<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 September 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 27,310,723 shares of common stock, $.01 par value,
outstanding as of October 30, 1998
<PAGE>
INDEX
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 1997
and September 30, 1998 (unaudited).......................................2
Consolidated Statements of Operations - Three and Nine Month
Periods Ended September 30, 1997 and 1998 (unaudited)....................3
Consolidated Statements of Cash Flows - Nine Month Periods Ended
September 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...............................................7
Part II - OTHER INFORMATION
Item 1. None.
Item 2. None.
Item 3. None.
Item 4. None.
Item 5. Other Information................................................15
Item 6. Index to 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, September 30,
1997 1998
-------------- ---------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents..................................................... $ 33,165 $ 19,982
Accounts receivable:
Trade....................................................................... 154,223 153,347
Other....................................................................... 32,200 43,108
--------- ---------
186,423 196,455
Less - Allowance for doubtful accounts...................................... 5,474 5,666
--------- ---------
180,949 190,789
Inventory..................................................................... 60,437 42,912
Prepaids and other current assets ............................................ 3,255 4,846
--------- ---------
Total current assets..................................................... 277,806 258,529
--------- ---------
PROPERTY, EQUIPMENT AND SOFTWARE, AT COST:
Computer hardware and software................................................ 22,118 24,725
Land, buildings and leasehold improvements.................................... 3,402 3,579
Furniture, fixtures and equipment............................................. 8,579 9,112
--------- ---------
34,099 37,416
Less - Accumulated depreciation and amortization............................. 17,649 22,044
--------- ---------
16,450 15,372
--------- ---------
GOODWILL AND OTHER ASSETS, NET OF ACCUMULATED
AMORTIZATION.................................................................. 37,812 31,786
--------- ---------
$ 332,068 $ 305,687
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Lines of credit............................................................... $ 154,714 $ 136,192
Accounts payable.............................................................. 43,271 43,691
Accrued expenses and other current liabilities. .............................. 19,557 24,070
Current portion of capital lease obligations.................................. 680 717
Current portion of long-term debt.. .......................................... 78 80
--------- ---------
Total current liabilities.............................................. 218,300 204,750
--------- ---------
OTHER DEFERRED LIABILITIES...................................................... 2,213 2,214
CAPITAL LEASE OBLIGATIONS, NET OF CURRENT PORTION............................... 920 377
LONG-TERM DEBT, NET OF CURRENT PORTION.......................................... 332 314
--------- ---------
3,465 2,905
--------- ---------
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 - 27,218,239 and 27,547,061 shares.................................. 272 275
Additional paid-in capital.................................................... 100,726 101,271
Retained earnings (deficit)................................................... 9,369 (3,780)
Treasury stock, at cost - 56,319 and 191,338 shares .......................... (549) (1,108)
Cumulative translation adjustment............................................. 485 1,374
--------- ---------
Total stockholders' equity................................................. 110,303 98,032
========= =========
$ 332,068 $ 305,687
========= =========
</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 Nine Months Ended
September 30, September 30,
---------------------- ----------------------
1997 1998 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net sales................................................. $ 198,373 $ 194,993 $ 572,809 $ 576,819
Cost of sales............................................. 174,337 175,530 505,879 512,616
---------- ---------- ---------- ---------
Gross profit.............................................. 24,036 19,463 66,930 64,203
Expenses:
Selling, general and administrative..................... 17,922 21,837 52,597 58,702
Research and development................................ 350 474 915 1,094
Restructuring and other related charges................. -- 12,338 -- 12,338
---------- ----------- ---------- ----------
Total expenses............................................ 18,272 34,649 53,512 72,134
---------- ----------- ---------- ----------
Operating profit(loss).................................... 5,764 (15,186) 13,418 (7,931)
Interest expense ......................................... (1,390) (2,162) (3,639) (6,327)
Interest income and other, net............................ 256 241 972 637
---------- ----------- ---------- ----------
Income (loss) before income taxes......................... 4,630 (17,107) 10,751 (13,621)
Provision for (recovery of) income taxes.................. 1,218 (2,071) 3,316 (472)
---------- ----------- ---------- ----------
Net income (loss)......................................... $ 3,412 $ (15,036) $ 7,435 $ (13,149)
========== =========== =========== ==========
Basic net income (loss) per share......................... $ 0.13 $ (0.55) $ 0.28 $ (0.48)
========== =========== =========== ==========
Basic weighted average shares outstanding................. 27,017 27,356 26,876 27,322
========== =========== =========== ==========
Diluted net income (loss) per share....................... $ 0.11 $ (0.55) $ 0.26 $ (0.48)
========== =========== =========== ==========
Diluted weighted average shares outstanding............... 29,481 27,356 28,853 27,322
