual rent of approximately $127,000. The lease on
such property expires in April 2000. The Company leases an additional 15,000
square feet of office space in Sao Paulo for an annual rent of approximately
$132,000. The lease on such property expires in December 2000. The Company
leases approximately 160,000 square feet of manufacturing and administrative
space in Ilheus for an annual rent of approximately $157,000. Such lease expires
in May 2000. In addition, the Company leases warehouse and retail space in
Recife and Belo Horizonte.
The Company believes that in the event that the lease with respect to
any of the aforementioned facilities should not be renewed, alternative space
will be available at comparable rates.
11
<PAGE>
In 1996, the Company began the development of a new 70,000 square foot
manufacturing plant and administrative center in Ilheus. The leased
manufacturing facility in Ilheus that the Company currently occupies may be
available for purchase through auction and the Company is currently evaluating
the purchase thereof. In 1997, the Company suspended the ground breaking of the
new manufacturing plant while evaluating the purchase of its present facility.
See "Business - Engineering and Manufacturing".
In addition to the facilities discussed above, the Company owns, for
investment purposes, two undeveloped parcels of land near Ilheus. The Company
does not plan to make material capital expenditures or improvements with respect
to this property during the next fiscal year.
Legal Proceedings
The Company has been named in a lawsuit in the United States by IBM
relating to TNT Systems, Inc., a business in which Georges C. St. Laurent III,
the Company's Chairman of the Board and Chief Executive Officer, was a 60%
shareholder and which ceased operations in 1993. The Company believes that the
IBM lawsuit is frivolous and without merit and is not likely to have a material
adverse effect on the Company's financial conditions or results of operation.
Additionally, Georges C. St. Laurent III has agreed to indemnify the Company
against any and all claims having to do with these lawsuits or others that may
arise from the past operations of businesses owned by Georges C. St. Laurent
III. William C. St. Laurent has also agreed to indemnify the Company against any
and all claims having to do with lawsuits that may arise from the past
operations of businesses owned by William C. St. Laurent.
On October 28, 1995, Meris Financial Incorporated ("Meris") entered
into a Loan Agreement with the Company pursuant to which Meris made available a
loan to the Company in the principal amount of US$ 2,000,000. The loan was to
mature on October 28, 1997 and bore interest at a rate of 12% per annum payable
monthly. The loan was secured by the assets of the Company exclusive of
inventory and receivables. In connection with the loan, Meris received a
guarantee by Georges St. Laurent III and William C. St. Laurent, the President
and Chief Operating Officer of the Company, and his wife, Wendy St. Laurent, a
stock pledge agreement by such parties, a collateral assignment of various
rights of the St. Laurents as well as assignments of life insurance policies on
the lives of Messrs. St. Laurent and St. Laurent. The note was convertible into
approximately 4.7% of the shares of the Company's common stock. In addition,
certain options were provided to Meris which afforded them the right to purchase
up to an aggregate of 5% capital stock interest in the Company. On July 20,
1996, the Company and Meris entered into an Amendment of such Loan Agreement
pursuant to which the Company was obligated to make principal and interest
payment during the period between July 20, 1996 and by November 1, 1996, with
the remaining principal balance to be paid on November 1, 1996. In connection
with the Amendment, the conversion rights provided by the Note and the options
were cancelled provided all payments of principal and interest under the Note
are made as set forth above. The Company made all payments in accordance with
such Amendment and on October 30, 1996, repaid the note in full. In February of
1998, Meris filed a UCC-3 in favor of the Company releasing any claim that Meris
had on the assets of the Company as a result of a UCC-1 filed when Meris entered
into the Loan Agreement with the Company.
In October 1996, Meris had advised the Company that, irrespective of
the Amendment, it believed it had certain rights to an equity ownership position
in the Company. In June 1998, Meris filed a law suit with the United States
District Court in Arizona affirming such claim against the Company. While the
Company believes such claims are without merit, Georges C. St. Laurent III and
William C. St. Laurent have agreed to settle such equity claims, should the need
arise, from their personal share holdings. Any expense associated with defending
such a claim will be incurred as an expense by the Company.
Other than as discussed above and other than in the ordinary course of
its business, the Company knows of no other litigation or claims pending,
threatened, or contemplated to which the Company is or may become a party.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's stockholders,
through the solicitation of proxies or otherwise, during the fourth quarter of
fiscal 1998.
12
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
The Common Stock of the Company is traded on The Nasdaq National Market
tier of The Nasdaq Stock Market under the symbol: VTCH3. The following table
sets forth, for the period indicated, the high and low sales price for the
Common Stock as reported in the consolidated transaction reporting system. The
information set forth in this table has been adjusted to reflect a 10% Common
Stock dividend that was distributed on July 27, 1998.
HIGH LOW
---- ---
FISCAL YEAR 1997:
Quarter ended March 31 $ 14.55 $ 7.39
Quarter ended June 30 $ 17.84 $ 8.41
Quarter ended September 30 $ 16.02 $ 12.73
Quarter ended December 31 $ 20.91 $ 12.73
FISCAL YEAR 1998:
Quarter ended March 31 $ 17.16 $ 13.41
Quarter ended June 30 $ 19.25 $ 14.77
Quarter ended September 30 $ 21.25 $ 7.50
Quarter ended December 31 $ 18.00 $ 8.25
Holders
As of March 1, 1999 there were approximately 2,411 holders of record of
the Common Stock.
Dividends
On June 15, 1998, Vitech declared a 10% Common Stock dividend. The
dividend was distributed on July 27, 1998 to holders of record of the Common
Stock as of July 13, 1998. Other than this dividend, Vitech has not declared or
paid any dividends on the Common Stock since inception nor does it intend to pay
any cash dividends to its shareholders in the foreseeable future. The Company
currently intends to reinvest earnings, if any, in the development and expansion
of its business. The declaration of dividends in the future will be at the
discretion of the Board of Directors and will depend upon the earnings, capital
requirements, and financial position of the Company, general economic
conditions, and other pertinent factors.
At December 31, 1998 and 1997, shareholders' equity consisted of
$46,335,016 and $27,874,495, respectively, in retained earnings generated from
the operations of the Company's subsidiaries. Of these amounts, $46,631,976 and
$26,941,252, respectively, were generated from the operations of Bahiatech.
Bahiatech is exempted from the payment of certain Brazilian federal income taxes
through and including the year 2004, provided that the Company meets certain
budgeted production goals. Under current Brazilian law, tax exemption benefits
cannot be distributed as dividends to Vitech in U.S. Dollars and are segregated
for capital reserves and offsetting accumulated losses. For the years ended
December 31, 1998, 1997 and 1996 the tax exemption benefits amounted to
approximately $5,600,000 ($0.42 per share), $3,000,000 ($0.25 per share) and
$2,200,000 ($0.22 per share), respectively. See "Risk Factors - The Effect of
Volatility on the Repatriation of Excess Retained Earnings Through the Floating
Rate Market", and "Business - Tax-Exempt Status".
For the foreseeable future, Bahiatech does not intend to distribute any
excess retained earnings to Vitech, but intends to reinvest such earnings, if
any, in the development and expansion of its business. In the future, however,
should Bahiatech wish to remit retained earnings in excess of the tax exemption
benefits in U.S. Dollars, it may do so only in Reais convertible into U.S.
Dollars at the Floating Market Rate. There are two legal foreign exchange
markets in Brazil: the Commercial Market Rate and the Floating Market Rate. The
Commercial Market Rate is the commercial selling rate for Brazilian currency
into U.S. Dollars, as reported by the Central Bank. The Floating Market Rate
generally applies to transactions to which the Commercial Market Rate does not
apply. Prior to the implementation of the Real Plan, the Commercial Market Rate
and the Floating Market Rate differed significantly at times. Since the
introduction of the Real, the two rates have not differed significantly.
However, there can be no assurance that there will not be significant
differences between the two rates
13
<PAGE>
in the future. Both the Commercial Market Rate and the Floating Market Rate are
reported by the Central Bank on a daily basis.
In order for a company to remit retained earnings abroad in U.S.
dollars at the Commercial Market Rate, Brazilian law first requires the
registration of the foreign capital upon which those retained earnings were
made. Bahiatech has not made such registration and therefore is only able to
remit excess retained earnings at the Floating Market Rate. The Company uses the
Commercial Market Rate for the translation of Bahiatech's results into U.S.
Dollars. In the event that Bahiatech remits excess retained earnings at the
Floating Market Rate, there can be no assurance that such remittance will not
vary from the Company's reported results because of the differences between the
Commercial Market Rate and the Floating Market Rate. Although Microtec does not
currently intend to distribute any retained earnings to Vitech, it is eligible
to remit retained earnings in U.S. Dollars at the Commercial Market Rate. See
"Risk Factors - The Effect of Volatility on the Repatriation of Excess Retained
Earnings Through the Floating Rate Market", "Management's Discussion and
Analysis of Financial Condition and Results of Operation" and "Exchange Rates".
ITEM 6. SELECTED FINANCIAL DATA
Statement of Operations Data:
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------- --------------- ------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Sales $ 195,334,579 $ 117,537,403 $ 73,321,398 $ 48,488,996 $ 17,407,363
Cost of sales 115,630,389 76,813,191 53,470,340 39,156,239 16,483,232
Gross profit 79,704,190 40,724,212 19,851,058 9,332,757 924,131
Selling, general and
administrative expenses 41,586,843 18,167,737 8,083,287 1,234,108 505,448
Income from operations 38,117,347 22,556,475 11,767,771 8,098,649 418,683
Interest and financing
expense 17,357,001 6,047,396 2,310,704 328,278 171,743
Foreign currency exchange
losses 1,603,670 2,665,224 547,077 16,229 -
Net income (1) 17,862,012 12,792,261 8,230,588 6,904,834 149,570
Earnings per common
share - Basic 1.36 1.07 0.90 0.78 0.02
Earnings per common
Share - Assuming dilution 1.34 1.06 0.85 0.76 0.02
Balance Sheet Data:
<CAPTION>
As of December 31,
---------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------- --------------- ------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Current assets $ 147,179,591 $ 121,939,015 $ 41,959,441 $ 21,267,881 $ 7,595,246
Working capital 70,174,161 82,555,097 31,873,405 6,412,154 403,181
Total assets 195,666,975 155,504,902 47,376,586 22,260,817 7,692,321
Long-term liabilities 16,440,190 61,085,153 1,757,367 0
0
Total liabilities 93,445,620 100,469,071 11,843,403 14,855,727 7,192,065
Shareholders' equity (1) 102,221,355 53,608,389 35,533,183 7,405,090 500,256
</TABLE>
- --------------
(1) Restrictions presently exist on the ability of Bahiatech to distribute
retained earnings. See Part II, Item 5 "Dividends" and the Notes to the
Company's Financial Statements contained elsewhere in this report.
14
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
information contained in the Consolidated Financial Statements and the Notes
thereto appearing elsewhere in this report.
Results of Operations
The following table sets forth for the periods indicated certain line
items from the Company's statement of income as a percentage of the Company's
consolidated net sales:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------------
1998 1997 1996
-------------------------- ------------------------ ------------------------
<S> <C> <C> <C> <C> <C> <C>
Net sales $ 195,334,579 100% $ 117,537,403 100% $ 73,321,398 100%
Cost of sales 115,630,389 59.2 76,813,191 65.4 53,470,340 72.9
Gross profit 79,704,190 40.8 40,724,212 34.6 19,851,058 27.1
Selling, general and
administrative expenses 41,586,843 21.3 18,167,737 15.5 8,083,287 11.0
Income from operations 38,117,347 19.5 22,556,475 19.1 11,767,771 16.1
Net interest and financing expense 17,357,001 8.9 6,047,396 5.1 2,310,704 3.2
Foreign currency exchange losses 1,603,670 0.8 2,665,224 2.3 547,077 .8
Net income $ 17,862,012 9.1% $ 12,792,261 10.9% $ 8,230,588 11.2%
</TABLE>
Year Ended December 31, 1998 Compared to the Year Ended December 31, 1997
Net sales increased by $77.8 million, or approximately 66%, to $195.3
million for the year ended December 31, 1998, as compared to $117.5 million for
the year ended December 31, 1997. For the year ended December 31, 1998, the
Company sold approximately 110,000 PC units as compared to approximately 72,000
PC units during the year ended December 31, 1997. Such increase in sales (both
in dollars and in PC units sold) was primarily attributable to the acquisition
of Microtec, increased demand by the Company's customers, the expansion of the
Company's direct end-user sales strategy and the expansion of the Company's
sales through new channels and into new markets. The acquisition of Microtec,
which was completed in July 1997 and accounted for under the purchase method of
accounting, has enabled the Company to expand into the corporate and
governmental markets offering complete integrated solutions from high-end
network servers to low-end workstations. Additionally, the acquisitions of two
retail and distribution operations in the fourth quarter of 1997 strengthened
the Company's direct relationship with end-users in the consumer market.
Cost of sales during the year ended December 31, 1998 were $115.6
million, representing 59.2% of sales during the period, as compared to $76.8
million for the year ended December 31, 1997, representing 65.4% of sales for
the period. The decrease in cost of sales as a percentage of sales during the
year ended December 31, 1998, when compared to the year ended December 31, 1997,
was attributable to the expansion of the Company's end-user sales strategy which
has provided the Company with better control over its margins through the
elimination of distribution layers and the retention of pricing power. The
decrease was also attributable to the Company's product mix. As the Company has
expanded into the corporate and governmental markets with integrated network
solutions, there were a higher percentage of networking products, which have a
higher margin, included in its sales mix. Also contributing to the reduction in
cost of sales as a percentage of sales was the Company's reduction of consumer
electronics in its product mix. Contract manufacturing of consumer electronics
represents a lower margin sale than that of the Company's core products, PCs.
The Company phased out the contract manufacturing of consumer manufacturing in
July 1997, and as a result, none of the sales during the year ended December 31,
1998 resulted from such business. During the year ended December 31, 1997,
approximately 9% of the Company's sales resulted from the contract manufacturing
of consumer electronics.
Selling, general, and administrative expenses increased by $23.4
million, or approximately 129%, to $41.6 million for the year ended December 31,
1998, as compared to $18.2 million for the year ended December 31, 1997. The
increase was primarily attributable to the acquisition of Microtec and to the
increased costs associated with expanding the Company's manufacturing capacity
as well as the increase in operating expenses required to meet the demands of
the Company's growth. Selling, general, and administrative expense as a
percentage of sales was 21.3% for the year December 31, 1998, compared to 15.5%
for the year ended December 31, 1997. Such increase was primarily attributable
to the acquisition of Microtec and the incorporation of its selling, general and
administrative expenses into the Company's operations, which more than offset
the Company's increases in sales in percentage terms. Also contributing to the
increase in selling, general, and administrative expenses as a percentage of
sales was the increased marketing expenditures associated with the Company's
direct end-user
15
<PAGE>
sales strategy and the increased operating expenses associated with selling
higher end integrated networking systems. While the level of these expenses in
future years can not be predicted and is dependent in large part upon the
Company's success in implementing its business strategy, management anticipates
that the increased expenses will be offset by the increases in revenues
resulting from the expansion of distribution channels. Additionally, the Company
is implementing certain expense reduction plans as part of its consolidation of
the operations of Bahiatech and Microtec.
Income from operations increased by $15.5 million, or approximately
69%, to $38.1 million for the year ended December 31, 1998, as compared to $22.6
million for the year ended December 31, 1997. Such increase was primarily
attributable to the aforementioned increase in sales and the decrease in cost of
sales as a percentage of sales which more than offset the increase in selling,
general, and administrative expenses. Income from operations as a percentage of
sales increased to 19.5% for the year ended December 31, 1998 from 19.1% for the
year ended December 31, 1997. This increase was primarily attributable to the
aforementioned decrease in cost of sales as of percentage of sales which more
than offset the increase in selling, general, and administrative expenses as a
percentage of sales.
Interest and financing expense increased by $11.4 million, or
approximately 190%, to $17.4 million for the year ended December 31, 1998, as
compared to $6 million for the year ended December 31, 1997. Interest and
financing expense as a percentage of sales increased to 8.9% for the year ended
December 31, 1998 from 5.1% for the year ended December 31, 1997. These
increases were primarily attributable to the Company's increased use of debt
financing and the discount on the sale of accounts receivable to TAC to support
its working capital needs. Additionally, interest and financing expense for the
year ended December 31, 1998 includes a non-recurring charge of $1,079,609
associated with the additional shares given as an incentive for certain holders
of convertible notes to convert their notes early into the Common Stock of the
Company during the third quarter of 1998, and a financing expense of $1,150,000
associated with a put premium for certain convertible notes that were put to the
Company during the fourth quarter of 1998. See "Liquidity and Capital
Resources".
During the year ended December 31, 1998, the Company experienced a
foreign currency transaction loss of $1.6 million, or 0.8% of sales, from the
settlement of certain receivables and payables denominated in the Brazilian
Real. At December 31, 1998, the Commercial Market Rate for the Real was R$1.2090
per US$1.00 as compared to R$1.1164 per US$1.00 at December 31, 1997.
Net income increased by $5.1 million, or approximately 40%, to $17.9
million for the year ended December 31, 1998, as compared to $12.8 million for
the year ended December 31, 1997. The increase in net income was primarily
attributable to the aforementioned increase in income from operations which more
than offset increases in interest and financing expense. Net income as a
percentage of sales decreased to 9.1% for the year ended December 31, 1998 from
10.9% for the year ended December 31, 1997. This decrease was primarily
attributable to the increases in interest and financing expense as a percentage
of sales which more than offset the increase in income from operations as a
percentage of sales.
Net income per common share, assuming dilution, increased by $0.28, or
approximately 26%, to $1.34 for the year ended December 31, 1998, as compared to
$1.06 for the year ended December 31, 1997.
Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996
Net sales increased by $44.2 million, or approximately 60%, to $117.5
million for the year ended December 31, 1997 as compared to $73.3 million for
the year ended December 31, 1996. For the year ended December 31, 1997, the
Company sold approximately 72,000 PC units as compared to approximately 28,000
PC units during the year ended December 31, 1996. Such increase in sales (both
in dollars and in PC units sold) was primarily attributable to the acquisition
of Microtec, increased demand by the Company's customers, the expansion of the
Company's direct end-user sales strategy and the expansion of the Company's
sales through new distribution channels. The acquisition of Microtec, which was
completed in July 1997, has enabled the Company to expand into the corporate and
governmental markets.
Cost of sales during the year ended December 31, 1997 were $76.8
million, representing 65.4% of the sales during the period, as compared to $53.5
million for the year ended December 31, 1996, representing 72.9% of sales for
the period. The decrease in cost of sales as a percentage of sales during the
year ended December 31, 1997, when compared to the year ended December 31, 1996,
was attributable to the expansion of the Company's end-user sales strategy which
has provided the Company with better control over its margins through the
elimination of distribution layers and the retention of pricing power. Also
contributing to the reduction in cost of sales as a percentage of sales was the
Company's reduction of consumer electronics in its product mix. Contract
manufacturing of consumer electronics represents a lower margin sale than that
of the Company's core products, PCs. Sales of consumer electronics to Casas
Bahia represented approximately 9.09% of sales during year ended December 31,
1997 as compared to approximately 30% of sales during the year ended December
31, 1996.
16
<PAGE>
Historically, the Company initiated the contract manufacturing of consumer
electronic products in order to utilize excess capacity in its manufacturing
facility. As the Company has expanded the production and sales of PCs, it has
elected to phase out the contract manufacturing of consumer electronics.
Selling, general, and administrative expense increased by $10.1
million, or approximately 125%, to $18.2 million for the year ended December 31,
1997 as compared to $8.1 million for the year ended December 31, 1996. The
increase was primarily attributable to the acquisition of Microtec and to the
increased costs associated with expanding the Company's manufacturing capacity,
as well as the increase in operating expenses to meet the demands of the
Company's growth. Selling, general, and administrative expense as a percentage
of sales was 15.5% for the year ended December 31, 1997, compared to 11% for the
year ended December 31, 1996. Such increase was primarily attributable to the
acquisition of Microtec and the incorporation of its selling, general and
administrative expenses into the Company's operations, which more than offset
the Company's increase in sales in percentage terms. Also contributing to the
increase in selling, general, and administrative expense as a percentage of
sales was the increase in marketing expenditures associated with the Company's
direct end-user sales strategy. While the level of these expenses in future
years can not be predicted and is dependent in large part upon the Company's
success in implementing its business strategy, management anticipates that
increased selling, general and administrative expense will be offset by the
increases in revenues resulting from the expansion of distribution channels.
Income from operations increased by $10.8 million, or approximately
92%, to $22.6 million for the year ended December 31, 1997 as compared to $11.8
million for the year ended December 31, 1996. Such increase was primarily
attributable to the aforementioned increase in sales and the decrease in cost of
sales as a percentage of sales, which more than offset the increase in selling,
general, and administrative expenses. Income from operations as a percentage of
sales increased to 19.1% for the year ended December 31, 1997 from 16.1% for the
year ended December 31, 1996. This increase was primarily attributable to the
aforementioned increase in sales and decrease in cost of sales as a percentage
of sales, which more than offset the increase in selling, general, and
administrative expenses as a percentage of sales.
Net interest and financing expense increased by $3.7 million, or
approximately 162%, to $6 million for the year ended December 31, 1997 as
compared to $2.3 million for the year ended December 31, 1996. Interest and
financing expense as a percentage of sales increased to 5.1% for the year ended
December 31, 1997 from 3.2% for the year ended December 31, 1996. These
increases were primarily attributable to the Company's increased use of debt
financing and the sale of accounts receivable to support its working capital
needs.
During the year ended December 31, 1997, the Company experienced a
foreign currency exchange loss of $2.7 million, or 2.3% of sales, from the
settlement of certain receivables and payables denominated in the Brazilian Real
and the translation of financial statements from the Real to the U.S. Dollar as
compared to $0.5 million, or 0.8% of sales, during the year ended December 31,
1996. At December 31, 1997, the Commercial Market Rate for the Real was R$1.1164
per US$1.00 as compared to R$1.0394 per US$1.00 at December 31, 1996. At
December 31, 1997, the Company had a net exposure to currency fluctuations of
approximately $68.4 million consisting primarily of cash and accounts receivable
denominated in Reais less payables denominated in Reais.
Net income increased by $4.6 million, or approximately 55%, to $12.8
million for the year ended December 31, 1997 as compared to $8.2 million for the
year ended December 31, 1996. The increase in net income was primarily
attributable to the aforementioned increase in income from operations, which
more than offset increases in interest and financing expense and foreign
currency exchange losses. Net income as a percentage of sales decreased to 10.9%
for the year ended December 31, 1997 from 11.2% for the year ended December 31,
1996. This decrease was primarily attributable to the increases in interest and
financing expense as a percentage of sales and foreign currency exchange losses
as a percentage of sales, which more than offset the increase in income from
operations as a percentage of sales.
Net income per common share assuming dilution increased by $0.21, or
24.7%, to $1.06 for the year ended December 31, 1997 as compared to $0.85 for
the year ended December 31, 1996. The percentage increase in net income per
common share assuming dilution was less than the percentage increase in net
income primarily because of the dilution resulting from the issuance of
2,115,500 shares in the Company's initial public offering in November of 1996 as
well as the issuance of common stock options and warrants.
Hedging Activities
Although the Company's consolidated financial statements are presented
in U.S. Dollars in accordance with U.S. generally accepted accounting
principles, the Company's transactions are consummated in both the Real and the
U.S. Dollar. Inflation and fluctuations in exchange rates have had, and may
continue to have, an effect on the Company's results of
17
<PAGE>
operations and financial condition. Although the Company had used Real futures
and options contracts during 1996, in an effort to hedge against currency risks,
its highest coverage at any one time had only met 20% of its exposure,
consisting of accounts receivable denominated in Reais, net of accounts payable
and other current liabilities denominated in Reais. Currently, the Company is
not engaged in any hedging activities. However, the Company is constantly
monitoring its exposure to currency risks and plans to use hedging activities to
offset currency risks as it deems appropriate. Accordingly, to the extent that
the Company is not adequately hedged against currency risks, any significant
devaluation, such as occurred during the first quarter of 1999, of the Real
relative to the U.S. Dollar could have a material adverse effect on the
Company's operating results.
Liquidity and Capital Resources
The Company's primary cash requirements have been to fund increased
levels of inventories and accounts receivable. Up to the Company's initial
public offering in November of 1996, the Company had historically satisfied its
working capital requirements through cash flow from operations and debt
financing. On November 7, 1996, the Company completed an initial public offering
of securities issuing 2,327,050 shares of the Common Stock for $9.09 per share.
Such offering provided the Company with net proceeds of approximately
$18,000,000 which were used to expand inventory, to expand consumer financing
operations, to expand marketing activities, to repay indebtedness, to increase
manufacturing capacity, and for general working capital purposes. During the
year ended December 31, 1997, the Company continued to use debt and convertible
debt financing to satisfy its working capital requirements. During the year
ended December 31, 1998, the Company used cash generated from operations,
short-term bank borrowings, and accounts receivable financing to finance its
working capital needs.
At December 31, 1998, the Company had a working capital surplus of
$70.2 million compared to $82.6 million at December 31, 1997. This decrease in
working capital was primarily attributable to the increased levels of trade
accounts payable and short-term debt which more than offset the increases in the
increased levels of inventory and accounts receivable
Net cash provided by operating activities for the year ended December
31, 1998 was $348,227 as compared to $24.2 million in cash used by operating
activities during the year ended December 31, 1997. The decrease in cash used
was primarily attributable to the increases in net income, the increase in
accounts payable and the sales of accounts receivable to TAC, which more than
offset the increases in inventories and other assets.
Net cash used in investing activities was $11.1 million for the year
ended December 31, 1998. Such use of cash was primarily related to the purchase
of production equipment associated with the expansion of the Company's
manufacturing capacity, the purchase of computer hardware and software to
support the Company's management information system, the acquisition of
facilities and the purchase of additional interests in subsidiaries.
Net cash used in financing activities was $2.7 million for the
year ended December 31, 1998 and resulted primarily from the repayment of
convertible notes which more than offset the increase in short-term borrowings.
The Company has a revolving line of credit in the amount of $4,000,000
with Eastern National Bank in Miami, Florida, with which the Company maintains
its primary banking relationship. Such line consists of $3,000,000 for working
capital and $1,000,000 for trade finance used to support letters of credit which
the Company may issue to secure purchase obligations. This credit line is
secured by a lien on certain property owned by the Company. The credit line
bears interest at a floating rate equal to prime (currently 8.75%) and
terminates in May 1999. As of December 31, 1998, there was $3,000,000 owed under
the working capital line and $650,000 of exposure under the letter of credit
facility.
As of December 31, 1998, the Company had approximately $22 million in
short-term borrowings from various banks in Brazil with rates of interest
averaging 2% per month and maturing on a revolving basis. As of December 31,
1998, the Company had available approximately $8 million in unused credit
facilities at various banks in Brazil at rates of approximately 2.5% per month
and subject to certain collateral requirements as defined.
On June 26, 1997, the Company completed a private placement of a two
year senior convertible note to Georges C. St. Laurent Jr. ("GSL Jr."), the
father of Georges C. St. Laurent III, the Chairman of the Board and Chief
Executive Officer of the Company, and William St. Laurent, the President and
Chief Operating Officer of the Company, for the principal amount of $10 million.
The note accrued interest at an annual rate of 10% payable monthly and was
convertible into Common Stock, in whole or in part, at the rate of one share of
Common Stock for each $13.64 of principal converted. The proceeds of the note
were used for the acquisition of Microtec and for general working capital
purposes. On July 15, 1998, GSL Jr. converted
18
<PAGE>
such note into an aggregate of 755,333 shares of Common Stock, which included
22,000 shares as an incentive for GSL Jr. to convert such note.
On August 19, 1997, the Company entered into a loan agreement with GSL
Jr. for a principal amount of up to $10,000,000 to be evidenced by senior
convertible notes. The notes had a two year term and accrued interest at an
annual rate of 10% payable monthly and were convertible into Common Stock, in
whole or in part, at the rate of one share of Common Stock for each $14.64 of
principal converted. On August 19, 1997, the Company issued the first of such
notes for the principal sum of $5,000,000. On October 10, 1997, the Company
issued the second of such notes for the principal sum of $5,000,000. The
proceeds of the notes were used for general working capital purposes. The
Company registered the resale of the shares of Common Stock issuable upon
conversion. On July 15, 1998, GSL Jr. converted such notes into an aggregate of
703,727 shares of Common Stock, which included 21,497 shares as an incentive for
GSL Jr. to convert such notes.
On October 10, 1997, the Company completed a private placement of three
year 10% convertible promissory notes (the "Notes") resulting in gross proceeds
to the Company of $20,000,000. The private placement was between the Company and
four institutional investors. The Notes are convertible at a conversion price of
$15.00 subject to stock-splits, stock dividends, rights offering other similar
events. In the event that the Company shall have declined to repay in full,
following the exercise by noteholders of the First or Second Put Right (as
defined below), the Initial Conversion Price shall be (i) the lesser of .85
multiplied by the 10-day weighted average sale price on Nasdaq as reported by
Bloomberg, LP (or other principal exchange on which the Company's securities are
traded) for the lowest 10-day consecutive period during the 30 consecutive
trading day period ending one trading day prior to the conversion date or (ii)
$15.00 per share. The net proceeds of this offering were used for the repayment
of $10 million of 20% notes payable to GSL Jr., for the purchase of Microtec and
for general corporate and working capital purposes.
Beginning October 10, 1998 and continuing for a period of 30 days
thereafter, each noteholder shall have the right ("First Put Right") to request
the Company to repurchase all, but not less than all of the outstanding Notes
held by such holder at a price equal to 110% of the principal amount thereof,
plus accrued and unpaid interest thereon. Commencing 180 days after the First
Put Date and continuing for a period of 30 days thereafter, each Noteholder
shall have a second right (the "Second Put Right") to request the Company to
repurchase all, but not less than all of the outstanding Notes at a price equal
to 115% of the principal amount thereof plus accrued and unpaid interest
thereon. The purchase price for any Put Right shall be paid in four equal
monthly installments on the last business day of each month commencing on the
first full month following the put notice with respect to the applicable First
or Second Put Right, with interest on each installment at the rate of 10% per
annum. The Company shall have the right at any time from time to time commencing
on October 10, 1998 to purchase 8.33% of the Notes in any one month from any
holder at a call price equal to 112% of the principal amount, plus accrued and
unpaid interest thereon, provided that such call price shall increase by 1% on
the 10th day of each subsequent month until October 10, 1999.
In July 1998, holders of the Notes converted $400,000 in principal
amount, plus accrued interest, into 26,780 shares of Common Stock. On October
31, 1998, the Company called and repurchased an aggregate principal amount
$1,632,680 of the Notes at a call price of 112% of the principal amount. On
October 31, 1998, the holders of the Notes exercised their First Put Right and
requested the Company to repurchase the remaining aggregate principal amount of
$17,967,320 of the Notes at a put price equal to 110% of the principal amount.
In accordance with the terms of the Notes, the Company was to pay the put price
in four equal monthly installments commencing November 30, 1998, with interest
on each installment accruing at the rate of 10% per annum. The Company made the
first two of such payments on November 30, 1998 and December 31, 1998. In
February 1999, the Company entered into an agreement with the holders of the
Notes to repay the remaining principal outstanding on the Notes over a five
month period commencing March 31, 1999, with monthly principal payments of
approximately $2 million plus accrued interest.
Additionally, on October 10, 1997, the Company completed the issuance
of an additional $18,608,250 of three year 10% convertible notes. The notes were
issued in a private placement transaction to 52 accredited investors. The net
proceeds from such offering were used for the expansion of inventory, the
increase of manufacturing capacity and for the repayment of short-term debt to
Brazilian banks. This offering, which was not conditioned on completion of the
previously described offering of Notes, provided for the issuance of convertible
notes containing substantially the same terms and conditions of the Notes as set
forth above, including the First and Second Put Right. The Company has
registered the resale of the shares of Common Stock issuable upon conversion. In
July 1998, certain holders of these notes converted $13,754,500 in principal
amount into an aggregate of 944,476 shares of Common Stock, which included
27,509 shares as an incentive for the noteholders to convert. On October 1,
1998, holders of an aggregate principal amount of $913,750 of such notes
exercised their right to request the Company to repurchase their notes at a
price equal to 110% of the principal amount. In accordance with the terms of the
notes, the Company paid for the repurchase of the notes in four equal monthly
installments, with interest on each installment accruing at the rate of 10% per
annum.
19
<PAGE>
The issuance of 71,006 shares of Common Stock as incentives for the
conversion of $33,754,500 of convertible notes as discussed above resulted in a
non-recurring charge to earnings in the amount of $1.07 million. In addition,
any premiums paid in connection with the put or call provisions of the
convertible note discussed above will result in a financing expense for the
Company of approximately $2.1 million, $1,150,000 of which was incurred during
the year ended December 31, 1998.
In September 1998, the Company issued a 3 year convertible note for the
principal sum of $450,000. The convertible note bears interest at the annual
rate of 10% and is convertible into common shares of the Company at the rate of
$10 per share. The proceeds of the convertible note were used for the
acquisition of the minority interest of Microtec.
During the fourth quarter of 1998, the Company received a loan for $6.7
million from GSL Jr. The loan is evidenced by a promissory note and bears
interest at the annual rate of 15% and is payable on demand. The loan is secured
by certain assets of the Company. The Company used the proceeds from the loan
for the repayment of the Notes that were put to the Company as discussed above.
In April 1998, the Company entered into an accounts receivable
financing program with TAC, an independently owned special purpose corporation,
whereby the Company's subsidiary, Bahiatech, may sell certain of its accounts
receivable to TAC. The program is a $150 million collateralized global medium
term note program whereby TAC may issue notes which are collateralized by the
purchased accounts receivable. TAC is an exempted company incorporated under the
laws of the Cayman Islands. One hundred percent (100%) of TAC's voting shares
are held by a Cayman Islands trust. TAC is a special purpose company that was
established solely to participate in the securitization, to acquire and hold the
designated receivables and to issue collateralized notes under a note program.
TAC has covenanted in the indenture pursuant to which the notes are issued not
to engage in any activities other than those contemplated by the indenture. The
receivables constitute the principal asset of TAC.
During the year ended December 31, 1998, the Company completed the sale
of an aggregate face amount of approximately $140 million of its accounts
receivable to TAC at a discount of approximately $7.5 million for cash and a
subordinated debenture. The subordinated debenture is a revolving, non-interest
bearing, bearer debenture, which constitutes the Company's retained interest in
the program.
The accounts receivable financing program with TAC contains a
repurchase provision whereby Bahiatech is required to repurchase the receivables
sold to TAC under certain circumstances, including default under the program,
delinquencies or violations of certain concentration limits. The repurchase
obligation may be satisfied by transferring to TAC, for no additional
consideration, an aggregate amount of additional receivables, the net present
value of which is equal to the repurchase price. If the net present value of the
receivables available to Bahiatech to effect such substitution is less than the
relevant repurchase price, then Bahiatech will be required to pay in cash the
excess of the repurchase price over the net present value of the additional
receivables transferred to TAC pursuant to such substitution. Vitech serves as
guarantor of the repurchase obligation. If Bahiatech fails to comply in full
with its repurchase obligation on or prior to the required repurchase date,
Vitech is required to deposit, within twenty-four (24) hours of such expired
required repurchase date, the amount of the repurchase price not paid by
Bahiatech. As a result of the structure of the program, at December 31, 1998,
there is a contingent liability in the amount of approximately $60.9 million
which represents the balance, at face value, of the accounts receivable sold to
TAC. The Company maintains an allowance for doubtful accounts on its balance
sheet with respect to the sold receivables. "Item 1. Business - Technology
Acceptance Corp."
