<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 000-27376
---------------
ELCOM INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3175156
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10 OCEANA WAY
NORWOOD, MASSACHUSETTS 02062
(781) 440-3333
(Address, including zip code, and telephone number,
including area code, of registrant's principal
executive offices)
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 registrant had 27,355,723 shares of common stock, $.01 par value,
outstanding as of July 31, 1998.
<PAGE>
INDEX
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements Page
Consolidated Balance Sheets as of December 31, 1997
and June 30, 1998 (unaudited)...................................2
Consolidated Statements of Operations - Three and Six Month
Periods EndedJune 30, 1997 and 1998 (unaudited).................3
Consolidated Statements of Cash Flows - Six Month Periods Ended
June 30, 1997 and 1998 (unaudited)..............................4
Notes to Consolidated Financial Statements (unaudited).............5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................6
Part II - OTHER INFORMATION
Item 1. None.
Item 2. None.
Item 3. None.
Item 4. Submission of Matters to a Vote of Security Holders............14
Item 5. Other Information..............................................14
Item 6. Exhibits and Reports on Form 8-K...............................15
Signature .............................................................15
1
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<TABLE>
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31, June 30,
1997 1998
-------------- --------------
<S> <C> <C>
ASSETS (unaudited)
CURRENT ASSETS:
Cash and cash equivalents.................................................... $ 33,165 $ 34,619
Accounts receivable:
Trade................................................................... 154,223 148,792
Other................................................................... 32,200 46,345
-------------- --------------
186,423 195,137
Less - Allowance for doubtful accounts.................................. 5,474 4,259
-------------- --------------
180,949 190,878
Inventory...................................................................... 60,437 48,549
Prepaids and other current assets.............................................. 3,255 5,136
-------------- --------------
Total current assets..................................................... 277,806 279,182
-------------- --------------
PROPERTY, EQUIPMENT AND SOFTWARE, AT COST:
Computer hardware and software............................................... 22,118 25,733
Land, buildings and leasehold improvements................................... 3,402 3,513
Furniture, fixtures andequipment............................................. 8,579 8,829
-------------- --------------
34,099 38,075
Less -- Accumulated depreciation and amortization............................ 17,649 20,755
-------------- --------------
16,450 17,320
-------------- --------------
GOODWILL AND OTHER ASSETS, NET OF ACCUMULATED AMORTIZATION..................... 37,812 36,472
-------------- --------------
$ 332,068 $ 332,974
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Lines ofcredit................................................................ 154,714 138,670
Accounts payable.............................................................. 43,271 59,310
Accrued expenses and other current liabilities................................ 19,557 18,551
Current portion of capital lease obligations.................................. 680 705
Current portion of long-term debt............................................. 78 79
-------------- --------------
Total current liabilities................................................. 218,300 217,315
-------------- --------------
OTHER DEFERRED LIABILITIES...................................................... 2,213 2,214
CAPITAL LEASE OBLIGATIONS, NET OF CURRENT PORTION............................... 920 561
LONG-TERM DEBT, NET OF CURRENT PORTION.......................................... 332 317
-------------- --------------
3,465 3,092
-------------- --------------
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; Authorized -- 10,000,000 shares --
Issued and outstanding -- None............................................ -- --
Common stock, $.01 par value; Authorized -- 50,000,000 shares --
Issued and outstanding - 27,218,239 and 27,500,907 shares................ 272 275
Additional paid-in capital.................................................... 100,726 101,209
Retained earnings............................................................. 9,369 11,256
Treasury stock, at cost - 56,319 and 191,338 shares .......................... (549) (1,108)
Cumulative translation adjustment............................................. 485 935
-------------- --------------
Total stockholders'equity................................................. 110,303 112,567
============== ==============
$ 332,068 $ 332,974
============== ==============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
2
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<TABLE>
ELCOM INTERNATIONAL, INC
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------- --------- --------- ---------
1997 1998 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net sales...................................................................... $ 198,157 $ 191,778 $ 374,436 $ 381,826
Cost of sales ................................................................. 175,465 169,192 331,542 337,086
--------- --------- --------- ---------
Gross profit................................................................... 22,692 22,586 42,894 44,740
Expenses:
Selling, general and administrative .......................................... 18,307 19,006 34,675 36,864
Research and development ..................................................... 290 346 565 621
--------- --------- --------- ---------
Total expenses.................................................................. 18,597 19,352 35,240 37,485
--------- --------- --------- ---------
Operating profit ............................................................... 4,095 3,234 7,654 7,255
Interest expense ............................................................... (1,105) (2,223) (2,249) (4,165)
Interest income and other, net.................................................. 142 225 716 396
--------- --------- --------- ---------
Income before income taxes .................................................... 3,132 1,236 6,121 3,486
Provision for income taxes...................................................... 1,071 721 2,098 1,599
-------- -------- -------- --------
Net income ..................................................................... $ 2,061 $ 515 $4,023 $ 1,887
========= ========= ========= =========
Basic net income per share...................................................... $ 0.08 $ 0.02 $ 0.15 $ 0.07
========= ========= ========= =========
Basic weighted average shares outstanding ...................................... 26,869 27,379 26,805 27,305
========= ========= ========= =========
Diluted net income per share.................................................... $ 0.07 $ 0.02 $ 0.14 $ 0.07
========= ========= ========= =========
Diluted weighted average shares outstanding .................................... 28,847 28,254 29,232 28,512
========= ========= ========= =========
Other Comprehensive Income, Net of Tax:
Net income ..................................................................... $ 2,061 $ 515 $ 4,023 $ 1,887
Foreign currency translation adjustments ....................................... 13 (70) (653) 450
--------- --------- --------- ---------
Comprehensive income ........................................................... $ 2,074 $ 445 $ 3,370 $ 2,337
