<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the three months ended SEPTEMBER 30, 1998 Commission File Number 0-14371
- --------------------------------------------- ------------------------------
COMPUCOM SYSTEMS, INC.
- --------------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
DELAWARE 38-2363156
- ---------------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
7171 FOREST LANE, DALLAS, TX 75230
- ---------------------------------------- ----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 856-3600
----------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
The number of shares of the Registrant's common stock outstanding as of November
10, 1998 was 46,941,820 shares.
- --------------------------------------------------------------------------------
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Index
PART I. FINANCIAL INFORMATION Page
- ------- --------------------- ----
Item 1. Condensed Consolidated Balance Sheets
September 30, 1998 and December 31, 1997 (unaudited) 3
Condensed Consolidated Statements of Operations
Three and nine months ended September 30, 1998
and 1997 (unaudited) 4
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 1998 and 1997 (unaudited) 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
PART II. OTHER INFORMATION
- -------- -----------------
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K 17
2
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------------- ----------------
Assets
------
<S> <C> <C>
Current assets:
Cash $ 4,453 $ 4,456
Receivables 246,456 177,141
Inventories 144,821 197,958
Other 3,781 2,880
---------------- ----------------
Total current assets 399,511 382,435
Property and equipment, net 72,985 63,359
Cost in excess of fair value of tangible net assets
purchased, less accumulated amortization 66,225 13,569
Other 4,094 3,227
---------------- ----------------
$542,815 $462,590
================ ================
Liabilities and Shareholders' Equity
------------------------------------
Current liabilities:
Accounts payable $129,335 $ 72,475
Accrued liabilities 72,187 71,791
Current portion of long-term debt 4,000 3,000
---------------- ----------------
Total current liabilities 205,522 147,266
Long-term debt 110,791 97,400
Deferred income taxes 6,584 7,198
Other 626 526
Shareholders' equity:
Preferred stock 15,000 15,000
Common stock 463 461
Additional paid-in capital 66,336 65,762
Retained earnings 137,493 128,977
---------------- ----------------
Total shareholders' equity 219,292 210,200
---------------- ----------------
$542,815 $462,590
================ ================
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine Months ended
September 30, September 30,
1998 1997 1998 1997
-------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenue
Product $531,640 $437,089 $1,438,913 $1,241,047
Service 67,488 60,513 187,743 173,956
Other 4,202 3,902 11,983 9,610
-------------- -------------- --------------- ---------------
Total revenue 603,330 501,504 1,638,639 1,424,613
-------------- -------------- --------------- ---------------
Cost of revenue
Product 482,054 393,066 1,294,919 1,116,993
Service 45,716 38,541 127,846 110,478
Other 2,076 1,773 6,071 4,578
-------------- -------------- --------------- ---------------
Total cost of revenue 529,846 433,380 1,428,836 1,232,049
-------------- -------------- --------------- ---------------
Gross margin 73,484 68,124 209,803 192,564
Operating expenses
Selling 29,999 18,538 79,447 58,051
Service 14,131 13,430 41,835 35,344
General and administrative 17,726 15,108 48,304 44,788
Depreciation and amortization 4,535 2,946 11,561 8,189
-------------- -------------- --------------- ---------------
Total operating expenses 66,391 50,022 181,147 146,372
-------------- -------------- --------------- ---------------
Earnings from operations 7,093 18,102 28,656 46,192
Financing expenses 5,322 4,039 13,337 10,709
Nonrecurring gain (1,706) (1,706)
-------------- -------------- --------------- ---------------
Earnings before income taxes 1,771 15,769 15,319 37,189
Income taxes 708 6,307 6,128 14,875
-------------- -------------- --------------- ---------------
Net earnings $ 1,063 $ 9,462 $ 9,191 $ 22,314
============== ============== =============== ===============
Earnings per common share
(excluding nonrecurring gain)
Basic $ .02 $ .18 $ .18 $ .45
Diluted $ .02 $ .17 $ .18 $ .43
Earnings per common share
Basic $ .02 $ .20 $ .18 $ .47
Diluted $ .02 $ .19 $ .18 $ .45
Average common shares outstanding
Basic 46,256 45,868 46,180 45,585
Diluted 46,991 50,323 47,274 49,891
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, 1998 and 1997
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
1998 1997
---------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net earnings $ 9,191 $ 22,314
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Depreciation and amortization 11,561 8,189
Deferred income taxes (582) 613
Nonrecurring gains (1,706)
Changes in assets and liabilities:
Receivables 2,579 153,460
Inventories 62,704 63,720
Other current assets 1,048 529
Accounts payable (6,625) (139,071)
Accrued liabilities and other (13,793) 8,122
---------------- ----------------
Net cash provided by operating activities * 66,083 116,170
---------------- ----------------
Cash flows from investing activities:
Capital expenditures, net (12,174) (18,581)
Business acquisitions, net of cash acquired (49,288)
Proceeds from sale of securities 2,724
---------------- ----------------
Net cash (used in) investing activities (61,462) (15,857)
---------------- ----------------
Cash flows from financing activities:
Net bank credit facility and other borrowings (4,525) (102,252)
Issuance of common stock 576 2,529
Preferred stock dividend (675) (675)
---------------- ----------------
Net cash (used in) financing activities * (4,624) (100,398)
---------------- ----------------
Net decrease in cash (3) (85)
Cash at beginning of period 4,456 4,320
---------------- ----------------
Cash at end of period $ 4,453 $ 4,235
================ ================
</TABLE>
* In 1997, $100 million securitization was presented as a cash inflow from
operations and cash used in financing activities.