In January 1999, the Brazilian government allowed its currency, the
Real, to trade freely against other foreign currencies, which resulted in an
immediate devaluation of the Real against the U.S. dollar. With the post
devaluation exchange rates of the Real to the U.S. dollar the overcollateral
ratio fell below its required minimum which caused trigger and default events,
as defined, of the TAC program. As a result, the Company is currently not
selling any of its accounts receivable to TAC, and may not, other than pursuant
to its repurchase obligation.
TAC has made a proposal to the holders of TAC notes for temporary and
permanent adjustments to the structure of the TAC program inorder to allow the
TAC program to operate more effectively in the post devaluation environment.
While the Company continues to believe that TAC could continue to be a viable
financing source, should TAC fail to gain consensus among the holders of TAC
notes concerning its proposal or should the macroeconomic conditions fail to
recover, then the Company may choose not to sell any additional accounts
receivable to TAC, other than pursuant to its repurchase obligation.
20
<PAGE>
In 1996, the Company began the development of a new 70,000 square foot
manufacturing plant and administrative center in Ilheus, Brazil. In connection
with the development thereof, the Company secured a $3.4 million loan from the
Development Bank of the State of Bahia to fund the development of such new
facility. The loan facility consists of a working capital line of credit of
approximately $758,000 and a construction loan credit facility of approximately
$2,619,000. In 1997, the Company suspended the ground breaking of the new
manufacturing plant while evaluating the purchase of its present facility. As of
December 31, 1998, the Company had a balance of $623,305 associated with such
construction loan credit facility. The Company has become aware that the current
leased manufacturing facility in Ilheus that it currently occupies will be
available for purchase through auction and the Company is currently evaluating
the purchase thereof. See "Item 1. Business - Engineering and Manufacturing".
In March 1998, the Company entered into a capital lease of $1,200,000
for the acquisition of equipment. This capital lease has a term of 60 months and
bears an adjustable interest rate (currently 9.9%). In 1998, the Company entered
into operating leases for equipment ranging from 36 to 84 months and requiring
monthly payments of $105,965. These leases are noncancelable and expire at
various dates through 2005.
In December 1998, the Company entered into sale leaseback transaction,
whereby the Company sold a net amount of $2,500,000 of assets to an unrelated
third party. The Company in turn entered into an operating lease for the use of
the assets. The operating lease has a term of 36 months and requires monthly
payments of $73,790.
In connection with its acquisition of Microtec in 1997, the Company
recorded a provision for costs relating to the involuntary termination and
relocation of Microtec employees in the amount of $1.1 million. Such provision
is associated with the Company's plans to cease certain manufacturing operations
at Microtec's facility and to consolidate all of the manufacturing of the
Company at its facility in Bahia. During the year ended December 31, 1998, the
Company had incurred $1.1 million in expenses relating to such provision.
On June 15, 1998, the Board of Directors of the Company, approved a 10%
Common Stock dividend to be distributed to shareholders of record of the Common
Stock as of July 13, 1998. The Common Stock issued as a result of this stock
dividend was distributed on July 27, 1998. All references in this report to the
common stock of the Company and net income per common share have been
recalculated to reflect the 10% common stock dividend.
In March of 1999, the Company received a loan from GSL Jr. for the
principal amount of $10 million. The loan bears interest at the annual rate of
10% and has a term of 120 days. The loan is evidenced by a promissory note and,
at the makers option, can be exchanged for a convertible note should the loan
not be repaid at maturity. Additionally, in April of 1999, the Company received
a loan from an unrelated third party for the principal amount of $11 million.
The loan bears interest at the annual rate of 10% and has a term of 90 days. The
loan is evidenced by a promissory note and is personally guaranteed by the
Company's two principal executive officers and majority shareholders. The
proceeds of these loans are being used for the repayment of indebtedness and for
general working capital purposes.
Business Conditions
In January 1999, the Brazilian government allowed its currency, the
Real, to trade freely against other foreign currencies, which resulted in an
immediate devaluation of the Real against the U.S. dollar. The Company's
accounts receivable are denominated in the Real while principally all of the
Company's trade accounts payable are denominated in U.S. dollars. At December
31, 1998, the Company had a net exposure of monetary assets subject to currency
translation of approximately $70 million. Accordingly, the devaluation should
have a significantly negative effect on the Company's results for the quarter
ended March 31, 1999. The ultimate amount of the Company's devaluation loss will
only be known when the Real stabilizes. However, based on a March 31, 1999 close
of 1.74 Real to the U.S. dollar, a proforma financial information as of December
31, 1998 after giving effect to the devaluation is as follows:
<TABLE>
<CAPTION>
Proforma as of December 31, 1998
---------------------------------------------------
Actual Adjustments As Adjusted
------------- ------------- -------------
<S> <C> <C> <C>
Total assets $ 195,666,975 $ (41,599,993) $ 154,066,982
Total liabilities 93,445,620 (8,033,924) 85,411,696
Total shareholders' equity 102,221,355 (33,566,069) 68,655,286
------------- ------------- -------------
</TABLE>
Furthermore, the devaluation and the resulting unfavorable business conditions
in Brazil are leading to reduced demand as well as less liquidity in the
borrowing capacity among the Company's customers and in the market in general.
In an effort to
21
<PAGE>
minimize any further effects of the currency devaluation, unfavorable business
conditions and to improve the liquidity of the Company, management has taken the
following actions:
o Indexed the pricing of its products in Reais to the U.S. dollar.
o Significantly reduced the credit terms that it extends to
customers.
o Renegotiated trade accounts payable of approximately $22 million
at December 31, 1998 to terms which average 10 months.
o Negotiated short term financing.
o Modified the repayment terms of certain convertible notes.
o Continue to negotiate with TAC.
o Completion of the consolidation of the manufacturing facilities in
1999 which reduces administrative expenses and inventory carrying
costs.
While the Company continues to believe that the long-term growth opportunities
remain for the Brazilian information technology market, it continues to evaluate
the impact of the current business conditions on its operations. The ultimate
resolution of these matters could have a material adverse effect on the
financial condition and results of operation for the quarter ended March 31,
1999 and possible for future quarters.
Year 2000 Compliance
Computers, software and other equipment utilizing microprocessors that
use only two digits to identify a year in a date field may be unable to process
accurately certain date-based information at or after the year 2000. The Company
recognizes the need to insure that its operations will not be adversely affected
by Year 2000 software failures. Software failures due to processing errors
potentially arising from calculations using the year 2000 date are a recognized
risk, and the Company is addressing this issue on several different fronts.
The Company believes that all Company-branded hardware products shipped
since January 1997 are Year 2000 compliant. Earlier Company-branded hardware
products can be made Year 2000 compliant through BIOS upgrades or software
supplements. In addition to internal Year 2000 software and equipment
implementation activities, the Company is in contact with its suppliers to
assess their compliance. There can be no assurance that there will not be a
material adverse effect on the Company if third parties do not convert their
systems in a timely manner and in a way that is compatible with the Company's
systems. The Company believes that its actions with suppliers will minimize
these risks.
Finally, the Company has established an internal workforce to
coordinate solutions for the Year 2000 issue for its own internal information
systems and as of December 31, 1998 has determined that its internal information
systems are Year 2000 compliant.
Through December 31, 1998, the Company has not incurred material
expenses relating to Year 2000 compliance efforts and believes that the expenses
associated with completing its Year 2000 compliance plans will not have a
material adverse impact on the Company's operations. Internal and external
expenses specifically associated with modifying internal-use software for the
Year 2000 will be expensed as incurred. The Company's current estimates of the
amount of time and expenses necessary to implement and test its computer systems
are based on the facts and circumstances existing at this time. Nevertheless,
achieving Year 2000 compliance is dependent on many factors, some of which are
not completely within the Company's control. Should either the Company's
internal system or the internal systems of one or more significant vendors or
suppliers fail to achieve Year 2000 compliance, the Company's business and its
results of operations could be adversely affected. See "Factors Affecting the
Company's Business and Prospects - Year 2000 Compliance".
Impact of Inflation on Results of Operations, Liabilities and Assets
For many years prior to July 1994, the Brazilian economy was
characterized by high rates of inflation and devaluation of the Brazilian
currency against the U.S. Dollar and other currencies. However, since the
implementation in July of 1994 of the Brazilian government's latest
stabilization plan, the "Real Plan", inflation, while continuing, has been
significantly reduced and the rate of devaluation has substantially diminished.
The Company has assessed the movement of the Brazilian currency based upon the
trading ranges stated by the policy of the Central Bank of Brazil and has been
able to offset any material effects of inflation. Although the Company had used
Real futures and options contracts during 1996, in an effort to hedge against
currency risks, its highest coverage at any one time had only met 20% of its
exposure, consisting of accounts receivable denominated in Reais, net of
accounts payable and other current liabilities denominated in Reais. Currently,
the Company is not engaged in any hedging activities. There can be no assurance
that the Real Plan will continue to be effective in combating inflation and
devaluation of Brazil's currency or that the Company's assessment of the
movement
22
<PAGE>
of Brazilian currency will be correct in the future. Inflation rates in Brazil
for the years 1998, 1997, 1996 and 1995 were approximately 1.7%, 7.5%, 10.3% and
22%, respectively. See "Factors Relating to Brazil".
Recent Accounting Pronouncements
The Company adopted Statement of Financial Accounting Standards No. 130
("SFAS 130"), "Reporting Comprehensive Income" during the year ended December
31, 1998. SFAS 130 establishes new rules for the reporting and presentation of
comprehensive income and its components. The Company's comprehensive income is
comprised of net income adjusted for foreign currency translation. For the year
ended December 31, 1998, comprehensive income was $13.3 million as compared to
reporting net income of $17.9 million. Comprehensive income includes a
cumulative translation adjustment of $4.6 million associated with the
translation of the Company's subsidiary financial statements to the US dollar.
Foreign Currency Translation
The financial statements of the Company have been prepared in
accordance with U.S. generally accepted accounting principles and are stated in
U.S. dollars. Until December 31, 1997, amounts in Brazilian currency were
remeasured into U.S. Dollars in accordance with the methodology set forth in
Statement of Financial Accounting Standards No. 52 ("SFAS 52") as it applies to
entities operating in highly inflationary economies. The assets and liabilities
of the Company's subsidiaries were translated into U.S. dollars at exchange
rates in effect at the balance sheet date for monetary items and at historical
rates for nonmonetary items. Revenue and expense accounts are translated at the
average exchange rate in effect during each month, except for those accounts
that relate to nonmonetary assets and liabilities which are translated at
historical rates.
Effective January 1, 1998, the Company determined that Brazil ceased to
be a highly inflationary economy under SFAS 52. Accordingly, as of January 1,
1998, the Company began using the Brazilian currency, the Real, as the
functional currency of its Brazilian subsidiaries. As a result, all assets and
liabilities are translated into dollars at period end exchange rates and all
income and expense items are translated into U.S. dollars at the average
exchange rate prevailing during the period. Any translation adjustments are
reflected as a component of shareholders' equity.
FACTORS AFFECTING THE COMPANY'S BUSINESS AND PROSPECTS
Statements contained in this report that are not based on historical
fact are "forward-looking statements" within the meaning of the private
securities litigation reform act of 1995. Forward-looking statements may be
identified by the use of forward looking terminology such as "may," "will,"
"expect," "believe," "estimate," "anticipate," "continue," or similar terms or
variations of those terms or the negative of those terms. Shareholders should
carefully consider the information set forth in such disclosure and the
following risk factors which constitutes cautionary statements identifying
important factors that could cause actual results to differ materially from
those in the forward-looking statements.
Factors Relating to the Company
Management of Growth. The Company has experienced substantial growth
from inception through both internal operations and acquisitions, with
consolidated net sales and consolidated net income increasing to $195 million
and $17.9 million, respectively, for the year ended December 31, 1998, from
$117.5 million and $12.8 million, respectively, for the year ended December 31,
1997. Consolidated net sales and consolidated net income increased to $73.3
million and $8.2 million, respectively, for the year ended December 31, 1996,
from $48.5 million and $6.9 million, respectively, for the year ended December
31, 1995. There can be no assurance that such growth will continue, and if such
growth continues, that the Company's infrastructure will continue to be
sufficient to support such larger enterprise. See "Risk Factors - Dependence on
Key Personnel; Recruitment of Additional Personnel", "Management's Discussion
and Analysis of Financial Condition and Results of Operations", "Business -
Employees".
Dependence on Key Personnel; Recruitment of Additional Personnel. The
ability of the Company to attract and retain highly skilled personnel is
critical to the operations of the Company. To date, the Company has been able to
attract and retain the personnel necessary for its operations. However, there
can be no assurance that the Company will be able to do so in the future,
particularly in light of the Company's expansion plans. If the Company is unable
to attract and retain personnel with necessary skills when needed, its business
and expansion plans could be materially adversely affected. The Company is
dependent upon the efforts and abilities of Georges C. St. Laurent III, its
Chairman of the Board and Chief Executive Officer, and William C. St. Laurent,
its President and Chief Operating Officer, each of whom is a substantial
shareholder in the Company. The loss or unavailability of the services of either
of these individuals for any significant period of time could have a material
adverse effect on the Company's business prospects. The Company has obtained,
and is the sole beneficiary of,
23
<PAGE>
key-person life insurance in the amount of $2 million on the life of each of
Messrs. St. Laurent. There can be no assurance that such insurance will continue
to be available on reasonable terms, or at all.
Fluctuation of Quarterly Results. The computer industry generally has
been subject to seasonality and to significant quarterly and annual fluctuations
in operating results, and the Company's operating results have been subject to
such fluctuations. The Company's quarterly net sales and operating results may
vary significantly as a result of, among other things, historical seasonal
purchasing patterns and the general economic climate in Brazil, the volume and
timing of orders received during a quarter, variations in sales mix, delays in
production schedules, new product developments or introductions, availability of
components, changes in product mix and pricing, and product reviews and other
media coverage. The Company's sales plan provides for approximately 40% of the
Company's sales to be made to federal, state, and municipal government
customers. Such sales at times may involve large contracts that can be a
significant part of the Company's sales. The Company's sales to the consumer and
small business markets fluctuate seasonally and are dependent in part on the
spending patterns of its customers, which in turn are subject to prevailing
economic conditions. Historically, the Company's sales have increased in the
third and fourth quarters due, in part, to holiday spending. Accordingly, the
Company's historical financial performance is not necessarily a meaningful
indicator of future results and, in general, management expects that the
Company's financial results may vary materially from period to period. See the
Notes to the Company's Consolidated Financial Statements.
Possible Need for Additional Financing. In order to pursue the
Company's business strategy, the Company may need to seek additional funding
through public or private financing and may, when attractive sources of capital
become available, elect to obtain capital in anticipation of such needs.
Adequate funds for growth through internal expansion and through acquisitions
may not be available when needed or may not be available on terms favorable to
the Company. If additional funds are raised by issuing equity securities or
related instruments with conversion or warrant features, dilution to existing
shareholders may result. If funding is insufficient, the Company may be required
to delay, reduce the scope of or eliminate some or all of its expansion
programs. In addition, the Company has in the past sought funding through third
parties related to the Company's management and there can be no assurance that
these sources can be relied upon in the future. More recently, the Company has
entered into a receivables financing facility with TAC, an independently owned
special purpose corporation, pursuant to which TAC issues and sells senior notes
to investors collateralized by certain receivables of the Company. The Company
is required to repurchase these receivables under certain circumstances,
including their non-payment.
The Company currently believes that the projected cash flows from
continuing operations and existing and contemplated sources of credit will be
sufficient to satisfy its capital requirements and finance its plans for
expansion for the next 12 months. Such belief is based on certain assumptions,
and there can be no assurance that such assumptions are correct. Accordingly,
there can be no assurance that such resources will be sufficient to satisfy the
Company's capital requirements or expansion plans for such period. There can be
no assurance that such contemplated sources will be available at the time they
are needed or that the receivables financing facility with TAC will be available
to the Company for financing accounts receivable at favorable terms. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Business Technology Acceptance Corp".
Competition. The manufacturing and sale of computer equipment and
related products is highly competitive and requires substantial capital. The
Company competes with, and will compete with, numerous international, national,
and regional companies, many of which have significantly larger operations and
greater financial, marketing, human, and other resources than the Company, which
may give such competitors competitive advantages, including economies of scale
and scope. Competitors in the computer hardware market include internationally
recognized companies such as IBM, Acer, Dell, Hewlett Packard and Compaq.
Additionally, the Company competes in the systems integration market with
internationally recognized systems integrators such as IBM, EDS and Unisys.
Competition is based on price, product quality, customer support and the ability
to deliver products in a timely fashion. No assurance can be given that the
Company will successfully compete in any market in which it conducts or may
conduct operations.
In addition, the Company competes with other small manufacturers of
computer equipment sold on what is known as the "gray market" in Brazil. Such
manufacturers are able to sell products at prices that are often significantly
lower than those offered by the Company and other legitimate manufacturers. Gray
market manufacturers are able to offer lower prices because of the avoidance of
import duties and other taxes, and the avoidance of necessary software licensing
fees. There can be no assurance that gray market activity will not continue to
flourish, putting downward pressures on the Company's profit margins as result
of low pricing strategies.
24
<PAGE>
Importance of Customer Credit and Risks of Customer Lending. In 1996,
the Company began providing extended credit terms to its customers. Credit sales
are an important component of the Company's results of operations. In 1997,
approximately 90% of the Company's net sales revenue was accounted for by sales
on credit (with terms from 1 to 24 months). The Company's results of operations
could be materially and adversely affected if demand for customer credit falls,
or if Brazilian Government policies curtail the Company's ability to extend
credit or to fund its extensions of credit. In addition, the Company's customer
credit activities expose it to significant risks. At December 31, 1998, the
Company's outstanding exposure to customer credit risk was approximately $60
million, including the balance of accounts receivable sold to TAC. While an
allowance for doubtful accounts (including those sold to TAC) is made monthly
based on management's reviews of prior period losses and anticipated losses,
there can be no assurance that such allowances would be sufficient to cover
actual losses. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Business - Customer Financing".