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
3
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<TABLE>
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended
June 30,
--------
1997 1998
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................................... $ 4,023 $ 1,887
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization............................................... 4,364 4,774
Provision for doubtful accounts............................................. 750 620
Other deferred liabilities.................................................. (4) --
Changes in current assets and liabilities, net of acquisitions
Accounts receivable....................................................... (2,739) (9,826)
Inventory ................................................................ (9,268) 12,123
Prepaids and other current assets......................................... (907) (1,904)
Accounts payable.......................................................... 21,549 15,477
Accrued expenses, other current liabilities and other .................... (12,067) (1,142)
-------- --------
Net cash provided by operating activities ............................. 5,701 22,009
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, equipment and software ................................. (4,866) (3,859)
Increase in other assets and deferred costs................................... (30) (73)
Purchase of Prophet Group..................................................... (391) --
Purchase of Data Supplies, net of cash acquired .............................. (2,660) --
Other investing activities.................................................... 15 --
-------- --------
Net cash used in investing activities .................................. (7,932) (3,932)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) under lines of credit .............................. 10,761 (16,407)
Purchase of treasury stock ................................................... -- (559)
Repayment of capital lease obligations........................................ (386) (351)
Proceeds from stock option exercises ......................................... 782 486
-------- --------
Net cash provided by (used in) financing activities .................... 11,157 (16,831)
-------- --------
FOREIGN EXCHANGE EFFECT ON CASH ................................................ 54 208
-------- --------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS............................................................. 8,980 1,454
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD .......................................................... 23,259 33,165
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD ....................................... $ 32,239 $ 34,619
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Interest paid ................................................................ $ 2,318 $ 4,134
======== ========
Income taxes paid ............................................................ $ 798 $ 406
======== ========
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Increase in capital lease obligations ........................................ $ 1,339 $ --
======== ========
Acquisition of businesses:
Fair value of assets acquired $ 6,332 $ --
Less cash paid 1,600 --
-------- --------
Liabilities assumed $ 4,732 $ --
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
4
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ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The consolidated financial statements include the accounts of Elcom
International, Inc. and its wholly owned subsidiaries (collectively, the
"Company"). All significant intercompany accounts and transactions have been
eliminated. In the opinion of management, the accompanying unaudited
consolidated financial statements contain all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial position
of the Company as of June 30, 1998, and the results of operations and cash flows
for the periods ended June 30, 1997 and 1998. The results of operations for
these periods are not necessarily comparable to, or indicative of, results of
any other interim period or for the year as a whole. Certain financial
information that is normally included in financial statements prepared in
accordance with generally accepted accounting principles, but which is not
required for interim reporting purposes, has been omitted. For further
information, reference should be made to the consolidated financial statements
and accompanying notes included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1997 and the Company's current report on Form 8-K
dated December 12, 1997, filed on March 11, 1998 concerning a change in the
Company's certifying accountant for its subsidiaries and operations domiciled in
the United Kingdom, and a second report on Form 8-K dated June 2, 1998, filed on
June 3, 1998 concerning a Company stock repurchase program.
On June 8, 1998, the Company changed the name of its U.S. PC
remarketer subsidiary, Catalink Direct, Inc., to Elcom Services Group, Inc. The
change in name is intended to more closely identify the subsidiary with the
Company's corporate name. The new name is more descriptive of the Company's
business focus, which includes an expanding range of professional technical and
customer services in addition to product supply. The U.K.-based PC remarketer
group will continue to operate under the Elcom Group Limited name.
2. Net Income Per Share
Net income per share is based on the weighted average number of common
and common equivalent shares outstanding during each period presented,
calculated in accordance with Statement of Financial Accounting Standards
("SFAS") No. 128, Earnings Per Share. This statement establishes revised
standards for computing earnings per share ("EPS") by replacing the presentation
of primary EPS with a presentation of basic EPS. Basic EPS excludes dilution and
is computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding during the period. Diluted EPS gives
effect to all potential common shares outstanding during the period. As a
result, all previously reported earnings per share have been restated.
Basic and diluted earnings per share were calculated as follows (in
thousands, except per share amounts):
<TABLE>
Three Months Ended Six Months Ended
June 30 June 30
----------------------------- ---------------------------
1997 1998 1997 1998
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Basic
-----------
Net income $ 2,061 $ 515 $ 4,023 $ 1,887
============ ============ =========== ============
Weighted average shares outstanding 26,869 27,379 26,805 27,305
============ ============ =========== ============
Basic net income per share $ 0.08 $ 0.02 $ 0.15 $ 0.07
============ ============ =========== ============
Diluted
-----------
Net income $ 2,061 $ 515 $ 4,023 $ 1,887
============ ============ =========== ============
Weighted average shares outstanding 26,869 27,379 26,805 27,305
Dilutive effect of stock options 1,978 875 2,427 1,207
------------ ------------ ----------- ------------
Weighted average shares as adjusted 28,847 28,254 29,232 28,512
============ ============ =========== ============
Diluted net income per share $ 0.07 $ 0.02 $ 0.14 $ 0.07
============ ============ =========== ============
</TABLE>
5
<PAGE>
Options to purchase 4,641,054 and 2,657,672 shares of common stock at
prices ranging from $5.03 to $8.80 and $5.44 to $8.80 were outstanding during
the quarter and six months ended June 30, 1998, respectively, but not included
in the computation of diluted earnings per share because such options' exercise
prices were greater than the average market price of the Company's common stock
for the applicable period ended June 30, 1998.