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 1998
(1) General
-------
These condensed interim consolidated financial statements should be
read in conjunction with the consolidated financial statements and the
summary of significant accounting policies and notes thereto included in
the 1997 Annual Report on Form 10-K for CompuCom Systems, Inc. (the
Company). The information furnished is unaudited but reflects all
adjustments consisting only of normal recurring accruals which are, in the
opinion of management, necessary to present a fair statement of the results
for these interim periods. Interim results are not necessarily indicative
of results expected for the full year.
(2) Contingencies
-------------
The Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position and results of operations, taken
as a whole.
(3) Earnings per share
------------------
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, Earnings Per Share
("Statement 128"). Statement 128 supersedes APB Opinion No. 15, Earnings
Per Share and specifies the computation, presentation, and disclosure
requirements for earnings per share ("EPS"). Basic earnings per common
share is based on net earnings after preferred stock dividend requirements,
if any, and the weighted-average number of common shares outstanding during
each period. Diluted earnings per common share assumes conversion of
dilutive convertible securities into common stock at the later of the
beginning of the period or date of issuance and includes the add-back of
related interest expense and/or dividends, as required. Prior period
earnings per share have been restated to conform to Statement 128. SFAS No.
128 also requires a reconciliation of the numerators and denominators of
the basic and diluted per share computations as follows (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
Three months ended September 30, 1998 Nine months ended September 30, 1998
------------------------------------------- -------------------------------------------
Income Shares Income Shares
(Numerator) (Denominator) EPS (Numerator) (Denominator) EPS
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Net earnings $1,063 $9,191
Less: Preferred stock dividends (225) (675)
Basic EPS
- ---------
Income available to common shareholders 838 46,256 $.02 8,516 46,180 $.18
Effect of dilutive securities
- -----------------------------
Stock options 735 1,094
------------- ------------- ------------- -------------
Diluted EPS
- -----------
Income available + assumed conversions 838 46,991 $.02 8,516 47,274 $.18
============= ============= ============= ============= ============= =============
</TABLE>
6
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 1998
<TABLE>
<CAPTION>
Three months ended September 30, 1997 Nine months ended September 30, 1997
------------------------------------------- -------------------------------------------
Income Shares Income Shares
(Numerator) (Denominator) EPS (Numerator) (Denominator) EPS
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Net earnings $9,461 $22,314
Less: Preferred stock dividends (225) (675)
Basic EPS
- ---------
Income available to common shareholders 9,236 45,868 $.20 21,639 45,585 $.47
Effect of dilutive securities
- -----------------------------
Stock options 1,851 1,702
Convertible preferred stock 225 2,216 675 2,216
Convertible debt 23 388 69 388
------------- ------------- ------------- -------------
Diluted EPS
- -----------
Income available + assumed conversions 9,484 50,323 $.19 22,383 49,891 $.45
============= ============= ============= ============= ============= =============
</TABLE>
The Company has excluded 2,250,811 and 1,782,335 shares from its
calculations of diluted earnings per share for the three and nine months
ended September 30, 1998, and has excluded 59,783 and 434,885 shares from
its calculations of diluted earnings per share for the three and nine
months ended September 30, 1997, respectively, as they are considered anti-
dilutive.
(4) Business Combinations
---------------------
During the nine months ended September 30, 1998, the Company consummated
three business combinations. The total consideration given for these
business combinations was approximately $49 million in cash. The business
combinations were accounted for as purchases and accordingly the condensed
consolidated financial statements reflect the operations of the acquired
entities since the respective acquisition dates. The Company has not
completed the allocation of the purchase price for these three
acquisitions. Therefore, the amount of goodwill recorded could be adjusted
once the allocation is finalized.
The following pro forma financial information presents the combined results
of operations as if the acquisitions had occurred as of the beginning of
1998, after giving effect to certain adjustments, including amortization of
goodwill, increased interest expense on debt related to the acquisitions,
and related income tax effects (amounts in thousands, except per share
data).
<TABLE>
<CAPTION>
Nine Months Ended
September 30, 1998
------------------
<S> <C>
Revenue $1,829,109
==========
Net Income $3,532
======
Diluted earnings per share $.06
====
</TABLE>
7
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
September 30, 1998
In management's opinion, the pro forma results of operations are not
indicative of the actual results that would have occurred had the
acquisitions been consummated at the beginning of the periods presented and
is not intended to be a projection of future results. Pro forma adjustments
that give effect to actions taken by management or other efficiencies
expected to be realized as a result of the transactions, including
termination of employees and closure of facilities, are not reflected in
the above pro forma results of operations.
(5) Subsequent Event
----------------
On October 22, 1998 the Company's Board of Directors approved a
restructuring plan designed to reduce the Company's product cost structure
by closing branch facilities and a reduction in the Company's workforce of
approximately 10%. The restructuring plan has not been finalized and
therefore the Company has not yet calculated the final amount of the
restructuring charge. However, the Company expects the charge to be
approximately $20 to $25 million and as a result, expects to incur a net
loss during the fourth quarter of 1998.