Dependence on Suppliers. The Company's manufacturing process requires a
high volume of quality components that are procured from third party suppliers.
Reliance on suppliers, as well as industry supply conditions, generally involves
several risks, including the possibility of defective parts (which can adversely
affect the reliability and reputation of the Company's products), a shortage of
components and reduced control over delivery schedules (which can adversely
affect the Company's manufacturing efficiencies) and increases in component
costs (which can adversely affect the Company's profitability). The Company
currently purchases all of its microprocessors from Intel. Additionally, the
Company has several other single-sourced supplier relationships, either because
alternative sources are not available or the relationship is advantageous due to
performance, quality, support, delivery, capacity or price considerations. If
these sources are unable to provide timely and reliable supply, the Company
could experience manufacturing delays or inefficiencies, adversely affecting its
results of operations. During the year ended December 31, 1998, the Company had
one supplier which accounted for more than 10% of purchases. Substantially all
of the Company's inventory has, and will be, purchased from manufacturers and
distributors with whom the Company has entered into non-exclusive agreements,
which are typically cancelable upon 30 days written notice. There can be no
assurance that such agreements will not be canceled. The loss of, or significant
disruptions in relationships with, suppliers could have a material adverse
effect on the Company's business since there can be no assurance that the
Company will be able to replace lost suppliers on a timely basis. See "Business
- - The Company", "- Industry Overview", "- Business Strategy", and "- Logistics
and Materials Management".
Acquisitions; Integration of Microtec Into the Company's Operations. In
July 1997, the Company completed the acquisition of Microtec and, in November
1997, the Company completed the acquisitions of majority interests in Rectech
and Techshop. The Company's business strategy includes other potential
acquisitions, although the Company is not currently negotiating to acquire any
other additional companies and has no commitments, understandings or
arrangements with respect to any specific transaction. Acquisitions, including
that of Microtec, involve a number of risks that could adversely affect the
Company's operating results, including (i) the diversion of management's
attention; (ii) the integration of the operations and personnel of the acquired
companies; (iii) the amortization of acquired intangible assets; (iv) the
assumption of potential liabilities, disclosed or undisclosed, associated with
the business acquired; (v) the possibility that the financial and accounting
systems utilized by the business acquired will not meet the Company's standards;
(vi) the possibility that the business acquired will not maintain the quality of
services that the Company has historically provided; (vii) the dilutive effect
of the use of the Company's Common Stock as consideration for transactions; and
(viii) the possibility that the Company will be unable to attract and retain
qualified local management for both the acquirees' operations and the ensuing
consolidated operations. There can be no assurance that the Company will
consummate any future acquisitions on satisfactory terms, that adequate
financing will be available on terms acceptable to the Company, or that any
acquired operations will be successfully integrated or that such operations will
ultimately have a positive impact on the Company, its financial condition or
results of operations.
Tax-Exempt Status. The government of the State of Bahia, Brazil has
issued a decree that exempts companies such as the Company's subsidiary,
Bahiatech, from the payment of state import duties, state sales tax, and state
services tax. Bahiatech has received an exemption from such taxes through and
including the year 2003. Additionally, Bahiatech is exempted from the payment of
Brazilian federal income tax through and including the year 2004, provided that
the Company meets certain budgeted production goals. The Company is not exempted
from the payment of a federal social contribution tax of approximately 8% of
pre-tax income. The normal rate of federal taxation on a non-exempt basis is
33%. In the event that the Company is unable to extend such tax-exempt status,
the Company's after-tax earnings as a percentage of net sales would decline by
the amount of the tax benefit, which may be substantial. See "Business - Tax
Exempt Status".
Consequences of Technological Changes. The market for the Company's
products is characterized by continuous and rapid technological advances and
evolving industry standards. Compatibility with industry standards in areas such
as operating systems and communications protocols is material to the Company's
marketing strategy and product development
25
<PAGE>
efforts. In order to remain competitive, the Company must respond effectively to
technological changes by continuing to enhance and improve its existing products
to incorporate emerging or evolving standards, and by successfully developing
and introducing new products that meet customer requirements. There can be no
assurance that the Company will successfully develop, market, or support such
products or that the Company will respond effectively to technological changes
or new product announcements or introductions by others. In the event that the
Company does not enhance and improve its products, the Company's sales and
financial results could be materially adversely affected. In addition, there can
be no assurance that, as a result of technological changes, all or a portion of
the Company's inventory would not be rendered obsolete. See "Business -
Products".
Affiliated Transactions and Conflicts of Interest. The Company has,
since 1995, received loans and sold securities and certain of its accounts
receivable to Georges C. St. Laurent Jr. ("GSL Jr."), the father of Georges C.
St. Laurent III, the Company's Chairman of the Board and Chief Executive
Officer, and William C. St. Laurent. The Company believes that the terms of
these transactions were no less favorable to the Company than could be obtained
from unaffiliated third parties. To the extent the Company enters into
transactions with affiliated persons and entities in the future, it will do so
only on terms no less favorable to the Company than those available from
unaffiliated third parties. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation", and the Notes to the Company's
Consolidated Financial Statements.
Assets Outside the U.S.; Enforceability of Civil Liabilities Against
Foreign Persons. While the Company is a U.S. corporation with executive offices
in Florida, its principal operations are conducted by its Brazilian
subsidiaries. For the foreseeable future, a substantial portion of the Company's
assets will be held or used outside the U.S. (in Brazil). Consequently,
enforcement by investors of civil liabilities under the Federal securities laws
may be adversely affected by the fact that, while the Company is located in the
U.S., its principal subsidiaries and operations are located in Brazil. Although
the Company's executive officers and directors are residents of the U.S., except
for Messrs. Touma Makdassi Elias and William R. Blackhurst, who are residents of
Brazil, all or a substantial portion of the assets of the Company are located
outside the U.S.
The Effect of Volatility on the Repatriation of Excess Retained
Earnings Through the Floating Rate Market. For the foreseeable future, Bahiatech
does not intend to distribute any excess retained earnings to Vitech, but
intends to reinvest such earnings, if any, in the development and expansion of
its business. Up to now, substantially all of the retained earnings of the
Company on a consolidated basis have been attributable to Bahiatech. Bahiatech
is exempted from the payment of Brazilian federal income tax through and
including the year 2004, provided that the Company meets certain budgeted
production goals. Tax exemption benefits cannot be distributed as dividends to
the parent company in U.S. Dollars and are segregated for capital reserves and
offsetting accumulated losses in accordance with Brazilian law. For the years
ended December 31, 1998, 1997 and 1996 the tax exemption benefits amounted to
$5,566,253 ($0.42 per share), $5,202,833 ($0.43 per share) and $2,163,667 ($0.22
per share), respectively.
In the future, should Bahiatech wish to remit retained earnings in
excess of the tax exemption benefits in U.S. Dollars, it may do so only in Reais
convertible into U.S. Dollars in the floating rate exchange market. There are
two legal foreign exchange markets in Brazil: the Commercial Market and the
Floating Market. The "Commercial Market Rate" is the commercial selling rate for
Brazilian currency into U.S. Dollars, as reported by the Central Bank. The
"Floating Market Rate" generally applies to transactions to which the Commercial
Market Rate does not apply. Prior to the implementation of the Real Plan, the
Commercial Market Rate and the Floating Market Rate differed significantly at
times. Since the introduction of the Real, the two rates have not differed
significantly. However, there can be no assurance that there will not be
significant differences between the two rates in the future. Both the Commercial
Market Rate and the Floating Market Rate are reported by the Central Bank on a
daily basis.
In order for a company to remit retained earnings abroad in U.S.
dollars at the Commercial Market Rate, Brazilian law first requires the
registration of the foreign capital upon which those retained earnings were
made. Bahiatech has not made such registration and therefore is only able to
remit excess retained earnings at the Floating Market Rate. The Company uses the
Commercial Market Rate for the translation of Bahiatech's results into U.S.
Dollars. In the event that Bahiatech remits excess retained earnings at the
Floating Market Rate, there can be no assurance that such remittance will not
vary from the Company's reported results because of the differences between the
Commercial Market Rate and the Floating Market Rate. Although Microtec does not
currently intend to distribute any retained earnings to Vitech, it is currently
eligible to remit retained earnings in U.S. Dollars at the Commercial Market
Rate. See "Management's Discussion and Analysis of Financial Condition and
Results of Operation", "Dividend Policy" and "Exchange Rates".
26
<PAGE>
Government Regulation. The manufacture of computer equipment and
related products is subject to various forms of government regulation in the
United States and Brazil. The Company and its operations are affected by
technology transfer and licensing regulations, tariff regulations, regulations
governing currency conversion and transfers of profits between jurisdictions,
and labor regulations, among others. While the Company does not believe that
such regulations adversely affect the Company or its business presently, there
can be no assurance that such regulations will not materially adversely affect
the Company in the future. In addition, the government of Brazil has exercised,
and continues to exercise, substantial influence over many aspects of the
private sector in Brazil.
Share Price Volatility. The market for securities of technology
companies and companies that participate in emerging markets historically has
been more volatile than the market for stocks in general. The price of the
Common Stock may be subject to wide fluctuations in response to
quarter-to-quarter variations in operating results, announcement of
acquisitions, vendor additions or cancellations, creation or elimination of
banking or other funding opportunities, favorable or unfavorable coverage of the
Company or its officers by the press, and the availability of new products,
technology, or services. In addition, the stock market has from time to time
experienced extreme price and volume fluctuations that have particularly
affected the market price for many technology and emerging market companies,
both related and unrelated to the operating results of such companies. These
market fluctuations and other factors may affect the market for the Common
Stock. See "Price Range of Common Stock".
Dependence on Manufacturing Facilities. The Company operates one
manufacturing facilities in Ilheus, Bahia, Brazil. In the event such facility
were to experience substantial damage or disruption of its operations for any
reason, the Company may be required to suspend manufacturing operations or
transfer manufacturing operations to an independent facility for an indefinite
period of time. While the Company maintains insurance covering various
contingencies, any such suspension or disruption of its manufacturing operations
could have a material adverse effect on the Company and its results of
operations. See "Item 2. Properties".
Year 2000 Compliance. Many existing computer systems and applications,
and other control devices, use only two digits to identify a year in the date
code field, and were not designed to account for the upcoming change in the
century. As a result, such systems and applications could fail or create
erroneous results unless corrected so that they can process data related to the
year 2000. The Company relies on its systems, applications and devices in
operating and monitoring all major aspects of its business, including financial
systems (such as general ledger, accounts payable and accounts receivable
modules), inventory and receivables systems, customer services, infrastructure,
embedded computer chips, networks and telecommunications equipment and end
products. The Company also relies, directly and indirectly, on systems of
external business enterprises such as distributors, suppliers, creditors,
financial organizations, and governmental entities, for accurate exchange of
data. Although the Company is in contact with its suppliers to assess their
compliance, there can be no assurance that there will not be a material adverse
effect on the Company if third parties do not convert their systems in a timely
manner and in a way that is compatible with the Company's systems, as the
Company could be affected through disruptions in the operation of the
enterprises with which the Company interacts. Based on the information currently
available, the Company believes that the costs associated with the year 2000
issue, and the consequences of incomplete or untimely resolution of the year
2000 issue, will not have a material adverse effect on its business, financial
condition and results of operations in any given year; however, there can be no
assurance that year 2000 issues will not have a material adverse effect on the
Company's business, financial condition or results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Year 2000 Compliance".
Factors Relating to Brazil
Political and Economic Conditions. The Brazilian economy has been
characterized by frequent and occasionally drastic intervention by the Brazilian
government. The Brazilian government has often changed monetary, credit, tariff
and other policies to influence the course of Brazil's economy. The Brazilian
government's actions to control inflation and effect other policies have often
involved wage and price controls as well as other measures, such as freezing
bank accounts, imposing capital controls and limiting imports into Brazil.
Changes in policy involving tariffs, exchange controls, and other matters could
have a material adverse effect on the Company, as could inflation, devaluation,
social instability and other political, economic or diplomatic developments, and
the Brazilian government's response to such developments.
The Brazilian political environment has been marked by high levels of
uncertainty since the country returned to civilian rule in 1985 after 20 years
of military government. The death of a President-elect in 1985 and the
resignation of another President in 1992 during his impeachment trial, as well
as frequent turnovers at and immediately below the cabinet level, particularly
in the economic area, historically have contributed to the absence of a coherent
and sustained policy to confront Brazil's economic problems.
27
<PAGE>
Mr. Fernando Henrique Cardoso, the Finance Minister at the time of the
implementation of Brazil's latest economic stabilization plan, was elected
President in October 1994. The Real Plan, which has significantly reduced
inflation since the introduction of the Real in July 1994, has been continued by
the Cardoso government. See "Impact of Extreme Inflation" below. President
Cardoso has continued to support free market and privatization measures of
recent years, and his government has taken steps in this regard, such as
proposing measures for the liberalization of the state petroleum and
telecommunications monopolies and the privatization of a number of state-owned
enterprises. Although these liberalization measures have enjoyed broad political
and public support, some important political factions remain opposed to
significant elements of the reform program. In addition, President Cardoso was
elected as the leader of a coalition of political parties and governs Brazil by
coalition government. As a result, President Cardoso's leadership of Brazil is
likely to be subject to more compromises and accommodations than if his party
alone had received support from the majority of voters. Furthermore, the
Brazilian government's desire to control inflation and to reduce budget deficits
may cause it to take actions that will slow or halt Brazilian economic growth.
Impact of Extreme Inflation. Brazil has historically experienced
extremely high rates of inflation. Inflation itself, as well as certain
governmental measures to combat inflation, have in the past had significant
negative effects on the Brazilian economy. Inflation, actions taken to combat
inflation and public speculation about possible future actions have also
contributed significantly to economic uncertainty in Brazil and to heightened
volatility in the Brazilian securities markets. Beginning in December 1993, the
Brazilian government introduced the Real Plan, an economic stabilization plan
designed to reduce inflation by reducing certain public expenditures, collecting
liabilities owed to the Brazilian government, increasing tax revenues,
continuing the privatization program and introducing a new currency. On July 1,
1994, as part of the Real Plan, the Brazilian government introduced the Real.
Since the introduction of the Real, Brazil's inflation rate has been
substantially lower than in previous periods. Inflation, as measured by the
IGP-DI, was approximately 2,708%, 910%, 15.7%, 9.3%, 7.5% and 1.7% in 1993,
1994, 1995, 1996, 1997 and 1998, respectively. There can be no assurance,
however, that the recent lower level of inflation will continue or that future
Brazilian governmental actions (including actions to adjust the value of the
Brazilian currency such as the devaluation of the Real in January 1999) will not
trigger an increase in inflation or that any such increase will not have a
material adverse effect on the Company.
Effects of Exchange Rate Fluctuations. The relationship of Brazil's
currency to the value of the U.S. Dollar, and the rates of devaluation of
Brazil's currency relative to the prevailing rates of inflation have affected,
and may affect, the Company's financial condition and results of operations.
Principally all of the Company's sales are denominated in the Real, while the
Company's operating results are recorded in U.S. Dollars. Any significant
devaluation of the Real relative to the U.S. Dollar could have a material
adverse effect on the Company's operating results. Although the Company had used
Real futures and options contracts during 1996, in an effort to hedge against
currency risks, its highest coverage at any one time had only met 20% of its
exposure, consisting of accounts receivable denominated in Reais, net of
accounts payable and other current liabilities denominated in Reais. Currently,
the Company is not engaged in any hedging activities. Currency transaction
losses for the years ended December 31, 1998 and 1997 were $1,603,670 and
$2,665,224, respectively, and were associated with dollar-denominated monetary
assets and liabilities held by the Company's Brazilian subsidiaries.
In the event of a significant devaluation of the Brazilian currency in
relation to the U.S. Dollar or other currencies, the ability of the Company to
meet its foreign currency denominated obligations could be adversely and
materially affected. Increases in the rate of inflation in Brazil subsequent to
such a devaluation of the Brazilian currency could adversely affect the
business, results of operations and financial condition of the Company. Although
the exchange rate between the Real and the U.S. dollar had been relatively
stable from mid-July 1994 through late 1998, the spread of the Asian and Russian
economic difficulties to South America culminated in the devaluation of the Real
in mid-January 1999. By the end of January 1999, the real dropped against the
dollar by approximately 45% compared to the end of December 1998. In addition,
Gustavo Franco, the president of Brazil's central bank and an architect of the
Real Plan, resigned, amid rumors of policy differences between Mr. Franco and
Mr. Francisco Lopes, then the central bank's Director of Monetary Policy and who
has since been replaced. Although some recent economic measures have been taken
by the Brazilian Federal Government in an effort to stabilize the Real, the
potential for future devaluation or volatility continues to persist. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Impact of Extreme Inflation".
Exchange Controls and Restrictions. Brazilian law provides that,
whenever there is a serious imbalance in Brazil's balance of payments or serious
reasons to foresee such imbalance, the Brazilian government may, for a limited
period of time, impose restrictions on the remittance to foreign investors of
the proceeds of their investments in Brazil, as it did for approximately six
months in 1989 and early 1990, and on the conversion of Brazilian currency into
foreign currencies. No assurance can be given that the international transfer of
Reais or the Floating Market will remain legally or commercially available to
Brazilian residents. There can be no assurance that the Brazilian government
will not in the future impose more
28
<PAGE>
restrictive foreign exchange regulations that would have the effect of
preventing or restricting the Company's access to foreign currency that it may
require to meet its foreign currency obligations under foreign currency
denominated liabilities.