3. Comprehensive Income
Effective January 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income. This statement establishes standards for reporting and
displaying comprehensive income and its components. The Company's comprehensive
income components consist of net income and foreign currency translation
adjustments.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
General
The Company was founded in 1992, commenced selling PC products in
December 1993, and initially experienced rapid growth. The Company achieved its
growth by using its proprietary Personal Electronic Catalog and Ordering System
("PECOS") as a value-add differentiator and by offering the use of PECOS through
Elcom Services Group, Inc. (formerly Catalink Direct, Inc.) to its customers and
by various marketing efforts, including the expansion of its direct sales force
nationwide, and by the acquisition of six PC products remarketers. To date, the
Company's net sales have been derived substantially from the sale of PC products
by the Company's wholly owned subsidiary, Elcom Services Group, Inc. ("Elcom
Services Group"), and its respective subsidiaries in the United States and
United Kingdom, to business and corporate customers. These sales are
accomplished through the Company's PECOS electronic commerce technology and
through telephone and other traditional ordering methods. In addition, the
Company, through its wholly owned subsidiary, Elcom Systems, Inc. ("Elcom
Systems"), licenses its PECOS technologies and provides implementation and
consulting services.
Elcom Services Group
In October 1994, the Company completed the acquisition of a
Connecticut-based PC products remarketer, which was accounted for on a
pooling-of-interests basis. Accordingly, the results of this entity (which was
merged into Elcom Services Group in December 1995) have been included with the
Company's results since the date of the Company's organization. In February
1995, the Company acquired Catalink Direct (Pennsylvania), Inc., formerly known
as Computerware Business Trust ("Computerware"), a Bristol, Pennsylvania-based
PC products remarketer (which was merged into Elcom Services Group in December
1997). In June 1995, the Company acquired all of the equity of a PC products
remarketer in the United Kingdom operating as Lantec Information Services
Limited ("Lantec"). The Computerware and Lantec acquisitions have been accounted
for as purchase transactions.
In February 1996, the Company completed the acquisition of AMA (U.K.)
Limited ("AMA"), a remarketer of PC products in the United Kingdom, which has
been accounted for on a pooling-of-interests basis. Accordingly, AMA's results
have been included with the Company's results since the date of the Company's
organization. In December 1996, the Company acquired Prophet Group Limited, a PC
products remarketer and in February 1997, the Company acquired Data Supplies
Limited, a PC products remarketer, both of which are located in the United
Kingdom. The Prophet Group and Data Supplies acquisitions have been accounted
for as purchase transactions.
6
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Elcom Services Group's revenues and resultant gross profit have always
been effected by price reductions by PC manufacturers, which have been
substantial over the last several years. Manufacturers' price reductions require
that Elcom Services Group increase its base unit volumes and associated
peripheral product sales to overcome the effect of such price decreases and to
increase its revenue volume in order to sustain its level of gross profit
dollars.
In addition to general price reductions by PC manufacturers, the
Company believes that its revenues in the first half of 1998 were effected by
delayed customer purchases in anticipation of further price decreases from major
manufacturers, several of which occurred late in the first quarter. Although the
Company's unit volume of personal computers shipped to customers showed 18%
growth in the first half of 1998 compared to the same period last year, these
price decreases had a significant effect on the average unit price of personal
computers sold and the Company's net sales, when compared to last year.
On June 8, 1998, the Company changed the name of its PC remarketer
subsidiary, Catalink Direct, Inc., to Elcom Services Group, Inc. The change in
name is intended to more closely identify the subsidiary with the Company's
corporate name and be more descriptive of the Company's business focus, which
includes an expanding range of professional technical and customer services in
addition to product supply. The U.K.-based PC remarketer group will continue to
operate under the Elcom Group Limited name.
Elcom Systems, Inc.
On a stand-alone basis, for the six- month periods ended June 30, 1998
and June 30, 1997, revenues generated from Elcom Systems' licenses, including
associated professional services and maintenance fees, were approximately $1.8
million and $2.5 million, respectively. Consequently, and despite relatively
flat overhead in the first six months of 1998 versus the same period in 1997,
Elcom Systems' consolidated operating loss increased $0.8 million to $1.2
million during the first half of 1998 versus an operating loss of $0.4 million
in the first half of 1997. The Company is currently investigating various
potential alternatives to appropriately capitalize and allow Elcom Systems to
operate as an independent and separate company, including the possibility of
entering into potential strategic alliances with a technology and/or financial
partner or, alternatively, the Company may integrate Elcom Systems with Elcom
Services Group. However, there can be no assurances that any of these
alternatives will be implemented or, if implemented, what financial benefit, if
any, they might have to the Company or its stockholders.
In April 1997, Elcom Systems acquired certain key elements of a
procurement software system which is being augmented and developed into PECOS
Procurement Manager ("PECOS.pm"). The purchase price, as amended, was
approximately $1.4 million, consisting of cash and stock. The Company intends to
continue its investment in PECOS.pm in 1998, including the continued development
of an intranet-enabled version which is now available in its first release.
Engagement of Salomon Smith Barney
On July 23, 1997, the Company announced that its Board of Directors had
authorized the engagement of the investment banking firm of Smith Barney Inc.
(which subsequently merged with Salomon Brothers Inc. to become Salomon Smith
Barney), to assist the Company by coordinating and evaluating options intended
to help enable the strategic potential of the Company to be realized. The rapid
growth of the Company prior to that time, and the Board of Directors' belief
that the Company's stock was undervalued in the marketplace, originally prompted
the Company to take this step. These actions, intended to maximize stockholder
value, include evaluating the possible sale or merger of the Company, strategic
financing options, and potential strategic partners. The Company is currently
engaged in ongoing discussions with multiple companies. As long as the Board of
Directors believes that such discussions may lead to a merger, acquisition, or
other potential financial arrangement which would be, in the Board's opinion, in
the best interests of the stockholders, these discussions will continue.