8
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
September 30, 1998
Results of Operations
- ---------------------
The following table shows the Company's total revenue, gross margin and gross
margin percentage by revenue source. Operating expenses, financing expense,
income taxes and net earnings are shown as a percentage of total net revenue for
the three and nine months ended September 30, 1998 and 1997.
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
-------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenue:
Product $531,640 $437,089 $1,438,913 $1,241,047
Service 67,488 60,513 187,743 173,956
Other 4,202 3,902 11,983 9,610
-------------- -------------- --------------- ---------------
Total revenue 603,330 501,504 1,638,639 1,424,613
-------------- -------------- --------------- ---------------
Gross margin:
Product 49,586 44,023 143,994 124,054
Service 21,772 21,972 59,897 63,478
Other 2,126 2,129 5,912 5,032
-------------- -------------- --------------- ---------------
Total gross margin 73,484 68,124 209,803 192,564
-------------- -------------- --------------- ---------------
Gross margin percentage:
Product 9.3% 10.1% 10.0% 10.0%
Service 32.3% 36.3% 31.9% 36.5%
Other 50.6% 54.6% 49.3% 52.4%
-------------- -------------- --------------- ---------------
Total gross margin percentage 12.2% 13.6% 12.8% 13.5%
Operating expenses:
Selling 5.0% 3.7% 4.8% 4.1%
Service 2.3% 2.7% 2.6% 2.5%
General and administrative 2.9% 3.0% 2.9% 3.1%
Depreciation and amortization 0.8% 0.6% 0.7% 0.6%
-------------- -------------- --------------- ---------------
Total operating expenses 11.0% 10.0% 11.0% 10.3%
-------------- -------------- --------------- ---------------
Earnings from operations 1.2% 3.6% 1.8% 3.2%
Financing expenses 0.9% 0.8% 0.8% 0.7%
Nonrecurring gain (0.3%) (0.1%)
-------------- -------------- --------------- ---------------
Earnings before income taxes 0.3% 3.1% 1.0% 2.6%
Income taxes 0.1% 1.2% 0.4% 1.0%
-------------- -------------- --------------- ---------------
Net earnings 0.2% 1.9% 0.6% 1.6%
============== ============== =============== ===============
</TABLE>
9
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
OVERVIEW
On October 22, 1998 the Company's Board of Directors approved a
restructuring plan designed to reduce the Company's product cost structure by
approximately 1.25% to 1.5% of sales by closing branch facilities and a
reduction in the Company's workforce of approximately 10%. The Company intends
to maintain local presence in all existing markets through the use of remote
communications. The restructuring plan has not been finalized and therefore the
Company has not yet calculated the final amount of the restructuring charge.
However, the Company expects the charge to be approximately $20 to $25 million
and to primarily consist of costs associated with closing branch facilities and
disposing of related fixed assets as well as employee severance and benefits
related to the reduction in workforce. As a result of this restructuring
charge, the Company expects to incur a net loss during the fourth quarter of
1998.
COMPARISON OF THE QUARTER ENDED SEPTEMBER 30, 1998 TO THE QUARTER ENDED
SEPTEMBER 30, 1997
Product revenue, which is primarily derived from the sale of distributed
desktop computer products to corporate customers, increased approximately 22% to
$531.6 million in the third quarter of 1998 from $437.1 million in the third
quarter of 1997. The increase in product revenue was due to the impact of the
May 13, 1998 acquisition of Computer Integration Corporation ("CIC") and the
June 26, 1998 acquisition of Dataflex Corporation ("Dataflex"), (collectively
"the acquisitions"). During the third quarter 1998, CIC and Dataflex contributed
approximately $98 million in product revenue. The number of desktop, laptop and
server units shipped during the three months ended September 30, 1998 increased
approximately 35% (16% excluding the effect of the acquisitions) compared to the
same period of 1997. However, a decline in the average sales price of these
units lessened the impact of this unit growth on revenue. Although the trend of
declining average sales price has continued to slow in 1998 relative to 1997,
the Company expects this trend will continue to be an issue in the short term
when comparing to previously announced results as the Company must sell more
units to generate the same amount of product sales revenue. Product gross margin
as a percentage of product revenue for the third quarter of 1998 was 9.3%
compared to 10.1% for the third quarter of 1997. The Company primarily
attributes this decline to heightened competition from other corporate resellers
and direct marketers.
Service revenue increased 11.5% to $67.5 million for the third quarter of
1998 from $60.5 million during the third quarter of 1997. Service revenue is
primarily derived from LAN/WAN projects, consulting, asset tracking, network
management, help desk, field engineering, procurement, configuration, and
software management. Service revenue reflects revenue generated by the actual
performance of specific services and does not include product sales associated
with service projects. The increase in service revenue is primarily due to the
acquisitions and an increase in systems engineering revenue. Excluding the
acquisitions, service revenue increased approximately 2.6%. Service gross margin
as a percentage of service net revenue for the three months ended September 30,
1998 was 32.3% compared to 36.3% for the same period in 1997. The decrease was
primarily due to lower billing per engineer for the Company's systems
engineering business. However, on a sequential basis, service gross margin as a
percentage of service net revenue improved from 31.3% in the second quarter 1998
to 32.3% in the third quarter 1998. This was primarily due to heightened
Company focus on its system engineering business during the third quarter 1998
resulting in slightly higher billing per engineer.