========== =========== =========== ==========
Other comprehensive income, net of tax:
Netincome(loss) .......................................... $ 3,412 $ (15,036) $ 7,435 $ (13,149)
Foreign currency translation adjustments................ 303 (956) 439 889
---------- ---------- ---------- ----------
Comprehensive income (loss)............................... $ 3,715 $ (15,992) $ 7,874 $ (12,660)
========== ========== ========== ==========
</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)
Nine Months Ended
September 30,
-------------------------------
1997 1998
-------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income(loss)................................................... $ 7,435 $ (13,149)
Adjustments to reconcile net income to net cash provided by
operating activities --
Depreciation and amortization...................................... 6,548 16,743
Provision for doubtful accounts.................................... 1,319 2,728
Other deferred liabilities......................................... 409 --
Changes in current assets and liabilities, net of acquisitions --
Accounts receivable................................................ (21,010) (10,701)
Inventory.......................................................... (10,632) 18,122
Prepaids and other current assets.................................. (244) (1,637)
Accounts payable................................................... 29,675 (852)
Accrued expenses, other current liabilities and other.............. (11,328) 4,132
-------- --------
Net cash provided by operating activities......................... 2,172 15,386
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, equipment and software....................... (6,947) (5,902)
(Increase) decrease in other assets and deferred costs............. 47 (3,057)
Purchase of Prophet Group.......................................... (391) --
Purchase of Data Supplies, net of cash acquired.................... (2,660) --
Other investing activities......................................... 37 --
-------- --------
Net cash used in investing activities........................... (9,914) (8,959)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) under lines of credit..................... 15,940 (19,495)
Repayment of capital lease obligations.............................. (559) (532)
Proceeds from stock option exercises ............................... 1,237 547
Purchase of Treasury Stock ......................................... (183) (559)
-------- --------
Net cash provided by (used in) financing activities ............. 16,435 (20,039)
-------- --------
FOREIGN EXCHANGE EFFECT ON CASH...................................... (592) 429
-------- --------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS..................................................... 8,101 (13,183)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD....................... 23,259 33,165
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD............................. $ 31,360 $ 19,982
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Interest paid........................................................ $ 3,732 $ 6,320
======== =========
Income taxes paid.................................................... $ 1,020 $ 599
======== =========
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Increase in capital lease obligations................................ $ 1,488 $ --
======== =========
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 September 30, 1998, and the results of operations and cash
flows for the periods ended September 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 also 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 shares of common stock outstanding during the period. Diluted EPS gives
effect to all potential shares of common stock 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 Nine Months Ended
September 30, September 30,
----------------------------- ---------------------------
1997 1998 1997 1998
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Basic
-------
Net income (loss)..................... $ 3,412 $ (15,036) $ 7,435 $ (13,149)
============ ============ =========== ============
Weighted average shares outstanding... 27,017 27,356 26,876 27,322
============ ============ =========== ============
Basic net income (loss) per share..... $ 0.13 $ (0.55) $ 0.28 $ (0.48)
============ ============ =========== ============
Diluted
--------
Net income (loss)..................... $ 3,412 $ (15,036) $ 7,435 $ (13,149)
============ ============ =========== ============
Weighted average shares outstanding... 27,017 27,356 26,876 27,322
Dilutive effect of stock options...... 2,464 -- 1,977 --
------------ ------------ ----------- ------------
Weighted average shares as adjusted... 29,481 27,356 28,853 27,322
============ ============ =========== ============
Diluted net income (loss) per share... $ 0.11 $ (0.55) $ 0.26 $ (0.48)
============ ============ =========== ============
</TABLE>
5
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Weighted average options and warrants to purchase 8,336,836 and
8,306,289 shares of common stock outstanding during the quarter and nine
months ended September 30, 1998, respectively, were not included in the
computation of diluted earnings per share because of their anti-dilutive
effect due to the Company's operating loss. If the Company had generated
income from operations, 570,000 and 813,000 dilutive shares would have been
included in the weighted average shares outstanding for the three and nine
month periods ended September 30, 1998, respectively.
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.
4. Restructuring and Other Related Charges
In August and September, 1998, the Company's senior management
approved restructuring plans related to its Elcom Systems, Inc. ("ESI")
subsidiary, its Elcom Services Group, Inc. ("ESG") government and
educational sales operations and consolidation of certain of its customer
support personnel in the U.S. This restructuring entails a workforce
reduction of approximately 35 of the Company's U.S. employees.