Further, due to the size and scale of the Company's PC remarketing and services
business in the United Kingdom and the current strength of the United Kingdom
stock market, particularly for information technology stocks, the Company and
Salomon Smith Barney are evaluating alternative options which would be intended
to take advantage of this strength, including potential separate transactions
for the Company's United Kingdom and United States remarketer
7
<PAGE>
businesses. This process also includes investigation of various potential
alternatives to appropriately capitalize and allow Elcom Systems to operate as
an independent and separate company, including the possibility of entering into
potentialstrategic alliances with a technology and/or financial partner. One
option would be to reduce its holdings in Elcom Systems to less than 50% in a
transaction with a strategic partner, in order to allow the Company to account
for its ownership via the equity method and therefore not report subsequent
operating losses incurred by Elcom Systems beyond the Company's residual
investment therein, if any. Alternatively, the Company may integrate Elcom
Systems with Elcom Services Group. However, there can be no assurances that any
of these alternatives will be implemented or what financial benefit, if any,
they might have to the Company or its stockholders.
The engagement of Salomon Smith Barney, which was scheduled to expire
on July 23, 1998, has been extended to November 30, 1998 to allow Salomon Smith
Barney to continue its assistance in the ongoing discussions with multiple
companies. However, there can be no assurances that the Company will be
successful in consummating any transaction(s) or realizing additional
stockholder value as a result of this process. During the engagement with
Salomon Smith Barney, multiple industry research analysts reporting on the
Company have elected to stop research coverage, ostensibly because the Company
is perceived to be "in play" via the engagement of Salomon Smith Barney.
Currently, no research analysts report on the Company and, while Salomon Smith
Barney is engaged, the Company does not expect any research analysts to begin
following it. The Company's common stock trading price has declined
significantly, which Management believes is at least partly attributable to the
lack of research analyst coverage/sponsorship as well as the duration of the
engagement with Salomon Smith Barney.
The Salomon Smith Barney strategic initiative has been ongoing for more
than one year. However, the current process now includes the potential of
separate component transactions and active discussions are ongoing with multiple
parties. Nonetheless, the Company believes that the length of the engagement to
date has created some uncertainty in the Company's personnel base which,
combined with previous problems associated with the Company's United States
implementation of an Oracle-based information system last November, has had a
negative impact on sales and profitability in the first and second quarters of
1998. These events are implicitly reflected in the Company's recent operating
results, as well as the other items described herein. Nonetheless, the Company
has retained substantially all of its customers and key personnel, has addressed
the majority of its most significant information systems issues, and is now
refocusing its sales force on increasing service and product revenues. To assist
in accomplishing these objectives, the Company has appointed James G. Jameson as
the President and Chief Executive Officer of Elcom Services Group's United
States operations. Mr. Jameson joins the Company with over 28 years of
experience in the technology and PC marketplaces, and is working towards
broadening the Company's professional technical and customer services offerings.
In addition, the Company recently introduced PECOS.web, an internally developed
Internet-based electronic commerce system which the Company believes can provide
a differentiating advantage over its competition and allow the Company's sales
personnel to aggressively pursue new customers.
As appropriate, the Company intends to acquire additional companies
either to expand its customer base and the use of PECOS or to complement its
Elcom Systems' PECOS technologies, although there can be no assurances as to the
success or timing of any such acquisitions.
Results of Operations
Quarter ended June 30, 1998 compared to the quarter ended June 30, 1997.
Net Sales. Net sales for the quarter ended June 30, 1998 were $192 million
versus $198 million in the same period of 1997, a decrease of $6 million, or 3%.
Net sales of the Company's United Kingdom-based operations increased 8% to $77
million in the 1998 quarter from $71 million in the second quarter of 1997. Net
sales in the United States were $115 million in the 1998 quarter versus $127
million in the quarter ended June 30, 1997, a 9% decrease. The decrease in net
sales in the United States reflects the impact of several factors including
completion of a substantial customer contract in late 1997 and the residual
impact on sales momentum of the Company's November 1997 United States
implementation of its Oracle-based management information system. The Company
8
<PAGE>
also believes that the decrease in net sales is partially attributable to
substantial price reductions made by manufacturers, which has not been
completely offset, despite an increase in units shipped by the Company.
Gross Profit. Gross profit for the quarter ended June 30, 1998 was
$22.6 million versus $22.7 million in the 1997 quarter. Gross profit as a
percent of net sales increased slightly from 11.5% in the 1997 quarter to 11.8%
in the 1998 quarter primarily due to an increase in the proportion of net sales
generated in the United Kingdom (where the gross profit percentage is slightly
higher than in the United States) and the direct purchasing programs implemented
in 1997 with certain manufacturers in the United States. The impact of such
direct purchasing was particularly apparent in the third and fourth quarters of
1997. The decrease in the gross profit percentage in the second quarter of 1998
to 11.8% from the 12.5% achieved in the fourth quarter of 1997 reflects a
decrease in the level of manufacturer funding and incremental discounts
available to the Company. The Company anticipates that a certain level of
ongoing direct purchasing volume and targeted growth in higher margin
professional services revenues should mitigate a portion of the product gross
margin decline expected to be associated with a planned expansion of sales to
high volume corporate accounts during 1998. However, due to ongoing reductions
in manufacturer policies concerning price protection and product return
privileges, the Company is reevaluating the level of products it purchases
directly and holds in inventory in the United States versus the cost of
electronically sourcing items from its primary distribution fulfillment partner
for direct shipment to customers or to a Company location.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the quarter ended June 30, 1998 increased to $19.0
million from $18.3 million in the 1997 quarter, an increase of $700,000, or 4%.
This increase is related primarily to the Company's investment in administrative
and operational infrastructure to support the anticipated future growth of both
the Company's remarketer and professional services business segments including
incremental investment in technical services and other sales-oriented personnel.