(Continued)
10
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Operating expenses increased $16.4 million for the three months ended
September 30, 1998 as compared to the same prior year period. As a percentage
of net revenue, operating expenses increased to 11.0% compared to 10.0% in 1997.
The percentage and dollar increases resulted primarily from increased selling
expenses. As a result of its recently announced restructuring plan, management
expects to realize reductions in operating expenses, primarily in selling and
general and administrative expenses. The reductions have not yet been completely
finalized and are not expected to be fully realized until the first quarter of
1999.
Selling expense increased in absolute dollars and as a percentage of net
revenues for the three months ended September 30, 1998 as compared to the same
prior year period. These increases resulted mainly from the Company hiring
additional sales representatives during the first quarter of 1998, higher
commission expense, and an increase in the Company's sales force as a result of
the acquisitions. Service expense increased in absolute dollars, but decreased
as a percentage of net revenues for the third quarter of 1998 compared to the
same prior year period. The increase in absolute dollars was primarily due to
the acquisitions.
General and administrative expense, as a percentage of net revenue,
decreased slightly for the three months ended September 30, 1998 relative to the
comparable period of the prior year. The decrease was primarily due to the
increase in net revenues, as general and administrative expense increased in
absolute dollars when comparing the same periods. The increase in absolute
dollars was mainly the result of costs associated with the integration of
the acquisitions as well as the Company's ongoing campus recruiting program. The
campus recruits complete training and certification programs before being added
to the Company's billable workforce. The Company's operating expenses are
reported net of reimbursements by certain manufacturers for specific training,
promotional and marketing programs. These reimbursements offset the expenses
incurred by the Company.
Depreciation and amortization expense increased for the three months ended
September 30, 1998 in absolute dollars, but decreased slightly as a percentage
of net revenue when compared to the same period in 1997. Depreciation expense
increased in absolute dollars due to upgrading of hardware and software at the
Company's headquarters and branch locations, and increased furniture and
fixtures to support headcount additions. Increased amortization expense is the
result of acquisitions completed during the second quarter of 1998. The
decrease in depreciation and amortization expense as a percentage of net revenue
is due to the increase in net revenue compared to the same prior year period.
Financing expense increased both as a percentage of net revenue and in
absolute dollars for the three months ended September 30, 1998, as compared to
the same period in 1997 primarily as a result of the increased borrowings
associated with the acquisitions. The Company's effective interest rate was 6.7%
in the third quarter 1998 compared to 6.8% in the same prior year period.
During the third quarter of 1997, the Company recognized a previously
deferred nonrecurring after-tax gain of $1.0 million. Recognition of the gain
was due to the early payment of a secured note related to the 1994 sale of the
Company's former subsidiary, PC Parts Express, Inc. (now known as PC Service
Source, Inc.).
As a result of the factors discussed above, net earnings decreased 88.8%
for the quarter ended September 30, 1998 to $1.1 million compared to the same
period net earnings of $9.5 million in 1997.
(continued)
11
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1998 TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997
Product revenue increased approximately 16% to $1.44 billion for the nine
months ended September 30, 1998 from $1.24 billion in the same period of 1997.
The majority of the increase in product revenue was due to the acquisitions. For
the nine months ended September 30, 1998, the acquisitions contributed
approximately $149 million in product revenue. Excluding the acquisitions,
product revenue for the Company increased 3.9% for the nine months ended
September 30, 1998 compared to the same prior year period. Product gross margin
as a percentage of product revenue for the nine months ended September 30, 1998
and the same prior year period was 10.0%. Though margins declined due to
heightened competition from other corporate resellers and direct marketers, an
increase in the amount of manufacturer sponsored incentives offset this decline.
Service revenue increased 7.9% to $187.7 million for the nine months ended
September 30, 1998 from $174.0 million during the same period of 1997. The
increase in service revenue was primarily due to increases in field engineering
and configuration revenues, which are typically driven in part by product unit
sales volume, and the acquisitions. Excluding the acquisitions, service revenue
increased approximately 4.4%. Service gross margin as a percentage of service
net revenue was 31.9% for the first nine months of 1998 compared to 36.5% for
the same period in 1997. The decrease was primarily caused by lower billing per
engineer for the Company's service personnel, particularly in the systems
engineering business.
Operating expenses increased $34.8 million for the nine months ended
September 30, 1998 as compared to the same prior year period. As a percentage
of net revenue, operating expenses increased to 11.0% compared to 10.3% in 1997.
The percentage and dollar increases resulted primarily from increased selling
expenses.
Selling expense increased in absolute dollars and as a percentage of net
revenues for the nine months ended September 30, 1998 as compared to the same
prior year period. These increases resulted from the Company hiring additional
sales representatives during the first quarter of 1998, higher commission
expense, and an increase in the Company's sales force as a result of the
acquisitions. Service expense, as a percentage of net revenues, increased
slightly for the nine months ended September 30, 1998 compared to the same prior
year period due primarily to increased headcount in certain service support
functions and increased spending on training of the Company's engineer force.