As a result of this restructuring, ESI will discontinue maintenance of
its Commerce Manager technology and will focus primarily on serving as an
electronic commerce-oriented systems integration arm of ESG, thereby
enabling ESG with the capability to offer its U.S. and U.K. customers PECOS
Procurement Manager, ESI's multi-catalog and multi-vendor electronic
ordering and automated procurement management system. In addition, the
Company is no longer an Apple Educational Sales Agent and will henceforth
concentrate instead on building an educational sales force focused on
providing Windows and Intel-based ("Wintel") solutions to the education
market in the U.S.
The total pre-tax charge of $12.3 million is comprised of $900,000 in
severance costs, $1 million of estimated liabilities related to acquitting
the Company's responsibilities concerning certain existing technology
licenses, a $10 million write down to estimated fair market value of
certain unrealizable intangible assets related to prior U.S. acquisitions,
and $400,000 of other charges. The Company estimates that the restructuring
will entail cash expenditures of approximately $1.5 million that will be
incurred on a declining basis from the fourth quarter of 1998 through the
end of 1999.
6
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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.
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 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.
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 nine months 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 13%
growth in the first nine months of 1998 compared to the same period last year,
these price decreases had a significant effect on the average unit price of
personal computers
7
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sold and the Company's net sales, when compared to last year. Further, the
Company experienced a softening of customer demand in the second half of
September 1998, which the Company has attributed to the Asian financial crisis,
and the related uncertainties that have impacted many of the Company's
customers.
The Company recently announced a third-quarter restructuring of its
operations. The primary restructuring objectives are to centralize and/or better
leverage the Company's customer relations support and sales functions and to
re-focus its Elcom Systems subsidiary as the electronic commerce-oriented
systems integration arm of Elcom Services Group. In connection with this
restructuring, the Company has elected not to pursue renewal of its Apple
Educational Sales Agent contract, which management deemed to be restrictive.
Elcom Systems, Inc.
On a stand-alone basis, for the nine-month periods ended September 30, 1998
and September 30, 1997, revenues generated from Elcom Systems' licenses,
including associated professional services and maintenance fees, were
approximately $2.3 million and $3.9 million, respectively. Consequently, because
Elcom Systems' expenses were relatively stable in both periods, its consolidated
operating loss (excluding the restructuring and other related charges) increased
$1.7 million to $2.3 million during the first nine months of 1998 versus an
operating loss of $0.6 million in the first nine months of 1997. The decline in
Elcom Systems' revenues reflects the shift in the Company's focus from its
Commerce Manager technology to its recently introduced automated Procurement
Management technology. As a result of its investigation of several alternatives
to appropriately capitalize and allow Elcom Systems to operate as an independent
and separate company, the Company has determined that, in light of market
conditions, an initial public offering or spin-off to stockholders is not
appropriate at this time. As the Company recently announced, Elcom Systems will
be restructured to serve as an electronic commerce-oriented systems integration
arm of Elcom Services Group, the Company's PC-remarketing and professional
services subsidiary.
Salomon Smith Barney Engagement
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, prompted the
Company to take this step. These actions, intended to maximize stockholder
value, included evaluating the possible sale or merger of the Company, strategic
financing options, and potential strategic partners. Due to the size and scale
of the Company's PC remarketing and services business in the United Kingdom and
the relative strength of the United Kingdom stock market, particularly for
information technology stocks, the Company and Salomon Smith Barney also
evaluated alternative options intended to take advantage of this strength,
including potential separate transactions for the Company's United Kingdom and
United States remarketer businesses.
The engagement of Salomon Smith Barney, which was scheduled to expire on
July 23, 1998, had been extended to allow Salomon Smith Barney to continue its
assistance in the ongoing discussions with multiple companies. On September 17,
1998, the Company announced that its Board of Directors voted to continue to
build its business as a standalone company and therefore disengaged from its
activities with Salomon Smith Barney associated with the evaluation of strategic
alternatives for the Company. The Board of Directors decided that none of the
preliminary proposals or alternatives potentially available to it at that time
were of a structure or amount which, if consummated, would have been in the best
interests of its stockholders. The Board of Directors decided, in light of the
proposals discussed during the engagement, that the interests of the
stockholders would best be served by the Company continuing to develop its
business as a stand-alone company. The Company intends to further this objective
by soliciting research coverage on the Company, increasing revenue momentum in
the United States and United Kingdom marketplaces, focusing on broadening its
range of professional services and providing electronic PC product fulfillment
solutions to its customers. The Company also intends to use its electronic
commerce systems, integrated with its information systems, to increase
operational efficiencies.