Change of Economic Environment. Despite the success to date of the Real
Plan in reducing inflation in Brazil, the fiscal adjustment program necessary to
reduce government expenditures is not complete after the fifth year of the Real
Plan. There can be no assurance that the Real Plan will be more successful than
previous economic programs in reducing inflation over the long term, especially
in light of (i) the Brazilian congress' delay in the Real Plan and in the reform
of the social security system, and (ii) the negative effects of the Asian,
Russian and Latin American crises on Brazil, which has caused a flight of
foreign investment, the devaluation of the Real and new inflationary pressures
on the Brazilian economy. Accordingly, periods of substantial inflation may once
again have significant adverse effects on the Brazilian economy, on the value of
the Real and on the Company's financial condition, results of operations and
future prospects.
29
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
Independent Auditor's Report
Board of Directors and Shareholders
Vitech America, Inc.
We have audited the accompanying balance sheet of Vitech America, Inc. and
Subsidiaries as of December 31, 1998 and December 31, 1997, and the related
statements of income, changes in shareholders' equity and cash flows for each of
the three years ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
1997 financial statements of Microtec Sistemas Industria e Comercio S.A.
(Microtec), a subsidiary, which statements reflect total assets of $19,437,700
at December 31, 1997, and revenues of $34,714,000 for the period July 10, 1997
(date of acquisition) through December 31, 1997 and are included in the
consolidated totals. The financial statements of Microtec were audited by other
auditors whose report thereon has been furnished to us, and our opinion, insofar
as it relates to the amounts included for Microtec, is based solely upon the
report of the other auditors.
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, based upon our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material aspects,
the financial position of Vitech America, Inc. and Subsidiaries as of December
31, 1998 and 1997 and the results of operations and cash flows for each of the
three years ended December 31, 1998 in conformity with generally accepted
accounting principles.
/s/ Pannell Kerr Forster PC
New York, New York
April 12, 1999
30
<PAGE>
VITECH AMERICA, INC.
Balance Sheet
<TABLE>
<CAPTION>
December 31,
--------------------------------
1998 1997
------------- -------------
Assets
<S> <C> <C>
Current assets
Cash and cash equivalents $ 7,719,185 $ 22,704,632
Accounts receivable, net 75,893,857 59,137,869
Inventories, net 40,351,585 34,347,087
Deferred tax asset - 702,000
Due from officers - 370,623
Investment in subordinated debentures - short term 14,676,585 -
Other current assets 8,538,379 4,676,804
------------- -------------
Total current assets 147,179,591 121,939,015
Property and equipment, net 19,696,097 12,946,523
Investment in subordinated debentures - long term 2,677,906 -
Investments 1,248,434 1,181,632
Goodwill, net 20,191,646 17,570,705
Deferred tax asset 1,567,000 493,000
Other assets 3,106,301 1,374,027
------------- -------------
Total assets $ 195,666,975 $ 155,504,902
------------- -------------
Liabilities and Shareholders' Equity
Current liabilities
Trade accounts payable $ 36,748,951 $ 15,482,640
Accrued expenses 4,811,130 3,131,670
Taxes payable 1,804,792 -
Deferred tax liability 1,041,000 -
Notes payable - related party 6,700,000 -
Current maturities of long-term debt 863,021 350,439
Short-term debt 25,036,536 20,419,169
------------- --------------
Total current liabilities 77,005,430 39,383,918
------------- -------------
Long-term liabilities
Convertible notes - related party - 20,000,000
Convertible notes 13,730,535 38,608,250
Income and sales tax payable - 472,839
Long-term debt 2,709,655 2,004,064
------------- -------------
Total long-term liabilities 16,440,190 61,085,153
------------- -------------
Commitments and contingencies
Minority interest - 1,427,442
------------- -------------
Shareholders' equity
Preferred stock, no par value, 3,000,000 shares authorized, no shares issued - -
Common stock, no par value, 30,000,000 shares authorized,
14,635,655 and 12,175,639 shares issued and outstanding 60,844,866 25,486,848
Accumulated other comprehensive loss (4,607,064) -
Retained earnings 45,983,553 28,121,541
------------- -------------
Total shareholders' equity 102,221,355 53,608,389
------------- -------------
Total liabilities and shareholders' equity $ 195,666,975 $ 155,504,902
------------- -------------
</TABLE>
See notes to financial statements
31
<PAGE>
VITECH AMERICA, INC.
Statement of Income
<TABLE>
<CAPTION>
Year Ended
December 31,
--------------------------------------------------
1998 1997 1996
-------------- ------------ ------------
<S> <C> <C> <C>
Net sales $ 195,334,579 $ 117,537,403 $ 73,321,398
Cost of sales 115,630,389 76,813,191 53,470,340
------------- ------------- ------------
Gross profit 79,704,190 40,724,212 19,851,058
Selling, general and administrative expenses 41,586,843 18,167,737 8,083,287
------------- ------------- ------------
Income from operations 38,117,347 22,556,475 11,767,771
------------- ------------- ------------
Other (income) expenses
Interest expense 17,021,670 6,416,206 1,466,773
Interest income (8,240,546) (1,866,222) (589,268)
Discount on sale of receivables 7,496,268 1,497,412 1,433,199
Foreign currency exchange losses 1,603,670 2,665,224 547,077
Other financing expenses 1,079,609 (36,000) -
------------- ------------- ------------
Total other expenses 18,960,671 8,676,620 2,857,781
------------- ------------- ------------
Income before provision for
income taxes and minority interest 19,156,676 13,879,855 8,909,990
Provision for income taxes 2,007,830 980,510 679,402
------------- ------------- ------------
Income before minority interest 17,148,846 12,899,345 8,230,588
Minority interest (713,166) 107,084 -
------------- ------------- ------------
Net income $ 17,862,012 $ 12,792,261 $ 8,230,588
------------- ------------- ------------
Earnings per common share - Basic:
Net income $ 17,862,012 $ 12,792,261 $ 8,230,588
Weighted common shares 13,166,157 11,924,422 9,144,114
Net income per common share $ 1.36 $ 1.07 $ 0.90
------------- ------------- ------------
Earnings per common share - Assuming dilution:
Net income $ 17,862,012 $ 12,792,261 $ 8,334,538
Weighted common shares 13,348,269 12,033,798 9,796,754
Net income per common share $ 1.34 $ 1.06 $ 0.85
------------- ------------- ------------
</TABLE>
See notes to financial statements
32
<PAGE>
VITECH AMERICA, INC.
Statement of Changes in Shareholders' Equity
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Accumulated
Number of Common Retained Comprehensive
Shares Stock Earnings Loss Total
---------- ------------ ------------ ------------- -----------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 8,800,000 $ 306,398 $ 7,098,692 $ - $ 7,405,090
Issuance of common stock for cash
in private placement in August
1996 ($1.36 per share) 15,014 20,472 - - 20,472
Issuance of common stock for
cash in initial public offering
in November 1996 ($9.09 per
share) 2,327,050 17,877,033 - - 17,877,033
Issuance of common stock for
conversion of note payable
in November 1996 652,641 2,000,000 - - 2,000,000
Net income - - 8,230,588 - 8,230,588
---------- ------------ ------------ ------------- -------------
Balance at December 31, 1996 11,794,705 $ 20,203,903 $ 15,329,280 $ - $ 35,533,183
Issuance of common stock for
cash from the exercise of warrants
in 1997 ($9.09 per share) 22,327 202,960 - - 202,960
Issuance of common stock for
acquisition of business in July
1997 ($12.73 per share) 212,145 2,700,000 - - 2,700,000
Issuance of common stock for
acquisition of businesses in
November 1997 ($16.25 per share) 146,462 2,379,985 - - 2,379,985
Net income - - 12,792,261 - 12,792,261
---------- ------------ ------------ ------------- -------------
Balance at December 31, 1997 12,175,639 $ 25,486,848 $ 28,121,541 $ - $ 53,608,389
Issuance of common stock for cash
from the exercise of warrants in
1998 ($9.09 per share) 2,200 20,000 - - 20,000
Issuance of common stock for cash
from the exercise of warrants in
1998 ($12.73 per share) 27,500 350,075 - - 350,075
Issuance of common stock for
conversion of notes payable in 1998
($14.40 average price per share) 2,430,316 34,987,943 - - 34,987,943
Net income - - 17,862,012 - 17,862,012
Foreign currency translation adjustment - - - (4,607,064) (4,607,064)
---------- ------------ ------------ ------------- -------------
Balance at December 31, 1998 14,635,655 $ 60,844,866 $ 45,983,553 $ (4,607,064) $ 102,221,355
---------- ------------ ------------ ------------- -------------
</TABLE>
See notes to financial statements
33
<PAGE>
VITECH AMERICA, INC.
Statement of Cash Flows
<TABLE>
<CAPTION>
Year Ended
December 31,
------------------------------------------------
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 17,862,012 $ 12,792,261 $ 8,230,588
Adjustments to reconcile net income to net cash provided
(used) in operating activities
Depreciation 2,662,489 1,184,707 263,800
Amortization of goodwill 924,949 321,369 -
Minority interest (713,166) 107,084 -
Provision for doubtful accounts 3,314,367 286,276 563,434
Provision for inventory obsolescence 914,546 - 181,566
Changes in assets and liabilities
Accounts receivable (39,980,910) (22,137,077) (15,164,106)
Inventories (6,919,044) (12,259,189) (5,997,069)
Deferred tax asset 669,000 (398,995) 102,530
Other assets (7,655,794) (4,855,932) (204,793)
Trade accounts payable 21,266,311 1,858,457 (4,484,367)
Accrued expenses 1,679,460 502,512 231,565
Due to/from officers 370,623 (298,411) (196,645)
Income and sales taxes payable 3,315,737 (1,333,389) 976,073
------------- ------------- -------------
Net cash provided (used) in operating activities 348,227 (24,230,327) (15,497,424)
------------- ------------- -------------
Cash flows from investing activities
Purchases of property and equipment (9,412,063) (6,597,303) (2,968,921)
Payment for business acquisitions, net of cash acquired (3,180,557) (10,376,969) -
Other investments (66,802) (398,440) (178,192)
------------- ------------- -------------
Net cash (used) in investing activities (12,659,422) (17,372,712) (3,147,113)
------------- ------------- -------------
Cash flows from financing activities
Deferred financing expense - (637,609) -
Net proceeds under short-term bank borrowings 6,877,589 13,443,649 (1,870,567)
Net payments of taxes payable (472,839) (230,236) -
Proceeds from notes payable - related party 5,000,000 5,000,000
Repayment of notes payable - related party (10,000,000) (1,911,917)
Proceeds from convertible note - related party 20,000,000 -
Proceeds from convertible notes (10,969,381) 38,608,250 -
Payment of note payable for business acquisition (2,260,222) (3,718,750) -
Proceeds from issuance of senior debentures - 1,365,000
Repayment of senior debentures - (1,365,000)
Proceeds from notes payable 7,918,173 768,225 1,191,564
Repayment of notes payable (886,549) (20,242)
Net proceeds from sale of common stock 370,075 202,960 17,897,505
------------- ------------- -------------
Net cash provided (used) by financing activities 1,463,395 62,549,940 20,286,343
Foreign exchange effect on cash and cash equivalents (1,500,000) - -
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents (14,985,447) 20,946,901 1,641,806
Cash and cash equivalents - beginning of year 22,704,632 1,757,731 115,925
------------- ------------- -------------
Cash and cash equivalents - end of year $ 7,719,185 $ 22,704,632 $ 1,757,731
------------- ------------- -------------
</TABLE>
See notes to financial statements
34
<PAGE>
VITECH AMERICA, INC.
Statement of Cash Flows (continued)
<TABLE>
<CAPTION>
Year Ended
December 31,
------------------------------------------------
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Supplemental disclosure of cash flow information
Cash paid during the year for
Interest and discount on sale of receivables $ 15,414,878 $ 6,836,325 $ 2,896,284
------------ ------------ -----------
Income taxes 351,552 $ 565,446 $ 852,119
------------ ------------ -----------
Supplemental schedule of non-cash investing and financing activities
Conversion of note payable to 652,641 shares of common stock $ - $ - $ 2,000,000
------------ ------------ -----------
Conversion of notes payable to 2,430,316 shares of common stock $ 34,154,500 $ - $ -
------------ ------------ -----------
Property and asset received in exchange for outstanding accounts
receivable $ - $ - $ 1,517,257
------------ ------------ -----------
Investment in property and equipment through financing agreements $ 2,122,330 $ 871,503 $ -
------------ ------------ -----------
Issuance of common stock and a note payable for the acquisitions
of subsidiaries $ - $ 11,029,985 $ -
------------ ------------ -----------
</TABLE>
See notes to financial statements
35
<PAGE>
VITECH AMERICA, INC.
Notes to Financial Statements
December 31, 1998
Note 1 - Organization and principal industry
Vitech America, Inc. (the "Company"), a Florida corporation, was incorporated in
June 1993. The Company, through its subsidiaries, is engaged in the manufacture
and sale of computer equipment and related products. On March 7, 1995, the
majority shareholders of the Company formed Bahiatech Bahia Tecnologia, Ltda.
("Bahiatech") and on October 12, 1995, the Company acquired a 99% interest in
Bahiatech. Bahiatech, located in Ilheus, Bahia, Brazil, is engaged in the
manufacture and sale of computer and electronic equipment and their components.
On July 10, 1997, the Company acquired a 94.4% interest in Microtec Sistemas
Industria e Comercio S.A. ("Microtec"). Microtec, located in Sao Paulo, Brazil,
is engaged in the manufacture and sale of computers and related products. In
September 1998, the Company acquired an additional 4.1% interest in Microtec to
bring its total ownership interest up to 98.5%. In November 1997, the Company
acquired a controlling interest in Techshop Ltda., Tech Stock Ltda. and Rectech
- - Recife Tecnologia Ltda., all of which are located in Brazil and are engaged in
the distribution and retail sale of computers and related equipment. In December
1998, the Company acquired an additional interest in Techshop Ltda., Tech Stock
Ltda. and Rectech - Recife Tecnologia Ltda., to bring its ownership interest up
to 99% for each.
All of the sales of the Company are concentrated in Brazil, with approximately
0%, 9% and 38% to one unrelated customer in 1998, 1997 and 1996, respectively,
and 11% to Vitoria Tecnologia S.A. ("Vitoria"), an affiliate through common
ownership, in 1996.
On June 15, 1998, the Board of Directors of the Company, approved a 10% common
stock dividend to be distributed to shareholders of record of the Company's
common stock as of July 13, 1998. The common stock issued as a result of this
stock dividend was distributed on July 27, 1998. All references in this report
to the common stock of the Company and net income per common share have been
recalculated to reflect the 10% common stock dividend.
Note 2 - Summary of significant accounting policies
Principles of consolidation
The consolidated financial statements include the accounts of the Company and
its majority owned subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation.
Use of estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during reporting
periods. Actual results could differ from these estimates.
Cash and cash equivalents
The Company considers all highly liquid investments with an original maturity of
three months or less at the time of acquisition to be a cash equivalent. The
Company maintains its cash in bank deposit accounts which, at times, may exceed
federally insured limits. The Company has not experienced any losses in such
accounts. The Company believes it is not exposed to any significant credit risk
on cash and cash equivalents.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method or
average cost method) or market. Inventories consist primarily of components and
subassemblies and finished products held for sale. Rapid technological change
and new product introductions and enhancements could result in excess or
obsolete inventory. To minimize this risk, the Company evaluates inventory
levels and expected usage on a periodic basis and records adjustments as
required.
36
<PAGE>
Certain components and products that meet the Company's requirements are
available from a limited number of suppliers. The rapid rate of technological
change and the necessity of developing and manufacturing products with short
life-cycles may intensify these risks. The inability to obtain components and
products as required, or to develop alternative sources, if and as required in
the future, could result in delays or reductions in product shipments, which in
turn could have a material adverse effect on the Company's business, financial
condition, and results of operations.
Disclosure about fair value of financial instruments
The carrying amount of the Company's financial instruments is a reasonable
approximation of fair value, except for related party debt which is not
practical to estimate as no similar market exists for these instruments.
Property and equipment
Property and equipment are stated at cost. The cost of maintenance and repairs
is charged against results of operations as incurred. Depreciation is computed
over the estimated service lives of the related assets using the straight-line
method. When assets are retired or otherwise disposed of, the cost and
accumulated depreciation are removed from the respective accounts and any gain
or loss is recognized.
Revenue recognition
The Company's policy is to record revenues upon transfer of title to the
customer. Title transfers to the customer upon receipt of the merchandise by the
customer.
In 1997, the Company implemented an accounting policy whereby it discounts all
of the sales associated with its "10X" consumer financing program using a
present value calculation with an imputed annual rate of 15%. Such 10X program
enables customers to enter into a consumer contract with the Company whereby the
customer makes equal monthly payments over a specified term ranging from 2 to 24
months. The discounted portion of such revenues is then recognized over the
remaining term of the contract.
Goodwill
Goodwill, representing the excess of the cost over the net tangible and
identifiable assets of acquired businesses, is stated at cost and is amortized,
on a straight-line basis, over the estimated future periods to be benefited
(20yrs.). On an annual basis, the Company reviews the recoverability of goodwill
based primarily upon an analysis of undiscounted cash flows from the acquired
businesses. At December 31, 1998 and 1997 the accumulated amortization of
goodwill was $1,246,318 and $321,369, respectively.
Investments
Investments include land held for development which is carried at cost and is
comprised of undeveloped parcels near Ilheus, Bahia, Brazil.
Research and development
Research and product development costs are expensed as incurred. For the years
ended December 31, 1998, 1997 and 1996, research and development expenses
amounted to $1,736,000, $1,346,000, and $0, respectively.