General and administrative expense, as a percentage of net revenue,
decreased for the nine months ended September 30, 1998 to 2.9% compared to 3.1%
for the comparable period of the prior year. The decrease was primarily due to
the increase in net revenues, as general and administrative expense increased in
absolute dollars when comparing the same prior year period. The increase in
absolute dollars was mainly the result of costs associated with the integration
of CIC and Dataflex during the second and third quarters of 1998 as well as
costs related to the Company's ongoing campus recruiting program.
Depreciation and amortization expense increased for the nine months ended
September 30, 1998 in absolute dollars and as a percentage of net revenue when
compared to the same period in 1997. The increase in depreciation expense is
associated with upgrading the Company's hardware and software at the Company's
headquarters and branch locations, increased furniture and fixtures to support
headcount additions, and depreciation expense related to the Company's corporate
headquarters and operations campus, which was placed in service during the third
quarter of 1997. Increased amortization expense is the result of the
acquisitions completed during the second quarter of 1998.
(Continued)
12
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Financing expense increased both as a percentage of revenue and in absolute
dollars for the nine months ended September 30, 1998, as compared to the same
period in 1997. The increase in financing expense was primarily a result of
increased borrowings due to the acquisitions. The Company's effective interest
rate was 6.5% for the nine months ended September 30, 1998 as compared to 6.7%
in the same prior year period.
During the third quarter of 1997, the Company recognized a previously
deferred nonrecurring after-tax gain of $1.0 million. Recognition of the gain
was due to the early payment of a secured note related to the 1994 sale of the
Company's former subsidiary, PC Parts Express, Inc. (now known as PC Service
Source, Inc.).
As a result of the factors discussed above, net earnings decreased 58.8%
for the nine months ended September 30, 1998 to $9.2 million compared to net
earnings of $22.3 million in the same period in 1997.
Some of the factors that may impact future profitability include the
following: the Company's ability to effectively manage inventory levels in
response to changes in its major suppliers price protection and return programs,
the Company's ability to effectively manage the utilization of service
personnel, the Company's control of operating expenses, demand for product,
competition, manufacturer product availability, effective utilization of vendor
programs, the Company's ability to successfully manage the implementation and
operation of the channel assembly programs of its major suppliers, the Company's
ability to adequately integrate recent acquisitions, and the Company's ability
to implement its recently announced virtual office strategy.
Liquidity and Capital Resources
- -------------------------------
Working capital at September 30, 1998 was $194 million compared to $235
million at December 31, 1997. The decrease is primarily due to an increase in
accounts payable and decrease in inventory, partially offset by an increase in
accounts receivable. The Company's accounts payable balance fluctuates relative
to the timing of product receipts and the mix of vendors. The decrease in
inventory is primarily due to the Company's effort to reduce its risk associated
with changes in its suppliers price protection and return programs and increase
its inventory turns. The increase in accounts receivable is mainly attributable
to the acquisitions completed during the second quarter which resulted in higher
revenues in the third quarter 1998 versus the fourth quarter 1997.
The Company's working capital requirements are generally funded through
financing arrangements and internally generated funds. During the second
quarter of 1998, the Company negotiated an expansion of its working capital
facility ("Revolver") from $125 million to $165 million with no significant
changes to the existing Revolver terms and conditions. The primary purpose of
the expansion was to provide financing for the acquisitions completed during the
second quarter. As of September 30, 1998, the Company's financing arrangements
consisted of a $175 million Securitization Facility, the $165 million Revolver
and a $25 million real estate loan. The Company is currently evaluating other
permanent financing options for the real estate loan.
The Company's business is not capital asset intensive, and capital
expenditures in any year normally would not be significant in relation to the
overall financial position of the Company. Excluding acquisitions, capital
expenditures were approximately $3.3 million and $12.2 million during the third
quarter of 1998 and for the nine months ended September 30, 1998, respectively,
as compared to $6.5 million and $18.5 million for the same periods in 1997. The
majority of the 1998 capital expenditures were related to the upgrading of
Company hardware and software located at both headquarters and branch locations.
The majority of the $18.5 million in 1997 was for facility improvements to
prepare the Company's headquarters and operations campus for full occupancy.
(Continued)
13
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Impact of Year 2000 Issue
The Year 2000 issue results from the fact many computer programs were previously
written using two digits rather than four to define the applicable year.
Programs written in this way may recognize a date ending in "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing business delays and disruptions of operations. The
Company has developed a step-by-step plan which details the tasks, deliverables,
resources, and target dates necessary to monitor the Company's information
systems at the turn of the century and beyond. Assessment of the Company's
systems has been divided into five areas Core information systems and components
("IS"), Distributed Desktop systems, Non-IS systems, new IS purchases by the
Company, and mergers and acquisitions.
The Company's Core IS include warehouse management, distribution, service
dispatch, service parts, engineer billing, and financial information systems.
Distributed Desktop systems include all desktop computers and related components
used by the Company's associates, wherever they are located. Initial assessment
of these systems has included the identification of each hardware, software,
tool, and package comprising these systems to determine whether or not they
support Year 2000 date codes. All testing, remediation, and validation of the
Company's Core IS and Distributed Desktop systems is expected to be completed by
the end of 1998. Remediation includes the enhancement, upgrading, migration, or
replacement of noncompliant hardware, software, tools and/or systems.