8
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The Company is not engaged currently in any substantive discussions or
negotiations, although it intends to have discussions if appropriate with
relevant and qualified companies to investigate possibilities to increase
stockholder value. The Company remains contractually committed to Salomon Smith
Barney for one year in the event a transaction is consummated with certain
parties. As appropriate, the Company also 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.
Year 2000 Compliance
As further described elsewhere herein, the Company has implemented an
Oracle-based year 2000 compliant management information system ("MIS") in the
United States. In the United Kingdom, the Company has implemented a year 2000
compliant upgrade to its Computer Associates International, Inc. software system
which operates on an IBM AS-400 hardware platform. Due to the extended time
frame of the United States Oracle-based system implementation, and related
ongoing enhancements, the Company has deferred implementation of the
Oracle-based system in the United Kingdom and has also deferred implementation
of a new warehousing system in the United States and is using its Oracle-based,
year 2000 compliant, warehousing system. In 1999, the Company will reassess
implementation of its Oracle-based system in the United Kingdom as well as its
new warehousing system in the United States. The Company's near term MIS efforts
will continue to be focused on additional enhancements to its systems, including
ensuring the Company remains current in applying any software "patches" issued
by its software vendors to address any year 2000 compliance issues. The Company
has been assured by its key electronic trading partners that their information
system applications either are, or will be, year 2000 compliant before issues
may arise. The Company's PECOS.net family of electronic commerce technology
applications have been developed in a year 2000 compliant fashion.
Results of Operations
Quarter ended September 30, 1998 compared to the quarter ended September 30,
1997.
Net Sales. Net sales for the quarter ended September 30, 1998 were $195.0
million versus $198.4 million in the same period of 1997, a decrease of $3.4
million, or 1.7%. Net sales of the Company's United Kingdom-based operations
decreased slightly to $73.4 million in the 1998 quarter from $73.9 million in
the third quarter of 1997. Net sales in the United States were $121.6 million in
the 1998 quarter versus $124.5 million in the quarter ended September 30, 1997,
a 2.3% decrease. The decrease in net sales in the United States reflects the
impact of several factors, including increased price competition in the
marketplace 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 also believes that the decrease in net sales is partially
attributable to substantial price reductions of PC systems made by
manufacturers, which has not been completely offset by a slight increase in
units shipped by the Company in the 1998 quarter versus the 1997 quarter.
Gross Profit. Gross profit for the quarter ended September 30, 1998 was
$19.5 million versus $24.0 million in the 1997 quarter. Gross profit as a
percent of net sales decreased from 12.1% in the 1997 quarter to 10.0% in the
1998 quarter reflecting the impact of a decrease in direct purchasing volume,
coupled with a decrease in vendor funding and incremental discounts available to
the Company as well as increased price competition in the marketplace. The
decrease in the gross profit percentage in the third quarter of 1998 to 10.0%
from the 11.8% achieved in the second quarter of 1998 also reflects a decrease
in the level of manufacturer funding and incremental discounts available to the
Company as well as increased price competition in the marketplace. The United
Kingdom group is authorized to "distribute" certain product lines to other PC
remarketers and these sales which are at lower margins than sales to end users,
have increased, thereby lowering overall gross profit margins.
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 relative reduction in the level of direct purchases as well as
a planned expansion of sales to high volume corporate accounts. However, due to
ongoing modifications in manufacturer policies concerning the
9
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time frame for and/or availability of price protection and product return
privileges, the Company has substantially reduced inventory levels and 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 September 30, 1998 increased to
$21.8 million from $17.9 million in the 1997 quarter, an increase of $3.9
million, or 22%. This increase is related primarily to the Company's incremental
investment in sales and technical services personnel, as well as administrative
and operational infrastructure to support the anticipated future growth of both
the Company's remarketer and professional services business segments. 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 to further improve the effectiveness
of the system are continuing. 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, in the
second quarter of 1998 the Company revised its strategy with respect to
implementation of the system in the United Kingdom. The Company is working with
Computer Associates International, Inc., its United Kingdom software vendor, and
during October implemented an upgrade to its existing software systems which
upgraded the software systems to be year 2000 compliant for the Company's United
Kingdom operations. During 1999, 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 September 30, 1998 to 11.2%, from
9.0% in the comparable 1997 quarter, reflecting the impact of a slight decrease
in net sales, as well as the Company's ongoing investment in sales and technical
personnel and 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
September 30, 1998 increased to $474,000 from $350,000 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, primarily focusing on the PECOS.pm technology, certain aspects of
which were acquired in 1997.