The Company's recently implemented, year-2000-compliant Oracle-based information
system in the United States is functional and is being augmented to enable the
Company to operate more efficiently. Towards the end of the second quarter,
certain improvements with respect to a number of sales and operational aspects
of the system were accomplished and efforts continue to further improve the
effectiveness of the system. The Company anticipates that this system will
provide an information systems backbone to help increase the productivity of
sales and operational personnel and to achieve more timely and precise
information reporting. Due to the anticipated length of time required to
complete the implementation of the United States information system, the Company
has revised its strategy with respect to implementation of the system in the
United Kingdom. The Company is working with Computer Associates International,
Inc., its current United Kingdom software vendor, to implement an upgrade to its
existing software systems which will result in a year-2000-compliant information
system for its United Kingdom operations. It is currently anticipated that this
upgrade, which does not involve a material expenditure, will be completed by
early 1999. Thereafter, the Company will reassess implementing its Oracle-based
information system in the United Kingdom.
Overall, selling, general and administrative expenses increased as a
percentage of net sales for the quarter ended June 30, 1998 to 9.9%, from 9.2%
in the comparable 1997 quarter, reflecting the impact of slower overall growth
in net sales, as well as the Company's ongoing investment in selling, general
and administrative infrastructure.
Research and Development Expenses. Research and development expenses
consist primarily of the cost of research and development personnel and
independent contractors. Research and development expenses for the quarter ended
June 30, 1998 increased to $346,000 from $290,000 in the comparable 1997
quarter. The Company believes that ongoing investments in research and
development are required to remain competitive in the electronic commerce
software industry and the Company expects to continue investing significant
amounts therein. The Company's research and development expenses are focused on
developing incremental functionality and features for its PECOS.net
technologies, including the aspects of the PECOS.pm technology acquired in 1997,
as well as modifications to allow PECOS to communicate using the Internet and
the continued development of a browser compliant and Java-enabled version of its
PECOS.net technologies for license to other companies.
9
<PAGE>
Interest Expense. Interest expense for the quarter ended June 30, 1998
increased to $2.2 million from $1.1 million in the comparable period of 1997.
Interest expense in both years relates to floor plan line of credit borrowings
which increased significantly in 1998 over 1997 in support of the Company's
balances of inventory and accounts receivable, and also reflects increased
interest rates in the United Kingdom in 1998 versus 1997. The Base Rate in the
United Kingdom has increased from 6% at June 30, 1997 to 7.25% at June 30, 1998.
Interest Income and Other, Net. Interest income and other, net, for the
quarter ended June 30, 1998 increased to $225,000 in the 1998 quarter from
$142,000 in the 1997 quarter, reflecting an increase in the Company's average
invested cash balances.
Income Tax Provision. The income tax provision in 1998 relates to both
domestic and foreign operations of the Company. The tax rate exceeds the
expected statutory rates due to the impact of non-deductible goodwill
amortization expense, which is approximately $800,000 per quarter. The tax
provision in the 1997 quarter related primarily to the Company's United Kingdom
operations and certain current state income taxes payable in the United States.
Net Income. The Company reported net income for the quarter ended June
30, 1998 as a consequence of the results of the factors described herein, and
despite a $486,000 increase in operating losses reported for the 1998 quarter by
Elcom Systems, its technology subsidiary. The June 30, 1998 quarter is the
eleventh consecutive quarter in which the Company has reported net income since
its initial public offering in December 1995, after reporting net losses in all
previous quarters from its inception in 1992.
Six months ended June 30,1998 compared to the six months ended June 30, 1997.
Net Sales. Net sales for the six months ended June 30, 1998 increased
to $382 million from $374 million in the same period of 1997, an increase of $8
million, or 2%. This increase is generally attributable to incremental
penetration of the marketplace. Net sales in the United States were $223 million
in the first half of 1998 versus $231 million in the six months ended June 30,
1997, a 4% decrease, which reflects relatively soft demand in the United States
in the first quarter of 1998, as well as the other factors described in the
quarterly and overview discussions above. Net sales of the Company's United
Kingdom-based operations increased to $159 million from $143 million in the
first six months of 1997, an increase of $16 million or 11%.
Gross Profit. Gross profit for the first six months of 1998 increased
to $44.7 million from $42.9 million in the first half of 1997, an increase of
$1.8 million, or 4%. Gross profit, as a percent of net sales increased slightly
from 11.5% in the first six months of 1997 to 11.7% in the first six months of
1998. The gross profit percentage was slightly higher in 1998 due to the
Company's direct purchasing arrangements in the United States and an increase in
the proportion of revenues generated by the Company's United Kingdom operations,
which generally achieve higher gross profit margins than the large customer
accounts where demand in the United States was softer than anticipated in the
first half of 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the six months ended June 30, 1998 increased to
$36.9 million from $34.7 million in the six months ended June 30, 1997, an
increase of $2.2 million, or 6%. This increase is attributable primarily to the
increase in the Company's work force, as the Company continues to invest in
administrative infrastructure to support its anticipated current and future
growth, including the ongoing development and implementation of its new
management information system. Selling, general and administrative expenses
increased as a percentage of net sales for the six months ended June 30, 1998 to
9.7%, from 9.3% in the comparable period of 1997.
Research and Development Expense. Research and development expense has
remained relatively constant between 1997 and 1998. The Company's research and
development expenses are focused on developing incremental functionality and
features for its PECOS technologies, including the recently acquired aspects of
the PECOS.pm technology as well as modifications to allow PECOS to communicate
using the Internet and the continued development of a browser compliant and
Java-enabled version of its PECOS.net technologies for license to other
companies.