Validation entails testing of all systems including a "quality control"
environment in which the date is artificially set forward to the Year 2000 to
simulate the turn of the century and beyond. The Company has also purchased a
Year 2000 compliance software package that will generate audit reports on a
regular basis to report back any noncompliant Core IS or Distributed Desktop
systems. The Company's use of this software package will commence by the end of
1998.
Non-IS systems include all microcontroller systems and disaster recovery
processes of Core IS. Microcontroller systems comprise all electronic systems
such as telephones, security systems, alarms, etc. Initial assessment and
remediation of the Company's Non-IS systems is currently expected to be
completed during the first quarter of 1999. The Company reviews each of its new
potential hardware and software purchases to ensure they are Year 2000
compliant. The Company has completed three acquisitions during 1998; however,
these acquisitions are currently being integrated into the Company and all
acquired systems will be replaced with the Company's Core IS by the first
quarter of 1999.
As part of its Year 2000 assessment, the Company must also consider the
compliance of third parties with which the Company has a material relationship,
namely its vendors, suppliers, and customers. As a reseller of computer
products, the Company only passes through to its customers the applicable
vendor's warranties; it makes no warranties regarding Year 2000 compliance on
any of the products it resells. However, if one of the Company's major vendors
or suppliers is found to be Year 2000 noncompliant which is not corrected on a
timely basis, it could have a material adverse effect on the Company's results
of operations. The Company also relies on vendors and suppliers for hardware,
software, and tools used within its own business environment. The Company has
developed a Year 2000 questionnaire which has been sent in order to ascertain
whether vendors and suppliers warrant their hardware, software, and tools to be
Year 2000 compliant and whether customers have adequately addressed the Year
2000 issue. The Company has documented compliance via the questionnaire for
approximately 75% of hardware, software, and tools currently in use. For the
remaining 25% of questionnaires, if documented compliance is not received, the
Company's plan is to upgrade for compliance, replace for compliance, or
decommission if necessary by the end of 1998.
(Continued)
14
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The Company currently anticipates it will spend approximately $1,400,000 on
Year 2000 compliance, of which approximately $800,000 has been spent through
September 30, 1998. The majority of the remaining expense is expected to be for
previously identified desktop equipment and full-time associates dedicated to
the Year 2000 compliance effort. All previous as well as future expenditures on
Year 2000 compliance have or will come from operating cash flow.
The Company's plan also includes the availability of a test team that will test
the Company's information systems on an on-going basis to further validate that
additions or modifications to any of the Company's systems do not create Year
2000 compliance issues. The Company's expectations with respect to the above
Year 2000 issues are based on the premise there will be no material general
failure of external systems (including power, communications, transportation or
financial systems) necessary for the ordinary conduct of business. At the
present time, the Company does not have a contingency plan to operate in the
event its computer systems or those of its vendors, suppliers, or customers are
not Year 2000 compliant. The Company expects to have a contingency plan
completed by June 1999.
The statements contained in this document that are not historical facts,
including but not limited to, statements identified by the use of terms such as
"may", "will", "could", "potential", "believe", "would" or "expect" or other
variations or negatives of these terms, are "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995 and involve
a number of risks and uncertainties. The actual results of the future events
described in the forward-looking statements in this document could differ
materially from those stated in the forward-looking statements. Among the
factors that could cause actual results to differ materially are: competitive
pricing and supply, short-term interest rate fluctuations, general economic
conditions, employee turnover and possible future litigation, the Company's
ability to effectively manage inventory in response to changes in its major
suppliers price protection and return programs, the Company's ability to
adequately implement its recently announced restructuring plan, as well as the
risks and uncertainties set forth from time to time in the Company's other
public reports and filings and public statements. Recipients of this document
are cautioned to consider these risks and uncertainties and to not place undue
reliance on these forward-looking statements.
15
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 5. Other Information.
Stockholders intending to present proposals at the next Annual Meeting of
Shareholders to be held in 1999 must notify the Company of the proposal no later
than December 8, 1998 if they wish to include the proposal on the Company's
proxy card and, along with any supporting statement, in the Company's proxy
statement. As to any proposal presented by a stockholder at the Annual Meeting
of Stockholders that has not been included in the Proxy Statement, the
management proxies will be allowed to use their discretionary voting authority
unless notice of such proposal is received by the Company no later than
February 21, 1999.
16
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
- ------- --------------------------------
(a) Exhibits
--------
Exhibit
No. Description
------- ----------------------------------
10.1 Stock Option Grant Agreement between CompuCom Systems, Inc.
and Thomas C. Lynch, dated as of October 22, 1998.
27 Financial Data Schedule
(b) Reports on Form 8-K
-------------------
No reports on Form 8-K have been filed by the Registrant during the
three months ended September 30, 1998.
17
<PAGE>
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Signatures
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.
COMPUCOM SYSTEMS, INC.
---------------------------------------
(Registrant)
DATE: November 16, 1998 /s/ Edward Anderson
---------------------------------------
Edward Anderson,
President and Chief Executive Officer
DATE: November 16, 1998 /s/ M. Lazane Smith
---------------------------------------
M. Lazane Smith,
Senior Vice President, Finance and
Chief Financial Officer
18
<PAGE>
EXHIBIT 10.1
[LOGO OF COMPUCOM APPEARS HERE]
STOCK OPTION GRANT AGREEMENT
CompuCom Systems, Inc., a Delaware corporation (the "Company"), hereby
grants to the grantee named below ("Grantee") an option (this "Option") to
purchase the total number of shares shown below of Common Stock of the Company
(the "Shares") at the exercise price per share set forth below, subject to all
of the terms and conditions contained in this Stock Option Grant Agreement.