Income taxes
The Company applies the asset and liability approach to financial accounting and
reporting for income taxes. The difference between the financial statement and
tax bases of assets and liabilities is determined annually. Deferred income tax
assets and liabilities are computed for those differences that have future tax
consequences using the currently enacted tax laws and rates that apply to the
period in which they are expected to affect taxable income. Valuation allowances
are established, if necessary, to reduce the deferred tax asset to the amount
that will more likely than not be realized. Income tax expense is the current
tax payable or refundable for the period plus or minus the net change in the
deferred tax assets and liabilities.
Bahiatech operates in the North-east region of Brazil and enjoys an exemption
from income taxes through and including the year 2004. Bahiatech is entitled to
an exemption from income taxes on the Brazilian operating profit ("Lucro da
37
<PAGE>
Exploracao") once twenty percent of the budgeted production goals in units are
met in each year during the exemption period. This benefit is reported as a
reduction of income tax expense for the period in which earned.
Net income per share
Basic and diluted earnings per share ("EPS") are calculated in accordance with
SFAS 128, "Earnings Per Share". Basic EPS is computed by dividing reported net
income by the weighted average shares outstanding. Diluted EPS assumes the
conversion of outstanding convertible debt and the dilutive effect of stock
options and warrants. The following table sets forth the computation of basic
and diluted earnings per share:
<TABLE>
<CAPTION>
Year Ended
December 31,
---------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net income for basic
income per common share $ 17,862,012 $ 12,792,261 $ 8,230,588
Adjustments to net income (a)(b) - - 103,950
------------ ------------ ------------
Net income for diluted
income per common share $ 17,862,012 $ 12,792,261 $ 8,334,538
------------ ------------ ------------
Weighted average number of shares
for basic income per share 13,166,157 11,924,422 9,144,114
Dilutive securities:
Stock options 142,515 81,746 -
Warrants 39,597 27,630 -
Convertible debt (a)(b) - - 652,640
------------ ------------ ------------
Weighted average number of shares
for diluted income per share 13,348,269 12,033,798 9,796,754
------------ ------------ ------------
Net income per common share:
Basic $ 1.36 $ 1.07 $ 0.90
------------ ------------ ------------
Assuming Dilution $ 1.34 $ 1.06 $ 0.85
------------ ------------ ------------
</TABLE>
(a) For the years ended December 31, 1998 and 1997, the effects on earnings
per share of the 10% convertible notes (see notes 12 and 13), which are
convertible into 930,369 and 3,990,447 shares of common stock,
respectively, would have been antidilutive and therefore are not
included in the above computation.
(b) The year ended December 31, 1996 include the effects of a 9%
convertible note.
For the year ended December 31, 1998, there were 3,300,000 outstanding stock
options not included in the computation of diluted earnings per share of common
stock because the options' exercise prices were greater than the average market
price of the common shares. For 1997, there were 3,326,400 outstanding stock
options not included in the computation of diluted earnings per share of common
stock because the options' exercise prices were greater than the average market
price of the common shares. In 1996, there were 4,477,000 outstanding stock
options and 250,025 warrants not included in the computation of diluted earnings
per share of common stock because the options and warrants' exercise prices were
greater than the average market price of the common shares
Translation into U.S. dollars
The financial statements of the Company have been prepared in accordance with
U.S. generally accepted accounting principles and are stated in U.S. dollars.
Until December 31, 1997, amounts in Brazilian currency were remeasured into U.S.
Dollars in accordance with the methodology set forth in Statement of Financial
Accounting Standards No. 52 ("SFAS 52") as it applies to entities operating in
highly inflationary economies. The assets and liabilities of the Company's
subsidiaries were translated into U.S. dollars at exchange rates in effect at
the balance sheet date for monetary items and at historical rates for
38
<PAGE>
nonmonetary items. Revenue and expense accounts are translated at the average
exchange rate in effect during each month, except for those accounts that relate
to nonmonetary assets and liabilities which are translated at historical rates.
Effective January 1, 1998, the Company determined that Brazil ceased to be a
highly inflationary economy under SFAS 52. Accordingly, as of January 1, 1998,
the Company began using the Brazilian currency, the Real, as the functional
currency of its Brazilian subsidiaries. As a result, all assets and liabilities
are translated into dollars at period end exchange rates and all income and
expense items are translated into U.S. dollars at the average exchange rate
prevailing during the period. Any translation adjustments are reflected as a
component of shareholders' equity. In addition, the Company recorded a currency
exchange transaction loss associated with dollar-denominated monetary assets and
liabilities held by the Company's Brazilian subsidiaries.
Exemption of value added tax (ICMS)
Bahiatech is exempt from ICMS (Value Added Tax) on imported materials and
components, and on the sales of the finished products arising from such raw
materials through and including the year 2003. The benefits are reflected in
sales and cost of sales.
International operations
The Company operates in one industry segment (the manufacture and distribution
of computer and electronic equipment and related products) and manufactures and
markets its products and services through its foreign subsidiaries located in
Brazil. As a result, principally all of the Company's sales and operations are
subject to certain risks, including adverse developments in the foreign
political and economic environment, exchange rates, tariffs and other trade
barriers, staffing and managing foreign operations and potentially adverse tax
consequences. There can be no assurance that any of these factors will not have
a material adverse effect on the Company's financial condition or results of
operations in the future. During 1998 and 1997, the Company did not enter into
any significant foreign exchange contracts as a hedge against exposures to
fluctuations in currency exchange rates associated with its foreign
subsidiaries. See Note 19 - Subsequent events.
Stock-based compensation
The Company accounts for its stock option plan in accordance with Accounting
Principles Board Opinion No. 25 (APB Opinion No. 25) and related
interpretations. The Company adopted the disclosure provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," (SFAS 123) in 1996. The Company has included in note 13, the
impact of the fair value of employee stock-based compensation plans on net
income and earnings per share on a pro forma basis for awards granted.
Comprehensive Income
The Company adopted Statement of Financial Accounting Standards No. 130 ("SFAS
130"), "Reporting Comprehensive Income" during the year ended December 31, 1998.
SFAS 130 establishes new rules for the reporting and presentation of
comprehensive income and its components. The Company's comprehensive income is
comprised of net income adjusted for foreign currency translation. For the year
ended December 31, 1998, comprehensive income was $13.3 million as compared to
reported net income of $17.9 million. Comprehensive income includes a cumulative
translation adjustment of $4.6 million associated with the translation of the
Company's subsidiary financial statements to the US dollar. For the years ended
December 31, 1997 and 1996, comprehensive income and reported net income were
the same.
Segment data
During 1998, the Company adopted SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information." SFAS No. 131 supercedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise", replacing the
"industry segment" approach with the "management" approach. The management
approach designates the internal reporting that is used by management for making
operating decisions and assessing performance as the source of the Company's
reportable segments. SFAS 131 also requires disclosures about products and
services, geographic areas and major customers. The adoption of SFAS 131 did not
affect the consolidated financial position or results of operations of the
Company. Management has determined it operates in one industry segment.
39
<PAGE>
New Accounting Pronouncements
In June of 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" which is
effective for fiscal years beginning after June 15, 1999. The objective of the
statement is to establish accounting and reporting standards for derivative
instruments and hedging activities. The Company may use foreign currency forward
contracts, a derivative instrument, to hedge foreign currency transactions and
anticipated foreign currency transactions. The adoption of this new accounting
pronouncement is not expected to be material to the Company's consolidated
financial position or results of operations.
In 1998, the Accounting Standards Executive Committee (AcSEC) issued Statement
of Position ("SOP") No. 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," which is effective for fiscal years
beginning after December 15, 1998. The SOP provides guidance on when costs
incurred for internal-use computer software are and are not to be capitalized,
and on the accounting for such software that is marketed to customers. The
adoption of this SOP is not expected to have a material impact on the Company's
consolidated financial position or results of operations.
The Financial Accounting Standards Board issued Statement 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,"
in June 1996. Statement 125 was effective for transfers and servicing of
financial assets and extinguishment of liabilities occurring after December 31,
1996, and the Company adopted it in the first quarter of 1998, since the Company
did not have transactions of this nature prior to 1998. Statement 125 provides
guidance in determining whether a transfer of a financial asset represents a
sale or a secured borrowing, as well as the accounting for any servicing assets
retained. The Statement also provides guidance relating to extinguishment of
liabilities by debtors. (See Notes 4 and 5)
Note 3 - Related party transactions
The Company made sales to Vitoria Tecnologia S.A., an entity related through
common ownership, during 1996 in the amount of $8,066,878. Additionally, during
1996, the Company purchased $4,181,727 of inventory from Vitoria.
As discussed in notes 7 and 11, the Company has outstanding debt obligations to
a related party.
During 1996, the Company's subsidiary sold to an affiliate $12,070,738 of its
trade accounts receivable for $10,637,539 and accordingly, recognized a discount
on the sale in the amount of $1,433,199 which is reflected in the accompanying
statement of income.
During 1998, the Company bought and sold products and services from/to ITC.net,
an entity related through common ownership, valued in the amount of
approximately $1.1 million. As of December 31, 1998, the Company had a payable
outstanding to ITC.net of $329,548 which is included in trade accounts payable.
Additionally, during 1998, the Company entered into a joint marketing agreement
with ITC.net, whereby the two companies will cross sell each others products. In
consideration for the joint marketing agreement, ITC.net granted to the
Company's shareholders of record date March 1, 1999, warrants to purchase one
share of ITC.net common stock for every share of the Company owned by the
shareholder. The warrants have an exercise price of $0.15 per share and are
non-exercisable and non-transferable until such time that there is an effective
registration statement covering the securities of ITC.net.
Note 4 - Accounts receivable
Accounts receivable as of December 31 consisted of the following:
1998 1997
------------ ------------
Consumer receivables - Class I (a) $ 18,553,473 $ 12,115,838
Consumer receivables - Class II (b) 3,500,427 12,403,825
Trade accounts receivables 59,340,035 36,803,916
------------ ------------
81,393,935 61,323,579
Allowance for doubtful accounts (5,500,078) (2,185,710)
------------ ------------
$ 75,893,857 $ 59,137,869
------------ ------------
40
<PAGE>
Consumer receivables are receivables generated through the Company's 10X plan
which enables customers to enter into a consumer contract with the Company
whereby the customer makes equal monthly payments over a specified term ranging
from 2 to 24 months. Such consumer receivables are categorized as follows:
(a) Class I consumer receivables represent accounts receivable for
which the Company has received post dated checks to be held for
deposit. Such post dated checks are applied against the receivable
and held as a security interest until the maturity of the
receivable.
(b) Class II consumer receivables represent consumer contracts which
specify payment on certain dates over the maturity of the
contract.
Trade accounts receivable represent normal trade receivables generated through
commercial sales at various terms ranging from 0 to 180 days.
In April 1998, the Company entered into an accounts receivable financing program
with Technology Acceptance Corp. ("TAC"), an independently owned special purpose
corporation, whereby the Company's subsidiary, Bahiatech, may sell certain of
its accounts receivable to TAC. The program is a $150 million collateralized
global medium term note program whereby TAC may issue notes which are
collateralized by the purchased accounts receivable. TAC is an exempted company
incorporated under the laws of the Cayman Islands. One hundred percent (100%) of
TAC's voting shares are held by a Cayman Islands trust. TAC is a special purpose
company that was established solely to participate in the securitization, to
acquire and hold the designated receivables and to issue collateralized global
medium term notes under a note program. TAC has covenanted in the indenture
pursuant to which the notes are issued not to engage in any activities other
than those contemplated by the indenture. The receivables constitute the
principal asset of TAC.
During the year ended December 31, 1998, the Company completed the sale of an
aggregate amount of approximately $140 million of its accounts receivable to TAC
at a discount of approximately $7.5 million for cash and a subordinated
debenture. The subordinated debenture is a revolving non-interest bearing bearer
note. (See Note 5)
There is a repurchase provision whereby Bahiatech is required to repurchase the
receivables sold to TAC under certain circumstances including default under the
program, delinquencies or violations of certain concentration limits. The
repurchase obligation may be satisfied by transferring to TAC, for no additional
consideration, an aggregate amount of additional receivables the net present
value of which is equal to the repurchase price. If the net present value of the
receivables available to Bahiatech to effect such substitution is less than the
relevant repurchase price thereof, then Bahiatech will be required to pay in
cash the excess of the repurchase price over the net present value of the
additional receivables transferred to TAC pursuant to such substitution. The
Company serves as guarantor of the repurchase obligation. If Bahiatech fails to
comply in full with its repurchase obligation on or prior to the relevant
repurchase date, the Company shall be required to deposit, within twenty-four
(24) hours of such expired required repurchase date, the amount of the
repurchase price not paid by Bahiatech. As a result of the structure of the
program, there is a contingent liability in the amount of approximately $60.9
million which represents the balance as of December 31, 1998, at face value, of
the accounts receivable sold to TAC. The Company maintains an allowance for
doubtful accounts on its balance sheet with respect to the sold receivables.
Note 5 - Investment in subordinated debentures
In connection with the TAC financing program whereby the Company receives cash
and subordinated debentures (which represents its retained interest in the
program) in consideration for the sale of its accounts receivable to TAC, the
Company has an investment in subordinated debentures at December 31, 1998 as
follows:
Current portion $ 14,676,585
Long term portion 2,677,906
------------
Total $ 17,354,491
------------
The subordinated debentures are U.S. dollar denominated, non-interest bearing
bearer notes that are subordinated to the senior notes issued by TAC and arise
from the overcollateral amount and the unpaid principal amount of each series of
senior notes outstanding. The financing program requires a minimum
overcollateral ratio, as defined, of 125%. With the exception of amounts payable
to it on any excess overcollateral date, as defined, the bearer of the debenture
will not be entitled to receive any payment until the final termination date, as
defined, of the program. The overcolleral ratio of the program at December 31,
1998 was approximately 127%.
41
<PAGE>
In January 1999, the Brazilian government allowed its currency, the Real, to
trade freely against other foreign currencies, which resulted in an immediate
devaluation of the Real against the U.S. dollar. With the post devaluation
exchange rates of the Real to the U.S. dollar the overcollateral ratio fell
below its required minimum which caused trigger and default events, as defined,
of the TAC program. As a result, the Company is currently not selling any of its
accounts receivable to TAC, and may not, other than pursuant to its repurchase
obligation.
TAC has made a proposal to the holders of TAC notes for temporary and permanent
adjustments to the structure of the TAC program inorder to allow the TAC program
to operate more effectively in the post devaluation environment. While the
Company continues to believe that TAC could continue to be a viable financing
source, should TAC fail to gain consensus among the holders of TAC notes
concerning its proposal or should the macroeconomic conditions fail to recover,
then the Company may choose not to sell any additional accounts receivable to
TAC, other than pursuant to its repurchase obligation.
Note 6 - Inventories
Inventories as of December 31 are summarized as follows:
1998 1997
------------ ------------
Consigned inventories $ - $ 3,961,748
Finished goods 8,962,317 11,338,211
Work in process 893,905 2,457,381
Components in the factory 22,886,048 14,163,444
Components in transit (a) 9,039,315 2,942,757
------------ ------------
41,781,585 34,863,541
Less allowance for obsolescence (1,430,000) (516,454)
------------ ------------
$ 40,351,585 $ 34,347,087
------------ ------------
(a) Components in transit consist of inventories in the Company's Miami,
Florida facility and inventories in route to the Company's factories in
Brazil.
Note 7 - Property and equipment
Property and equipment is summarized as follows:
1998 1997
------------ ------------
Property $ 3,889,000 $ 1,025,487
Furniture, office and transportation
equipment 8,198,197 4,906,174
Warehouse and manufacturing equipment 7,029,570 3,902,086
Computers and telecommunications equipment 4,066,794 3,742,926
Construction in progress and projects 1,604,519 1,306,910
------------ ------------
24,788,080 14,883,583
Less accumulated depreciation (5,091,980) (1,937,060)
------------ ------------
$ 19,696,097 $ 12,946,523
------------ ------------
The Company leases equipment under capital leases (See Note 10). As of December
31, 1998 and 1997, the cost of such equipment approximated $2,900,000 and
$870,000 respectively.
Note 8 - Notes payable - related party
The Company had the following note payable to an affiliate of the majority
shareholders' at December 31, 1998 and 1997:
1998 1997
----------- ----------
Promissory note payable, due on demand bearing
Interest at 15% $ 6,700,000 $ -
Additionally, in April 1997, an affiliate of the majority shareholders' loaned
the Company $5,000,000. The loan was evidenced by a promissory note bearing
interest at the rate of 20% per annum and had a term of 180 days. The note was
repaid in full in October 1997 from the proceeds of a convertible note issuance
(see note 12).
42
<PAGE>
During 1998, 1997 and 1996, the Company incurred interest expense of $77,424,
$1,265,754 and $38,356, respectively, in connection with these obligations.
Note 9 - Short-term debt
Short-term debt consists of the following at December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
------------ -------------
<S> <C> <C> <C>
Short-term bank loans denominated in Brazilian currency
bearing interest rates averaging 2.5% per month (2.6% per
month in 1997) and maturing on a revolving basis $ 11,629,143 $ 3,575,490
Short-term bank loans denominated in US dollars,
bearing interest rates averaging 1% per month and maturing
on a revolving basis 13,407,393 14,612,429
Note payable for the acquisition of Microtec maturing in
March 1998 - 2,231,250
------------ -------------
$ 25,036,536 $ 20,419,169
------------ -------------
</TABLE>
Weighted average interest rate on short-term borrowing amounted to approximately
1% and 1.8% per month for the years ended December 31, 1998 and 1997,
respectively.
As of December 31, 1998, the Company had approximately $9,500,000 ($5,800,000 as
of December 31, 1997) of its accounts receivable in guarantee of short-term
debt. As of December 31, 1998, the Company had available approximately $8
million in unused credit facilities at various banks in Brazil at rates of
approximately 2.5% per month and subject to certain collateral requirements as
defined.