10
<PAGE>
Interest Expense. Interest expense for the six month period ended June
30, 1998 increased to $4.2 million from $2.2 million in the comparable period of
1997 due primarily to higher average accounts receivable and inventory balances
and also reflects higher interest rates in 1998 in the United Kingdom versus
1997. The Base Rate in the United Kingdom has increased from 6% at June 30, 1997
to 7.25% at June 30, 1998. Interest expense in both years relates to floor plan
line of credit borrowings in support of the Company's accounts receivable and
inventory balances.
Interest Income and Other, Net. Interest income and other, net, for the
six month period ended June 30, 1998 decreased to $396,000 from $716,000 in the
same period of 1997. Other income in 1997 includes proceeds of $389,000
resulting from the sale of the Bristol, PA rental division in March 1997, net of
certain redundant operating and severance expenses of the Pennsylvania group
which have been phased-out and consolidated into the Company's headquarters and
new East coast configuration and distribution facility which was opened in
Canton, MA in the first quarter of 1997.
Income Tax Provision. The income tax provision in 1998, relates to both
domestic and foreign operations of the Company. The tax rate exceeds the
expected statutory rates due to the impact of non-deductible goodwill expense.
The tax provision in the first half of 1997 related primarily to the Company's
United Kingdom operations and certain current state income taxes payable in the
United States.
Net Income. The Company reported net income for the six month periods
ended June 30, 1998 and 1997 as a result of the factors described herein, and
despite an $809,000 increase in operating losses reported by Elcom Systems, its
technology subsidiary.
Liquidity and Capital Resources
Net cash provided by operating activities for the six month period
ended June 30, 1998 was $22.0 million and reflects a net increase in current
liabilities of $14.3 million (primarily related to the timing of certain
payments) and a $12.1 million decrease in inventory, and is net of a $9.8
million increase in accounts receivable. Net cash used for investing activities
was $3.9 million, consisting primarily of additions to property, equipment and
software. Net cash used in financing activities was $16.8 million, consisting
primarily of repayments under lines of credit.
Net cash provided by operating activities for the six month period
ended June 30, 1997 was $5.7 million, and reflects a net increase in current
liabilities of $9.5 million (primarily related to the timing of certain
payments) and is net of both a $2.7 million increase in accounts receivable,
resulting from the Company's increase in net sales during the 1997 period, and a
$9.3 million increase in inventory related to the Company's manufacturer direct
purchasing arrangements which were instituted in the United States in 1997. Net
cash used for investing activities was $7.9 million, consisting of $4.9 million
in additions to property, equipment and software and $3.0 million related to
acquisitions. Net cash provided by financing activities was $11.2 million,
including $782,000 in proceeds from the exercise of stock options and a $10.8
million net increase in borrowings under floor plan lines of credit.
At June 30, 1998, the Company's principal sources of liquidity included
cash and cash equivalents of $34.6 million and floor plan lines of credit from
Deutsche Financial Services Corporation ("DFSC"). The United States DFSC
facility provides for aggregate borrowings of up to $125 million, with interest
payable at prime (8.5% at June 30, 1998) minus 1%. Availability of United States
borrowings is based on DFSC's determination as to eligible accounts receivable
and inventory. As of June 30, 1998, the Company's borrowings from DFSC on its
United States floor plan line of credit were $102.1 million, which approximated
the Company's availability based on eligible accounts receivable and inventory
at that date. Approximately one half of the Company's initial United States
borrowings do not bear interest until after interest-free periods of 30 to 90
days have lapsed. The United States DFSC line of credit is secured by the
Company's United States inventory and accounts receivable, although
substantially all of the Company's other United States assets also are pledged
as collateral on the facility. In December 1997, the Company also established a
United Kingdom DFSC credit facility which provides for aggregate borrowings of
up to (pound)30 million, or approximately $50 million, as of June 30, 1998.
Availability of United Kingdom borrowings is based upon DFSC's determination of
eligible accounts receivable and amounts
11
<PAGE>
outstanding bear interest at the Base Rate of National Westminster Bank plc
(7.25% at June 30, 1998) plus 1.25%. The United Kingdom DFSC facility replaced
four separate facilities previously maintained in the United Kingdom. As of June
30, 1998, the Company's borrowings under its United Kingdom DFSC facility were
(pound)21.9 million, or $36.6 million, which approximated the Company's
availability thereunder. The Base Rate in the United Kingdom has increased from
6% at June 30, 1997 to 7.25% at June 30, 1998.
The Company is dependent upon the DFSC lines of credit to finance
increases in its eligible accounts receivable arising from sales of PC products
as well as its United States inventory purchases and, hence, the Company expects
that its borrowings under such facilities will need to increase in order to
support the Company's anticipated growth. There can be no assurance, however,
that the DFSC lines of credit will continue to be available, or be increased to
support the Company's requirements. The DFSC lines of credit limit borrowings to
defined percentages of eligible inventory (in the United States) and accounts
receivable and contain financial covenants with respect to the Company's net
worth and debt-to-equity ratios, and customary default provisions.
The Company also has a $9.5 million floor plan financing agreement with
IBM Credit Corporation ("IBMCC") to support purchases of IBM products. The IBMCC
borrowing facility is secured by the IBM products purchased under the
arrangement and relates to domestic operations only. At June 30, 1998, the
Company had no borrowings outstanding from IBMCC on this floor plan line of
credit.
As of June 30, 1998, the Company had borrowings aggregating
approximately $138.7 million outstanding under these borrowing facilities, which
approximated its availability thereunder.
Based upon ongoing analyses, and the requirement that it establish a
direct purchasing relationship with a major PC manufacturer to support
fulfillment requirements under a contract awarded in 1996, the Company started
purchasing selected products directly from certain manufacturers in late 1996.