GRANT DATE: OCTOBER 22, 1998
TYPE OF OPTION: NON-QUALIFIED STOCK OPTION
SHARES SUBJECT TO OPTION: 500,000
EXERCISE PRICE PER SHARE: $ 3.1875
TERM OF OPTION: 10 YEARS
Shares subject to issuance under this Option do not vest until the first
anniversary of the grant, and then shall vest according to the following vesting
schedule:
October 22, 1999 to October 21, 2000 25%
October 22, 2000 to October 21, 2001 50%
October 22, 2001 to October 21, 2002 75%
On or after October 22, 2002 100%
This Option shall become exercisable by Grantee at any time following
grant, subject to repurchase of any unvested Shares by the Company in the event
of Grantee's termination of employment for any reason prior to the scheduled
vesting date for such Shares. The purchase price for such unvested Shares shall
be equal to the purchase price paid for such Shares. In the event Grantee
exercises this Option to purchase unvested Shares, the certificate(s)
representing such Shares shall be held in escrow by the Company until such time
as the Shares become vested, and Grantee shall deposit with the Company a duly
executed assignment separate from certificate containing a medallion signature
guarantee.
Grantee acknowledges that the grant and exercise of this Option, and the
sale of Shares obtained through the exercise of this Option, may have tax
implications that could result in adverse tax consequences to the Grantee and
that Grantee is not relying on the Company for any tax, financial or legal
advice and will consult a tax adviser prior to such exercise or disposition.
1. OPTION EXPIRATION. The Option shall automatically terminate upon the
happening of the first of the following events:
(a) The expiration of the three-month period after the Grantee ceases to be
employed by, or in the service of, the Company if the termination is for any
reason other than disability, death or cause;
(b) The expiration of the one-year period after the Grantee ceases to be
employed by, or in the service of, the Company on account of the Grantee's
disability;
(c) The expiration of the one-year period after the Grantee ceases to be
employed by, or in the service of, the Company, if the Grantee dies while
employed by the Company or within three months after the Grantee ceases to be so
employed or provide such services on account of a termination described in
subparagraph (a) above; or
-1-
<PAGE>
(d) The date on which the Grantee ceases to be employed by the Company for
cause. For purposes of this Option, cause shall mean, except to the extent
otherwise specified by the Committee, a finding by the Committee that the
Grantee has breached his employment or service contract, non-competition
agreement or other obligation with the Company, or has been engaged in
disloyalty to the Company, including without limitation, fraud, embezzlement,
theft, commission of a felony or proven dishonesty in the course of his
employment of service, or has disclosed trade secrets or confidential
information of the Company to persons not entitled to receive such information.
Notwithstanding the foregoing, in no event may the Option be exercised
after the expiration of the Term of Option specified herein. Any portion of the
Option that is not vested at the time the Grantee ceases to be employed by, or
in the service of, the Company shall immediately terminate.
In the event a Grantee ceases to be employed by the Company for cause, the
Grantee shall automatically forfeit all shares underlying any exercised portion
of an Option for which the Company has not yet delivered the share certificates
upon refund by the Company of the exercise price paid by the Grantee for such
shares.
2. EXERCISE PROCEDURES.
(a) Subject to the provisions of this Stock Option Grant Agreement, the
Grantee may exercise part or all of the vested Option by giving the Company
written notice of intent to exercise in the manner provided in Paragraph 10
below, specifying the number of Shares as to which the Option is to be
exercised. On the delivery date, the Grantee shall pay the exercise price (i)
in cash, (ii) by delivering Shares of the Company (duly endorsed for transfer or
accompanied by stock powers signed in blank) which shall be valued at their fair
market value on the date of delivery, or (iii) by such other method as the
Committee may approve, including payment through a broker in accordance with
procedures permitted by Regulation T of the Federal Reserve Board or delivery of
a promissory note. The Board may impose from time to time such limitations as
it deems appropriate on the use of Shares of the Company to exercise the Option.
(b) The obligation of the Company to deliver Shares upon exercise of the
Option shall be subject to all applicable laws, rules, and regulations and such
approvals by governmental agencies as may be deemed appropriate by the Board,
including such actions as Company counsel shall deem necessary or appropriate to
comply with relevant securities laws and regulations. The Company may require
that the Grantee (or other person exercising the Option after the Grantee's
death) represent that the Grantee is purchasing Shares for the Grantee's own
account and not with a view to or for sale in connection with any distribution
of the Shares, or such other representation as the Board deems appropriate. All
obligations of the Company under this Stock Option Grant Agreement shall be
subject to the rights of the Company to withhold amounts required to be withheld
for any taxes, if applicable, or to deduct from other wages paid by the Company
the amount of any withholding taxes due with respect to such Options. Subject
to Committee approval, the Grantee may elect to satisfy any income tax
withholding obligation of the Company with respect to the Option by having
Shares withheld up to an amount that does not exceed the maximum marginal tax
rate for federal (including FICA), state and local tax liabilities.