Note 10 - Long-term debt
Long-term debt at December 31, 1998 and 1997 is summarized as follows:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Construction loan payable (a) $ 623,305 $ 757,664
Note payable maturing October 1999 which requires monthly
payments of $10,503 applied first to interest at 6.67% per
annum and the balance to reduction of principal 92,074 207,962
Notes payable for working capital and fixed asset purchases
maturing in January1999 with interest averaging 20%
per annum - 478,276
Note payable maturing September 2001 which requires quarterly
payments of $13,075 applied first to interest at 10.5% per
annum and the balance to reduction of principal 123,529 160,408
Note payable maturing August 2001 which requires monthly
payments of $750 applied first to interest at 9.9% per
annum and the balance to reduction of principal 20,578 27,161
Capital leases payable (b) 1,622,621 86,032
Others 1,090,569 637,000
----------- -----------
3,572,676 2,354,503
Less current maturities (863,021) (350,439)
----------- -----------
$ 2,709,655 $ 2,004,064
----------- -----------
</TABLE>
43
<PAGE>
(a) In August 1996 Bahiatech entered into a loan credit facility totaling
$3,405,329, comprised of a working capital line of credit of $757,664
and a construction loan credit facility of $2,619,484 to be utilized
for the construction of a new manufacturing and administrative plant in
Ilheus, Brazil. The working capital facility, which has been drawn
down, bears interest at the Brazil Central Bank rate for long-term
debts plus 7% (at December 31, 1998 approximately 25%). The terms of
this facility are currently being renegotiated. During 1998 and 1997,
there were no additional borrowings under the facility. Interest on the
working capital portion is being paid quarterly. The credit facilities
are guaranteed by a first mortgage lien on the new plant, a lien on
land held for development located in Ilheus, Bahia and the personal
guarantees of the two principal officers of the Company.
(b) In March 1998, the Company entered into a capital lease for $1,200,000
for the purchase of manufacturing equipment. The capital lease has a
term of 60 months, bears an adjustable interest rate (currently 9.9%)
and requires a monthly payment of $25,437. In October 1998, the Company
entered into a capital lease for $529,105 for the acquisition of
equipment. The capital lease has a term of 3 years and bears an annual
interest rate of 9.7% and requires quarterly payments of $51,000.
Maturities of long-term debt at December 31, 1998 are as follows:
Year ending
December 31,
------------
1999 $ 863,021
2000 1,139,856
2001 956,367
2002 413,078
2003 200,354
-----------
$ 3,572,676
-----------
Note 11 - Income taxes
The components of the provision for income taxes are as follows:
1998 1997 1996
---------- ---------- -----------
Current
Federal $ - $ 39,342 $ (140,770)
State - - -
Foreign 1,338,830 989,718 717,642
----------- ----------- -----------
1,338,830 1,029,060 576,872
----------- ----------- -----------
Deferred
Federal - - 92,652
State - - 9,878
Foreign 669,000 (48,550) -
----------- ----------- -----------
669,000 (48,550) 102,530
----------- ----------- -----------
$ 2,007,830 $ 980,510 $ 679,402
----------- ----------- -----------
There were no material reconciling items between the U.S. Federal Statutory tax
rate and the effective tax rate on U.S. based income. In 1996, the Company
carried back a current year operating loss to recover U.S. Federal income taxes
paid in prior years.
Included in the accompanying balance sheet at December 31, 1998, is a
non-current deferred tax asset of $1,567,000 and a current deferred tax
liability of $1,041,000 related to the operations of Microtec. Included in the
accompanying balance sheet at December 31, 1997, is a current deferred tax asset
of $702,000 and a non-current deferred tax asset of $493,000 related to the
operations of Microtec. Deferred income taxes reflect the effects of (a)
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes
calculated using enacted rates in effect in the years in which the differences
are expected to reverse and (b) tax-loss carryforwards.
44
<PAGE>
Principal components of deferred tax assets and liabilities included in the
balance sheet at December 31, 1998 and 1997 are as follows:
1998 1997
------------ ----------
Deferred tax assets (liabilities)
Net operating loss carryforward $ 1,567,000 $ 493,000
Operating costs currently not deductible 925,000 1,105,000
Revenues currently not taxable (1,966,000) (403,000)
------------ -----------
Net tax deferred assets $ 526,000 $ 1,195,000
------------ -----------
Although the realization of the net deferred tax asset is not assured,
management believes such realization is more likely than not to occur. The
amount of the deferred tax asset considered realizable, however, could be
reduced in the near term if estimates of future taxable income during the
carryforward period should be reduced.
At December 31, 1998, Microtec had tax loss carryforwards of $4,803,000 with no
expiration date.
The Brazilian federal statutory income tax rate varies according to the level of
income and to the taxes and levies applicable to any one year. The federal
statutory income tax rate applicable to the subsidiary is a composite rate
approximating 33% for 1998 and 1997. This rate includes a 8% federal levy on net
income, sometimes referred to as Social Contribution. The difference from the
effective tax rate and the composite rate relates to the income tax exemption of
Bahiatech as described in note 2.
As of December 31, 1998 and 1997, the Company has not provided for withholding
or U.S. federal income taxes on accumulated undistributed earnings of its
foreign subsidiaries as the Company does not intend to distribute such earnings
in the foreseeable future. The cumulative undistributed earnings of the
Company's foreign subsidiaries amounted to $39,430,996 and $27,874,495 at
December 31, 1998 and 1997, respectively. See note 14.
Note 12 - Convertible notes - related party
On June 26, 1997, the Company completed a private placement of a two year senior
convertible note to Georges C. St. Laurent Jr., ("GSL Jr."), the father of
Georges C. St. Laurent III, the Chairman of the Board and Chief Executive
Officer of the Company, and William St. Laurent, the President and Chief
Operating Officer of the Company, for the principal amount of $10 million. The
note accrued interest at an annual rate of 10% payable monthly and was
convertible into Common Stock, in whole or in part, at the rate of one share of
Common Stock for each $13.64 of principal converted. The proceeds of the note
were used for the acquisition of Microtec and for general working capital
purposes. On July 15, 1998, GSL Jr. converted such note into an aggregate of
755,333 shares of Common Stock, which included 22,000 shares as an incentive for
GSL Jr. to convert such note.
On August 19, 1997, the Company entered into a loan agreement with GSL Jr. for a
principal amount of up to $10,000,000 to be evidenced by senior convertible
notes. The notes had a two year term and accrued interest at an annual rate of
10% payable monthly and were convertible into Common Stock, in whole or in part,
at the rate of one share of Common Stock for each $14.64 of principal converted.
On August 19, 1997, the Company issued the first of such notes for the principal
sum of $5,000,000. On October 10, 1997, the Company issued the second of such
notes for the principal sum of $5,000,000. The proceeds of the notes were used
for general working capital purposes. The Company registered the resale of the
shares of Common Stock issuable upon conversion. On July 15, 1998, GSL Jr.
converted such notes into an aggregate of 703,727 shares of Common Stock, which
included 21,497 shares as an incentive for GSL Jr. to convert such notes.
During the year ended December 31, 1998, the Company recorded a financing
expense of $706,500 for the issuance of the additional shares included as an
incentive for GSL Jr.'s conversion of these notes.
Note 13 - Convertible notes
On October 10, 1997, the Company completed a private placement of three year 10%
convertible promissory notes (the "Notes") resulting in gross proceeds to the
Company of $20,000,000. The private placement was between the Company and four
institutional investors. The Notes are convertible at a conversion price of
$15.00 subject to stock-splits, stock dividends, rights offering other similar
events. In the event that the Company shall have declined to repay in full,
following the exercise by noteholders of the First or Second Put Right (as
defined below), the Initial Conversion Price shall be (i) the lesser of .85
multiplied by the 10-day weighted average sale price on Nasdaq as reported by
Bloomberg, LP (or other principal exchange on
45
<PAGE>
which the Company's securities are traded) for the lowest 10-day consecutive
period during the 30 consecutive trading day period ending one trading day prior
to the conversion date or (ii) $15.00 per share. The net proceeds of this
offering were used for the repayment of $10 million of 20% notes payable to GSL
Jr., for the purchase of Microtec and for general corporate and working capital
purposes.
Beginning October 10, 1998 and continuing for a period of 30 days thereafter,
each noteholder shall have the right ("First Put Right") to request the Company
to repurchase all, but not less than all of the outstanding Notes held by such
holder at a price equal to 110% of the principal amount thereof, plus accrued
and unpaid interest thereon. Commencing 180 days after the First Put Date and
continuing for a period of 30 days thereafter, each Noteholder shall have a
second right (the "Second Put Right") to request the Company to repurchase all,
but not less than all of the outstanding Notes at a price equal to 115% of the
principal amount thereof plus accrued and unpaid interest thereon. The purchase
price for any Put Right shall be paid in four equal monthly installments on the
last business day of each month commencing on the first full month following the
put notice with respect to the applicable First or Second Put Right, with
interest on each installment at the rate of 10% per annum. The Company shall
have the right at any time from time to time commencing on October 10, 1998 to
purchase 8.33% of the Notes in any one month from any holder at a call price
equal to 112% of the principal amount, plus accrued and unpaid interest thereon,
provided that such call price shall increase by 1% on the 10th day of each
subsequent month until October 10, 1999.
In July 1998, holders of the Notes converted $400,000 in principal amount, plus
accrued interest, into 26,780 shares of Common Stock. On October 31, 1998, the
Company called and repurchased an aggregate principal amount $1,632,680 of the
Notes at a call price of 112% of the principal amount. On October 31, 1998, the
holders of the Notes exercised their First Put Right and requested the Company
to repurchase the remaining aggregate principal amount of $17,967,320 of the
Notes at a put price equal to 110% of the principal amount. In accordance with
the terms of the Notes, the Company was to pay the put price in four equal
monthly installments commencing November 30, 1998, with interest on each
installment accruing at the rate of 10% per annum. The Company made the first
two of such payments on November 30, 1998 and December 31, 1998. In February
1999, the Company entered into an agreement with the holders of the Notes to
repay the remaining principal outstanding on the Notes over a five month period
commencing March 31, 1999, with monthly principal payments of approximately $2
million plus accrued interest.
Additionally, on October 10, 1997, the Company completed the issuance of an
additional $18,608,250 of three year 10% convertible notes. The notes were
issued in a private placement transaction to 52 accredited investors. The net
proceeds from such offering were used for the expansion of inventory, the
increase of manufacturing capacity and for the repayment of short-term debt to
Brazilian banks. This offering, which was not conditioned on completion of the
previously described offering of Notes, provided for the issuance of convertible
notes containing substantially the same terms and conditions of the Notes as set
forth above, including the First and Second Put Right. The Company has
registered the resale of the shares of Common Stock issuable upon conversion. In
July 1998, certain holders of these notes converted $13,754,500 in principal
amount into an aggregate of 944,476 shares of Common Stock, which included
27,509 shares as an incentive for the noteholders to convert. For the year ended
December 31, 1998, the Company recorded a financing expense of $373,000 for the
issuance of the additional shares included as an incentive for conversion of
these notes. On October 1, 1998, holders of an aggregate principal amount of
$913,750 of such notes exercised their right to request the Company to
repurchase their notes at a price equal to 110% of the principal amount. In
accordance with the terms of the notes, the Company paid for the repurchase of
the notes in four equal monthly installments, with interest on each installment
accruing at the rate of 10% per annum.
During the year ended December 31, 1998, the Company recorded a financing
expense of $373,109 for the issuance of the additional shares included as an
incentive for the conversion of these notes.
The Company incurred fees and expenses equal to approximately 1.75% of the gross
proceeds of the offerings, of which approximately $125,000 was paid to a
director of the Company, and issued warrants to purchase 219,443 shares of the
Company's Common Stock.
In September 1998, the Company issued a 3 year convertible note for the
principal sum of $450,000. The convertible note bears interest at the annual
rate of 10% and is convertible into common shares of the Company at the rate of
$10 per share. The proceeds of the convertible note were used for the
acquisition of the minority interest of Microtec.
46
<PAGE>
Note 14 - Shareholders' equity
Common stock
Information on warrants is shown in the following table:
<TABLE>
<CAPTION>
Warrants Warrants Price Weighted
Outstanding Exercisable Range Average Price
----------- ----------- -------------- -------------
<S> <C> <C> <C> <C>
Balances at December 31, 1995 - - $ - $ -
Granted in 1996 30,026 30,026 9.09 9.09
Granted in 1996 220,000 - 12.73 12.73
------- ------- -------------- -------
Balances at December 31, 1996 250,026 30,026 9.09 - 12.73 12.27
Granted in 1997 241,387 241,387 15.00 15.00
Became exercisable - 220,000 12.73 12.73
Warrants exercised (22,326) (22,326) 9.09 9.09
------- ------- -------------- -------
Balance at December 31, 1997 469,087 469,087 $ 9.09 - 15.00 $ 13.62
Granted in 1998 - - - -
Became exercisable - - - -
Warrants exercised (29,700) (29,700) 9.09 - 12.73 12.46
------- ------- -------------- -------
Balance at December 31, 1998 439,387 439,387 $ 9.09 - 15.00 $ 13.94
------- ------- -------------- -------
</TABLE>
Of the warrants outstanding, 5,500 expire in November 1999, 192,500 expire in
November 2001, and 241,387 expire in October 2002.
Subsidiary retained earnings and dividends
At December 31, 1998 and 1997, shareholders' equity consisted of $46,335,016 and
$27,874,495, respectively, in retained earnings generated from the operations of
the Company's subsidiaries. Of these amounts $46,631,976 and $26,941,252,
respectively, were generated from the operations of Bahiatech. Bahiatech is
exempt from the payment of Brazilian federal income tax through and including
the year 2004. Tax exemption benefits cannot be distributed as dividends to the
Company in U.S. dollars and are segregated for capital reserves and offsetting
accumulated losses in accordance with Brazilian law. For the years ended
December 31, 1998, 1997 and 1996 the tax exemption benefits amounted to
approximately $5,600,000 ($0.42 per share), $3,000,000 ($0.25 per share) and
$2,200,000 ($0.22 per share), respectively.
In the future, should Bahiatech wish to remit retained earnings in excess of the
tax exemption benefits, it may do so only in the Brazilian currency, the Reais,
convertible into U.S. dollars in the floating rate exchange market (the
"Floating Market"). There are two legal foreign exchange markets in Brazil: the
commercial rate exchange market (the "Commercial Market") and the floating rate
exchange market (the "Floating Market Rate"). The "Commercial Market Rate" is
the commercial selling rate for Brazilian currency into U.S. dollars, as
reported by the Central Bank of Brazil. The "Floating Market Rate" generally
applies to transactions to which the Commercial Market Rate does not apply.
Prior to the implementation of the Real Plan, the Commercial Market Rate and the
Floating Market Rate differed significantly at times. Since the introduction of
the Real, the two rates have not differed significantly, although there can be
no assurance that there will not be significant differences between the two
rates in the future. Both the Commercial Market Rate and the Floating Market
Rate are reported by the Central Bank on a daily basis.
In order for a company to remit retained earnings abroad in U.S. dollars at the
Commercial Market Rate, Brazilian law first requires the registration of the
foreign capital upon which those retained earnings were made. Bahiatech has not
made such registration and therefore is only able to remit excess retained
earnings at the Floating Market Rate. The Company uses the Commercial Market
Rate for the translation of Bahiatech's results into U.S. Dollars. In the event
that Bahiatech remits excess retained earnings at the Floating Market Rate,
there can be no assurance that such remittance will not vary from the Company's
reported results because of the differences between the Commercial Market Rate
and the Floating Market Rate. Microtec is eligible to remit excess retained
earnings at the Commercial Market Rate.
47
<PAGE>
Cumulative tax exemption benefits totaling $15,764,753 at December 31, 1998
cannot be distributed as dividends and are segregated for capital reserves and
offsetting accumulated losses in accordance with Brazilian law.
Stock options
Information on stock options is shown in the following table:
<TABLE>
<CAPTION>
Options Options Price Weighted
Outstanding Exercisable Range Average Price
----------------- ---------------- -------------- -----------------
<S> <C> <C> <C> <C>
Balances at December 31, 1995 403,150 39,710 .04 - .82 .18
Granted (a) 4,493,500 - .86 - 22.73 19.11
Became exercisable - 4,717,537 .04 - 22.73 18.21
Exercised (151,987) (151,987) .11 - .82 .33
--------- --------- -------------- --------
Balances at December 31, 1996 4,744,663 4,605,260 .04 - 22.73 18.10
Granted 144,427 - 8.18 - 16.36 12.16
Became exercisable - 176,437 .04 - 16.36 8.09
Exercised (152,130) (152,130) .04 - 1.16 .07
Other 24,387 (26,180) - -
--------- --------- -------------- --------
Balances at December 31, 1997 4,761,347 4,603,387 $ .04 - 22.73 $ 18.40
Granted 33,000 - 14.09 14.09
Became exercisable - 103,730 .04 - 14.09 4.51
Exercised (b) (11,440) (11,440) .04 .04
Other (28,600) (2,200)
--------- --------- -------------- --------
Balances at December 31, 1998 (c) 4,754,307 4,693,477 04 - 22.73 18.14
--------- --------- -------------- --------
</TABLE>
(a) Includes 16,500 options granted to certain employees and consultants of
the Company and are an option to purchase shares from the principal
shareholders of the Company. The exercise of such options will not
result in the issuance of new shares by the Company. The remainder of
such options consist of options granted by the Company to purchase
shares from the Company.
(b) Such exercised options consisted of options issued by principal
shareholders to certain employees of the Company. The exercise of such
options did not result in the issuance of new shares by the Company.
(c) Of the options outstanding at December 31, 1998, 128,480 consist of
options issued by principal shareholders to certain employees of the
Company. The exercise of such options will not result in the issuance
of new shares by the Company. The remainder of such options consist of
options granted by the Company to purchase shares from the Company.
In January 1998 and 1997, the Company granted options to purchase up to 33,000
and 22,000 shares of common stock to directors with an exercise price of $14.09
and $8.18 per share, respectively.