Although the Company's inventory investment imposes certain costs and risks and
has increased substantially since late 1996, the Company believes that this
investment can improve its delivery time to customers and the quality control of
configured systems and, over time, may increase the profitability of the
Company. These direct purchasing arrangements have favorably impacted gross
profit, particularly in the third and fourth quarters of 1997, as the volume of
direct purchases increased significantly over prior quarters and the Company
earned substantial direct purchasing rebates and incremental discounts. The
Company's purchasing volume in the first half of 1998 supported a reduced level
of such rebates and incremental discounts, versus the third and fourth quarters
of 1997. There can be no assurances that these manufacturer rebates and
discounts will be available in the future, or if available, that the Company
will be in a position to purchase the levels of products necessary to receive
comparable or increased levels of such rebates and incremental discounts. The
Company is working to reduce its inventory levels, particularly in the United
States where manufacturers are imposing new restrictions on returns and limiting
the availability of price protection. Accordingly, the Company is reevaluating
the levels of products it purchases directly and holds in inventory in the
United States versus the cost to electronically source items from its primary
distribution fulfillment partner for direct shipment to customers or to a
Company location. In addition, the Company believes that it can substantially
mitigate the risks associated with its additional inventory positions by
limiting the range of models it stocks to those in demand and by carefully
monitoring items on hand and their associated net carrying costs, relative to
demand. The Company also intends to continue to maintain logistical and
traditional relationships with selected distributors and/or aggregators.
On May 28, 1998, the Board of Directors of the Company authorized the
purchase of up to 800,000 shares of common stock to be held as treasury stock
specifically for reissuance in connection with acquisitions. The Company
purchased 135,019 shares during the second quarter and anticipates that it may
acquire additional shares under this authorization from time to time.
The Company's principal commitments consist of leases on its office
facilities, obligations under lines of credit, which are demand facilities and
are treated as current liabilities, and capital leases. Future growth of the
Company will require ongoing investment in property, equipment and software.
12
<PAGE>
The Company believes that its cash and cash equivalents, together with
its existing sources of liquidity, will be sufficient to meet its working
capital and capital expenditure requirements for the next year, so long as its
financing sources continue to make lines of credit available. However, as the
Company's business strategy includes growth through acquisitions, additional
sources of financing may be required to accomplish the Company's growth plans.
STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
Except for the historical information contained herein, the matters
discussed in this Quarterly Report on Form 10-Q include forward-looking
information. All statements other than statements of historical fact, including,
without limitation, those with respect to the Company's objectives, plans and
strategies set forth herein and those preceded by or that include the words
"believes," "expects," "anticipates," or similar expressions, are
forward-looking statements. Although the Company believes that such
forward-looking statements are reasonable, it can give no assurance that the
Company's expectations are correct. These forward-looking statements involve a
number of risks and uncertainties which could cause the Company's future results
of operations to differ materially from those anticipated. Such risks and
uncertainties include: availability and terms of appropriate financing,
customers' acceptance and usage of the Company's electronic commerce software
systems, the impact of competitive technology products, service providers, and
PC product pricing, control of expenses, levels of gross profits, revenue
growth, changes in manufacturer price protection, return and other policies,
availability of PC products, overall business conditions, corporate demand for
PC products, the success and timing of fully implementing the Company's
Oracle-based management information system and problems associated therewith,
risks associated with acquisitions of companies, and the other risks detailed in
the Company's 1997 Annual Report on Form 10-K and from time to time in the
Company's other reports filed with the SEC, including the Company's prospectus
included as part of the S-1 Registration Statement declared effective on
December 19, 1995 under the Securities Act of 1933. Regarding the Company's
evaluation of possible strategic partners and financing alternatives, including
those specific to Elcom Systems, there can be no assurance that any strategic
alternatives, including any possible arrangements with a strategic partner or a
possible sale, merger or financing can be successfully identified or solicited,
negotiated, or consummated to the betterment of the Company or the Company's
stock price, or what the timing, terms, or ultimate impact of any such
arrangement might be.
13
<PAGE>
Part II - Other Information
Item 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of the Company's stockholders was held on April 28,
1998. Three matters as specified in the Company's Notice of Annual Meeting and
Proxy Statement dated March 20, 1998, a copy of which has been previously filed
with the Securities and Exchange Commission, were considered, voted upon and
approved by the Company's stockholders. The specific results of the voting on
the three matters are as follows:
Proposal I: Messrs. Robert J. Crowell and William W. Smith were elected
to the Board of Directors of the Company, each for a term to
expire at the 2000 Annual Meeting, by the following vote:
Number of Shares Voted
-------------------------------
For Withheld
----------- -----------
Robert J. Crowell 18,207,992 60,704
William W. Smith 18,206,342 62,354
Following the meeting, each of Messrs. Cordsen, Ortiz, Rousou and
Harries also continued as Directors of the Company.
Proposal II: The Company's stockholders ratified and approved the
Company's 1997 Stock Option Plan by the following vote:
Number of Shares Voted
--------------------------------------------------------------------
For Against Abstain
------------------- ---------------------- --------------------
10,003,228 841,775 7,423,693*
* Includes 7,273,718 broker non-votes
Proposal III:The Company's stockholders ratified and approved the Elcom
International, Inc. Executive Profit Performance Bonus Plan
for Executive Officers by the following vote:
Number of Shares Voted
--------------------------------------------------------------------
For Against Abstain
------------------- -------------------- ---------------------
17,639,259 581,394 48,043
Item 5. Other Information
On June 30, 1998, J. Richard Cordsen voluntarily resigned his position as a
Director of Elcom International, Inc. due to the press of other business matters
and the policy of his employer. Mr. Cordsen's resignation was not the result of
any disagreement with the Board of Directors or the Company on any matter
relating to the Company's operations, policies or practices. Mr. Cordsen's Board
seat remains vacant pending evaluation of a potential replacement by the Board
of Directors.