3. RESTRICTIONS ON EXERCISE. Only the Grantee may exercise the Option
during the Grantee's lifetime. After the Grantee's death, the Option shall be
exercisable solely by the legal representatives of the Grantee, or by the person
who acquires the right to exercise the Option by will or by the laws of descent
and distribution, to the extent that the Option is exercisable pursuant to this
Stock Option Grant Agreement. Notwithstanding anything in this Stock Option
Grant Agreement to the contrary, the Committee may provide, at or after grant,
that a Grantee may transfer non-qualified stock options pursuant to a domestic
relations order or to family members or other persons or entities on such terms
as the Committee may determine.
4. GRANT SUBJECT TO COMMITTEE AUTHORITY. The grant and exercise of this
Option are subject to the interpretations, regulations and determinations
concerning this Option established from time to time by the Committee that
administers the Company's stock options, including, but not limited to,
provisions
-2-
<PAGE>
pertaining to (i) rights and obligations with respect to withholding taxes, (ii)
the registration, qualification or listing of the Shares, (iii) capital or other
changes of the Company, and (iv) other requirements of applicable law. The
Committee shall have the authority to interpret and construe the Option, and its
decisions shall be conclusive as to any questions arising hereunder.
5. NO EMPLOYMENT RIGHTS. The grant of the Option shall not confer upon
the Grantee any right to be retained by or in the employ or service of the
Company and shall not interfere in any way with the right of the Company to
terminate the Grantee's employment or service at any time. The right of the
Company to terminate at will the Grantee's employment or service at any time for
any reason is specifically reserved. No policies, procedures or statements of
any nature by or on behalf of the Company (whether written or oral, and whether
or not contained in any formal employee manual or handbook) shall be construed
to modify this Grant Agreement or to create express or implied obligations to
the Grantee of any nature.
6. NO STOCKHOLDER RIGHTS. Neither the Grantee, nor any person entitled to
exercise the Grantee's rights in the event of the Grantee's death, shall have
any of the rights and privileges of a stockholder with respect to the Shares
subject to the Option until certificates for Shares have been issued upon the
exercise of the Option.
7. NO DISCLOSURE. The Grantee acknowledges that the Company has no duty
to disclose to the Grantee any material information regarding the business of
the Company or affecting the value of the Shares before or at the time of a
termination of the Grantee's employment or service, including without limitation
any plans regarding a public offering or merger involving the Company.
8. ASSIGNMENT AND TRANSFERS. The rights and interests of the Grantee
under this Stock Option Grant Agreement may not be sold, assigned, encumbered or
otherwise transferred except, in the event of the death of the Grantee, by will
or by the laws of descent and distribution. In the event of any attempt by the
Grantee to alienate, assign, pledge, hypothecate, or otherwise dispose of the
Option or any right hereunder, except as provided for in this Stock Option Grant
Agreement, or in the event of the levy or any attachment, execution or similar
process upon the rights or interests hereby conferred, the Company may terminate
the Option by notice to the Grantee, and the Option and all rights hereunder
shall thereupon become null and void. The rights and protections of the Company
hereunder shall extend to any successors or assigns of the Company and to the
Company's parents, subsidiaries, and affiliates. This Stock Option Grant
Agreement may be assigned by the Company without the Grantee's consent.
9. APPLICABLE LAW. The validity, construction, interpretation and effect
of this instrument shall be governed by and determined in accordance with the
laws of the State of Delaware.
10. NOTICE. Any notice to the Company provided for in this instrument
shall be addressed to the Company in care of the Chief Financial Officer at the
Company's headquarters and any notice to the Grantee shall be addressed to such
Grantee at the current address shown on the payroll of the Company, or to such
other address as the Grantee may designate to the Company in writing. Any
notice shall be delivered by hand, sent by telecopy or enclosed in a properly
sealed envelope addressed as stated above, registered and deposited, postage
prepaid, in a post office regularly maintained by the United States Postal
Service.
In witness whereof, this Stock Option Grant Agreement has been executed by
the Company by a duly authorized officer as of the date specified herein.
COMPUCOM SYSTEMS, INC. ACCEPTED:
By: /s/ Edward R. Anderson By: /s/ Thomas C. Lynch
----------------------------- -------------------------------
Edward R. Anderson Thomas C. Lynch, Optionee
President and Chief Executive Officer
-3-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1998 AND THE CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 4,453
<SECURITIES> 0
<RECEIVABLES> 250,344
<ALLOWANCES> 3,888
<INVENTORY> 144,821
<CURRENT-ASSETS> 399,511
<PP&E> 104,692
<DEPRECIATION> 31,707
<TOTAL-ASSETS> 542,815
<CURRENT-LIABILITIES> 205,522
<BONDS> 110,791
0
15,000
<COMMON> 463
<OTHER-SE> 203,829
<TOTAL-LIABILITY-AND-EQUITY> 542,815
<SALES> 1,438,913
<TOTAL-REVENUES> 1,638,639
<CGS> 1,294,919
<TOTAL-COSTS> 1,428,836
<OTHER-EXPENSES> 181,147
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 13,337
<INCOME-PRETAX> 15,319
<INCOME-TAX> 6,128
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,191
<EPS-PRIMARY> 0.18
<EPS-DILUTED> 0.18
</TABLE>