During 1997, the Company granted options to purchase a total of 82,827 shares of
the Company's common stock at exercise prices of from $10.91 to $16.36 per share
to a related party. Such options were granted in connection with consulting
services performed for the Company. The options are exercisable for a five year
period. The options were issued pursuant to the provisions of the Company's 1996
Stock Option Plan.
In June 1997, the majority shareholders of the Company transferred a portion of
their options totaling 330,000 to purchase shares of the Company's common stock
to certain members of the Company's management. The options are exercisable at
$13.64 per share, and were transferred with the same terms and conditions as
originally granted.
The Company applies APB Opinion No. 25 and related interpretations in accounting
for its stock option plans and, accordingly, no compensation cost has been
recognized because stock options granted under the plans were at exercise prices
which were equal to or greater than market value at date of grant. Had
compensation expense been determined as provided in SFAS 123 for stock options
using the Black-Sholes option-pricing model, the pro forma effect on the
Company's net income and per share amounts would have been:
48
<PAGE>
1998 1997 1996
------------- ------------ ------------
Net income
As reported $ 17,862,012 $ 12,792,261 $ 8,230,588
Pro forma 17,680,512 12,565,061 4,409,388
Income per share
Basic
As reported $ 1.36 $ 1.07 $ 0.90
Pro forma 1.34 1.05 0.48
Assuming dilution
As reported $ 1.34 $ 1.06 $ 0.85
Pro forma 1.32 1.04 0.45
The fair value of each option grant is calculated using the following weighted
average assumptions:
1998 1997 1996
----------- ---------- ---------
Expected life (years) 4 4 4
Interest rate 6% 6% 6%
Volatility 40% 30% 30%
Dividend yield 0% 0% 0%
Note 15 - Major suppliers
The Company purchased merchandi se principally from suppliers located in the
United States. In 1998, purchases from one unrelated supplier account for
approximately 15.5% of total purchases. In 1997, one unrelated supplier
accounted for 12% of total purchases.
Note 16 - Commitments and contingencies
In August 1998, the Company entered into a one-year noncancelable lease
agreement for an office and warehouse building in Miami, Florida, at an annual
rental of approximately $102,000. The lease requires the Company to pay for its
proportionate share of real estate taxes, insurance and other taxes and
assessments.
The Company's Brazilian operations are located in Sao Paulo and Bahia. The
Company leases approximately 15,000 square feet of office space in Sao Paulo for
an annual rent of approximately $127,000. The lease on such property expires in
April 2000. The Company leases an additional 15,000 square feet of office space
in Sao Paulo for an annual rent of approximately $132,000. The lease on such
property expires in December 2000. The Company leases approximately 160,000
square feet of manufacturing and administrative space in Ilheus for an annual
rent of approximately $157,000. Such lease expires in May 2000. In addition, the
Company leases warehouse and retail space in Recife and Belo Horizonte.
In 1998, the Company entered into operating leases for equipment ranging from 36
to 84 months and requiring monthly payments of $105,965. These leases are
noncancelable and expire at various dates through 2005.
In December 1998, the Company entered into sale leaseback transaction, whereby
the Company sold a net amount of $2,500,000 of assets to an unrelated third
party. The Company in turn entered into an operating lease for the use of the
assets. The operating lease has a term of 36 months and requires monthly
payments of $73,790.
Minimum lease commitments under the above operating leases (inclusive of
the warehouse and office lease) as of December 31, 1998 are as follows:
1999 $ 1,863,592
2000 1,531,296
2001 1,197,002
2002 375,787
2003 369,834
Thereafter 549,743
-----------
$ 5,887,254
-----------
49
<PAGE>
Rent expense under all operating leases in 1998, 1997 and 1996, was
approximately $831,342, $495,500, and $362,500, respectively.
The Company has a revolving line of credit in the amount of $4,000,000 with
Eastern National Bank in Miami, Florida, with which the Company maintains its
primary banking relationship. Such line consists of $3,000,000 for working
capital and $1,000,000 for trade finance used to support letters of credit which
the Company may issue to secure purchase obligations. This credit line is
secured by a lien on certain property owned by the Company. The credit line
bears interest at a floating rate equal to prime (currently 7.75%) and
terminates in May 1999. As of December 31, 1998, there was $3,000,000 owed under
the working capital line which is included in short term debt and $650,000 of
exposure under the letter of credit facility.
The Company has been named in a lawsuit by IBM, relating to TNT Systems, Inc., a
business in which Georges C. St. Laurent III was a shareholder and which ceased
operations in 1993. The Company believes that the lawsuit is frivolous in nature
and without merit and is not material to the financial results or condition of
the Company. Mr. Georges C. St. Laurent III has agreed to indemnify the Company
against any and all claims having to do with these lawsuits against the Company
by IBM or and others that may arise from the past operations of businesses owned
by Mr. Georges C. St. Laurent III. Mr. William C. St. Laurent has agreed to
indemnify the Company against any and all claims having to do with lawsuits that
may arise from the past operations of businesses owned by Mr. William C. St.
Laurent.
The Company is subject to inspections and potential claims arising out of the
conduct of its business, principally in connection with tax, labor and
government regulatory matters, and is the defendant in certain legal actions
arising from its normal business practice. While the ultimate results of
inspections, claims, administrative processes and lawsuits cannot be determined,
management does not expect that the resolution of such matters will have a
material effect on the financial position or future results of operations of the
Company.
Note 17 - Acquisitions of minority interest
In September of 1998, the Company acquired an additional 4.1% of the outstanding
capital of Microtec for $785,000 to bring its total owners interest in Microtec
to 98.5%. In December 1998, the Company acquired an additional 48% of the
outstanding capital of Techshop Ltda. for $2,478,308 in cash to bring its total
ownership interest up to 99%. In December 1998, the Company acquired an
additional 38% of the outstanding capital of Rectech - Recife Tecnologia Ltda.
for $949,054 in cash to bring its total ownership interest up to 99%. The
acquisition of the minority interest in these subsidiaries resulted in an
addition to goodwill of $3,498,085 during the year ended December 31, 1998.
Note 18 - Retirement savings plan
Effective April 1, 1997, the Company established a retirement savings plan which
qualifies under Section 401(k) of the Internal Revenue Code. This retirement
plan allows eligible employees to contribute a percentage of their income on a
pretax basis to the plan. The Company matches 25% of the first 6% of the
employee's contribution. Such matching Company contributions are invested in
shares of the Company's common stock and have a five-year vesting period. In
addition, the plan provides for a discretionary employer contribution which may
be determined each year by the Company's Board of Directors. The Company made no
contributions to the plan during 1998 or 1997 other than the Company's 25%
matching amounts.
Note 19 - Subsequent events
In January 1999, the Brazilian government allowed its currency, the Real, to
trade freely against other foreign currencies, which resulted in an immediate
devaluation of the Real against the U.S. dollar. The Company's accounts
receivable are denominated in the Real while principally all of the Company's
trade accounts payable and other debts are denominated in U.S. dollars. At
December 31, 1998, the Company had a net exposure of monetary assets subject to
currency translation of approximately $70 million. Accordingly the devaluation
should have a significantly negative effect on the Company's results for the
quarter ended March 31, 1999. The ultimate amount of the Company's devaluation
loss will only be known when the Real stabilizes. However, based on a March 31,
1999 close of 1.74 Real to the U.S. dollar, a proforma financial information as
of December 31, 1998 after giving effect to the devaluation is as follows:
50
<PAGE>
Proforma as of December 31, 1998
----------------------------------------------
Actual Adjustments As Adjusted
------------- -------------- --------------
Total assets $ 195,666,975 $ (41,599,993) $ 154,066,982
Total liabilities 93,445,620 (8,033,924) 85,411,696
Total shareholders' equity 102,221,355 (33,566,069) 68,655,286
------------- ------------- -------------
Furthermore, the devaluation and the resulting unfavorable business conditions
in Brazil are leading to reduced demand as well as less liquidity in the
borrowing capacity among the Company's customers and in the market in general.
In an effort to minimize any further effects of the currency devaluation,
unfavorable business conditions and to improve the liquidity of the Company,
management has taken the following actions:
o Indexed the pricing of its products in Reais to the U.S. dollar.
o Significantly reduced the credit terms that it extends to
customers.
o Renegotiated trade accounts payable of approximately $22 million
at December 31, 1998 to terms which average 10 months.
o Negotiated short term financing (see below).
o Modified the repayment terms of certain convertible notes (see
Note 13).
o Continue to negotiate with TAC (see Note 5).
o Completion of the consolidation of the manufacturing facilities in
1999 which reduces administrative expenses and inventory carrying
costs.
While the Company continues to believe that the long-term growth opportunities
remain for the Brazilian information technology market, it continues to evaluate
the impact of the current business conditions on its operations. The ultimate
resolution of these matters could have a material adverse effect on the
financial condition and results of operation for the quarter ended March 31,
1999 and possible for future quarters.
In March of 1999, the Company received a loan from GSL Jr. for the principal
amount of $10 million. The loan bears interest at the annual rate of 10% and has
a term of 120 days. The loan is evidenced by a promissory note and, at the
makers option, can be exchanged for a convertible note should the loan not be
repaid at maturity. Additionally, in April of 1999, the Company received a loan
from an unrelated third party for the principal amount of $11 million. The loan
bears interest at the annual rate of 10% and has a term of 90 days. The loan is
evidenced by a promissory note and is personally guaranteed by the Company's two
principal executive officers and majority shareholders. The proceeds of these
loans are being used for the repayment of indebtedness and for general working
capital purposes.
Note 20 - Quarterly financial information (unaudited)
The following table presents the unaudited quarterly financial information for
the years ended December 31, 1998 and 1997:
<TABLE>
<CAPTION>
Quarter Ended
---------------------------------------------------------------------
December 31, September 30 June 30, March 31,
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
1998
Net sales $ 75,513,490 $ 47,410,603 $ 38,635,842 $ 33,774,664
Income from operations 13,925,160 11,066,274 7,195,953 5,929,960
Net income 6,192,570 4,638,840 3,924,101 3,106,500
Earnings per common share - Basic .42 .36 .32 .26
Earnings per common share - Diluted .42 .36 .32 .25
------------ ------------ ------------ ------------
1997
Net sales $ 45,929,482 $ 31,270,598 $ 23,342,760 $ 16,994,562
Income from operations 9,223,939 6,262,224 4,544,275 2,526,036
Net income 4,645,172 3,577,991 2,739,809 1,789,154
Earnings per common share - Basic .38 .30 .23 .15
Earnings per common share - Diluted .37 .30 .23 .15
------------ ------------ ------------ -------------
</TABLE>
51
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
To be incorporated by reference from the Company's definitive proxy
statement to be filed with the Securities and Exchange Commission within 120
days after December 31, 1998.
PART IV
ITEM 14. EXHIBITS, FINANCIAL SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following are filed as part of this report:
Financial statements and financial statement schedules - see "Item 8.
Financial Statements and Supplementary Data."
<TABLE>
<CAPTION>
Exhibits:
<S> <C>
(1.1) Form of Underwriting Agreement. (1)
(1.2) Form of Representative's Warrant Agreement. (1)
(2.1) Contract for Discontinuation of Company Participations and other Agreements between Vitech America, Inc., Microtec
Holding USA, Inc. and Microhold Participacoes e Empreendimentos S/C Ltda. dated July 10, 1997. (4)
(2.2) Purchase agreement between Vitech America, Inc. and Microtec Holdings USA, Inc. dated July 10, 1997. (4)
(2.3) Buy-Sell Contract between Vitech America, Inc. and Tech Shop Holdings USA, Inc. dated November 17, 1997. (6)
(2.4) Buy-Sell Contract between Vitech America, Inc. and Recife Holdings USA, Inc. dated November 18, 1997. (6)
(3.1) Articles of Incorporation dated June 24, 1993. (1)
(3.2) Amendments to the Company's Articles of Incorporation dated November 13, 1995 and July 26, 1996. (1)
(3.3) By-Laws of the Company. (1)
(4.1) Form of Common Stock Certificate. (1)
(10.1) Stock Option Plan. (1)
(10.2) Employment Agreement between the Company and William C. St. Laurent dated January 1, 1996. (1)
(10.3) Employment Agreement between the Company and Georges St. Laurent, III dated January 1, 1996. (1)
(10.5) Option Agreements for William C. St. Laurent and Georges St. Laurent, III. (1)
(10.6) Promissory Note as amended from the Company to Georges St. Laurent Jr. (1)
(10.11) Loan Agreement between the Company and Georges St. Laurent, Jr. dated December 17, 1996. (2)
(10.12) Loan Agreement between the Company and Georges St. Laurent, Jr. dated April 10, 1997. (3)
(10.13) Senior convertible note payable to Georges St. Laurent Jr. dated June 26, 1997. (4)
(10.14) Loan Agreement dated August 19, 1997 between the Company and Georges C. St. Laurent Jr. (7)
(10.15) Senior Convertible Note dated August 19, 1997 to Georges C. St. Laurent Jr. (7)
(10.16) Senior Convertible Note dated October 10, 1997 to Georges C. St. Laurent Jr. (7)
(10.17) Securities Purchase Agreement dated October 10, 1997, by and between the Company, H.W. Partners, L.P., as
Purchaser's Representative and Investor. (5)
(10.18) Form of Convertible Promissory Note dated October 10, 1997 for the Investors. (5)
(10.19) Put and Call Agreement dated October 10, 1997 between the Company and the Investors. (5)
(10.20) Registration Rights Agreement dated October 10, 1997 between the Company and the Investors. (5)
(10.21) Form of Convertible Promissory Note dated October 10, 1997. (5)
(10.22) Master Sales and Servicing Agreement among Technology Acceptance Corp., Technology Trust S.A., Bahiatech - Bahia
Tecnologia Ltda., Banco Credibanco, S.A. and Vitech America, Inc., dated April 16, 1998. (10)
(11) Statement re: Computation of per share earnings. (8)
52
<PAGE>
<S> <C>
(21) Subsidiaries of the Company. (9)
(27.1) Financial Data Schedule
</TABLE>
- --------------
(1) Incorporated by reference to exhibit filed with the Company's
Registration Statement on Form S-1, file #333-11505.
(2) Incorporated by reference to exhibit filed with the Company's Form 10-K
for the year ended December 31, 1996.
(3) Incorporated by reference to exhibit filed with the Company's Form 10-Q
for the quarterly period ended March 31, 1997.
(4) Incorporated by reference to exhibit filed with the Company's Form 8-K
dated July 10, 1997 as amended.
(5) Incorporated by reference to exhibit filed with the Company's Form 8-K
dated October 10, 1997.
(6) Incorporated by reference to exhibit filed with the Company's Form 8-K
dated November 17, 1997.
(7) Incorporated by reference to exhibit filed with the Company's Form 10-Q
for the quarterly period ended September 30, 1997.
(8) See note 2 to the Company's financial statements included in this
report.
(9) Incorporated by reference to exhibit filed with the Company's Form 10-K
for the year ended December 31, 1997.
(10) Incorporated by reference to exhibit filed with the Company's Form 10-Q
for the quarterly period ended March 31, 1998.
(b) Reports on Form 8-K:
None.
53
<PAGE>
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.
Vitech America, Inc.
By: /s/ Georges C. St. Laurent III
-----------------------------------
Georges C. St. Laurent
Chairman of the Board and
Chief Executive Officer
Date: April 14, 1999
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 dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Georges C. St. Laurent III Chairman of the Board of Directors April 14, 1999
- ---------------------------------------- and Chief Executive Officer (Principal
Georges C. St. Laurent III Executive Officer)
/s/ William St. Laurent President, Chief Operating Officer and April 14, 1999
- ---------------------------------------- Director
William St. Laurent
/s/ Edward A. Kelly Chief Financial Officer April 14, 1999
- ---------------------------------------- (Principal Accounting Officer)
Edward A. Kelly
/s/ Joseph K. Meyer April 14, 1999
- ---------------------------------------- Director
Joseph K. Meyer
/s/ H.R. Shepherd April 14, 1999
- ---------------------------------------- Director
H.R. Shepherd
/s/ Touma M. Elias April 14, 1999
- ---------------------------------------- Director
Touma M. Elias
- ---------------------------------------- Director
Robin Blackhurst
</TABLE>
54
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
1. Bahiatech - Bahia Tecnologia Ltda.
2. Microtech Holdings USA, Inc.
3. Tech Shop Holdings USA, Inc.
4. Recife Holdings USA, Inc.
5. Microtec Sistemas Industria e Comercio S.A.
6. Techshop Ltda.
7. Rectech - Recife Tecnologia Ltda.
55
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM VITECH
AMERICA, INC.'S CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED
DECEMBER 31, 1998 AND THE CONSOLIDATED BALANCE SHEET AS OF
DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 1021282
<NAME> VITECH AMERICA, INC
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1.000
<CASH> 7,719,185
<SECURITIES> 0
<RECEIVABLES> 75,893,857
<ALLOWANCES> 5,500,078
<INVENTORY> 40,351,585
<CURRENT-ASSETS> 147,179,591
<PP&E> 19,696,097
<DEPRECIATION> 3,154,920
<TOTAL-ASSETS> 195,666,975
<CURRENT-LIABILITIES> 77,005,430
<BONDS> 16,440,190
0
0
<COMMON> 60,844,866
<OTHER-SE> 41,376,489
<TOTAL-LIABILITY-AND-EQUITY> 195,666,975
<SALES> 195,334,579
<TOTAL-REVENUES> 195,334,579
<CGS> 115,630,389
<TOTAL-COSTS> 157,217,232
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 16,277,392
<INCOME-PRETAX> 19,156,676
<INCOME-TAX> 2,007,830
<INCOME-CONTINUING> 17,862,012
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,862,012
<EPS-PRIMARY> 1.36
<EPS-DILUTED> 1.34
</TABLE>