On July 7, 1998, the Company was notified that Local 1499 of the
International Brotherhood of Electrical Workers, AFL-CIO filed a petition on
behalf of the Company's Canton, Massachusetts warehouse and technical employees
for certification of representation. A vote for union representation covering
approximately 25 employees in the Eastern configuration and distribution center
is scheduled to be held on August 20, 1998. The Company is actively campaigning
against union representation in the facility.
14
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
(10.1) Form of Indemnity Agreement for Executive Officers and/or
Directors of the Company (1), with attached list of Director
and/or Executive Officer Indemnitees. (x)(*)
(10.42) Amendment to Business Credit and Security Agreement between
Elcom Services Group, Inc.and Deutsche Financial Services
Corporation dated June 24, 1998. (x)
(27.1) Financial Data Schedule. (x)
(27.2) Restated Financial Data Schedule - Six months ended
June 30, 1997. (x)
- -------------------
(1) Previously filed as an exhibit to Registration Statement
No. 33-98866 on Form S-1 and incorporated herein by reference.
(x) Filed herewith.
(*) Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K.
On June 3, 1998, the Company filed a current report on Form 8-K dated
June 2, 1998 concerning a stock repurchase program approved by the
Company's Board of Directors on May 28, 1998. Pursuant to the
authorization the Company may repurchase up to 800,000 shares of its
common stock in the open market or in privately negotiated
transactions.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) 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.
Elcom International, Inc.
(Registrant)
Date: August 11, 1998 By: /s/ Laurence F. Mulhern
----------------------------
Laurence F. Mulhern
Chief Financial Officer
and Treasurer
15
Exhibit 10.1
LIST OF DIRECTORS AND/OR EXECUTIVE OFFICERS
WITH INDEMNITY AGREEMENTS
WITH THE COMPANY
Name of Capacity in Date of
Indemnitee Which Indemnified Agreement
- ------------- -------------------- ------------
Robert J. Crowell Executive Officer and Director October 9, 1995
William W. Smith Director October 9, 1995
Laurence F. Mulhern Executive Officer October 9, 1995
John W. Ortiz Director October 9, 1995
Richard J. Harries, Jr. Director October 9, 1995
James Rousou Executive Officer and Director May 30, 1996
Peter F. McAree Executive Officer August 22, 1997
James G. Jameson Executive Officer April 13, 1998
John R. Kovalcik, Jr. Former Executive Officer October 9, 1995
and Former Director
David Wolf Former Executive Officer October 9, 1995
Andres Escallon Former Executive Officer October 9, 1995
J. Richard Cordsen Former Director October 9, 1995
EXHIBIT 10.42
AMENDMENT TO BUSINESS CREDIT AND SECURITY AGREEMENT
This Amendment is made to that certain Business Credit and Security
Agreement dated as of March 1, 1997 by and among Elcom Services Group, Inc.
(formerly known as Catalink Direct, Inc.) ("Borrower"; Borrower also being the
successor by merger into it of Catalink Direct (Pennsylvania), Inc.) and
Deutsche Financial Services Corporation ("DFS") (as amended, the "Agreement").
Capitalized terms used but not defined herein shall have the meanings given in
the Agreement.
WHEREAS, Borrower and DFS are parties to the Agreement and they now desire
to amend the Agreement on and subject to the terms hereof:
NOW, THEREFORE, in consideration of the covenants contained herein and for
other good and valuable consideration, the receipt and sufficiency of which are
acknowledged, DFS and Borrower agree as follows:
1. Effective June 9, 1998 "Catalink Direct, Inc." changed its name to
"Elcom Services Group, Inc." Effective December 31,1997, Catalink Direct
(Pennsylvania), Inc. merged with and into Borrower. The Agreement is hereby
amended in connection with the foregoing (i) by deleting each and every
reference therein to "Catalink Direct (Pennsylvania), Inc." and replacing it
with the one entity now known as "Elcom Services Group, Inc.", and (ii) such
that there shall hereafter be only one Borrower, Elcom Services Group, Inc.
2. The definition of "Permitted Purchase Money Indebtedness" in Section 2
of the Agreement is hereby deleted in its entirety and replaced with the
following:
"'Permitted Purchase Money Indebtedness' shall mean Purchase Money
Indebtedness of Borrower incurred in compliance with Section 9.2.12
which is secured by a Purchase Money Lien and which, when aggregated
with the principal amount of all other such Indebtedness and the
capitalized lease obligations of Borrower at the time outstanding, does
not exceed $15,000,000, provided, further that such amount shall at no
time consist of obligations of Borrower to IBM Credit Corporation or
any affiliate thereof in excess of the amount set forth on Schedule A
attached hereto. For the purposes of this definition, the principal
amount of any Purchase Money Indebtedness consisting of capitalized
leases shall be computed as a capitalized lease obligation."
All other terms as they appear in the Agreement, to the extent not
inconsistent with the foregoing, are ratified and remain unchanged and in full
force and effect.
IN WITNESS WHEREOF, Borrower and DFS have executed this Amendment to
Business Credit and Security Agreement as of the twenty-fourth day of June,
1998.
ELCOM SERVICES GROUP, INC.
(F/K/A CATALINK DIRECT, INC.)
ATTEST: /s/A. J. Gauvin By: /s/L. F. Mulhern
------------------ ------------------------
Assistant Secretary Title: Chief Financial Officer
-------------------- ------------------------
DEUTSCHE FINANCIAL SERVICES CORPORATION
By: /s/ A .D. Hartford
------------------------
Title: Regional Branch Manager
------------------------
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