Restructuring and Other Related Charges. In September, 1998, the Company
restructured Elcom Systems, its electronic commerce technology subsidiary, to
serve as an electronic commerce-oriented systems integration arm of Elcom
Services Group. In connection with the Elcom Systems restructuring, the Company
has recorded a total charge of approximately $4.2 million, consisting of
$800,000 of severance costs, a write-down to estimated net realizable value of
$2.1 million of unrealizable intangible assets, and approximately $1.3 million
in other estimated expenses and asset write downs.
In August 1998, the Company restructured Elcom Services Group's education
sales operations and in September consolidated certain of its customer support
personnel in the United States. The total charge related to the Elcom Services
Group restructuring is approximately $8.1 million, consisting of approximately
$100,000 of severance costs, a write-down to estimated net realizable value of
$7.0 million of unrealizable intangible assets and approximately $1 million in
other related expenses and asset write downs.
Interest Expense. Interest expensefor the quarter ended September 30, 1998
increased to $2.2 million from $1.4 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
10
<PAGE>
1997. The Base Rate in the United Kingdom has increased from 7% at September 30,
1997 to 7.25% at September 30, 1998.
Interest Income and Other, Net. Interest income and other, net, for the
quarter ended September 30, 1998 decreased to $241,000 in the 1998 quarter from
$256,000 in the 1997 quarter, reflecting a decrease in the Company's average
invested cash balances.
Income Tax Provision(Recovery). The recovery of income taxes in 1998 is
primarily related to the Company's net operating loss generated in the third
quarter of 1998. The level of benefit reflects the non-deductible nature of the
majority of intangible assets written down in the restructuring, and is net of
certain current state income taxes provided. 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 Loss. The Company reported a net loss for the quarter ended September
30, 1998 as a consequence of the results of the factors described herein,
primarily due to the restructuring and other related charges.
Nine months ended September 30,1998 compared to the Nine months ended September
30, 1997.
Net Sales. Net sales for the nine months ended September 30, 1998 increased
to $576.8 million from $572.8 million in the same period of 1997, an increase of
$4.0 million. Net sales in the United States were $345 million in the first nine
months of 1998 versus $356 million in the nine months ended September 30, 1997,
a 3% 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 $232 million from $217 million in the first nine months
of 1998, an increase of $15 million or 7%.
Gross Profit. Gross profit for the first nine months of 1998 decreased to
$64.2 million from $66.9 million in the first nine months of 1997, a decrease of
$2.7 million, or 4%. Gross profit, as a percent of net sales decreased from
11.7% in the first nine months of 1997 to 11.1% in the first nine months of
1998. The lower gross profit percentage in 1998 reflects a decrease in the
Company's direct purchasing volume, increased price competition in the market
place and an increase in the proportion of the United Kingdom Group's
distribution sales, as well as the other factors described in the quarterly and
overview discussions herein.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the nine months ended September 30, 1998 increased
to $58.7 million from $52.6 million in the nine months ended September 30, 1997,
an increase of $6.1 million, or 11.6%. This increase is attributable primarily
to the increase in the Company's work force, particularly in sales and
professional services personnel, as well as continued investment in
administrative infrastructure to support its anticipated future growth. Selling,
general and administrative expenses increased as a percentage of net sales for
the nine months ended September 30, 1998 to 10.2%, from 9.2% in the comparable
period of 1997.
Research and Development Expenses. In the first nine months of 1998,
research and development expenses have remained relatively constant with the
1997 period. 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.
Restructuring and Other Related Charges. Please refer to the quarterly and
overview discussions herein.
Interest Expense. Interest expense for the nine month period ended
September 30, 1998 increased to $6.3 million from $3.6 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
11
<PAGE>
1997. The Base Rate in the United Kingdom has increased from 7% at September 30,
1997 to 7.25% at September 30, 1998.
Interest Income and Other, Net. Interest income and other, net, for the
nine month period ended September 30, 1998 decreased to $637,000 from $972,000
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
East coast configuration and distribution facility which was opened in Canton,
MA in the first quarter of 1997.
Income Tax Provision(Recovery). The income tax benefit in 1998 relates
primarily to domestic operations of the Company. The tax rate of the benefit is
less than the expected statutory rate due to the impact of non-deductible
goodwill expense and also is net of a provision in the United Kingdom, as well
as a provision for certain current state income taxes. The tax provision in 1997
related primarily to the Company's United Kingdom operations and certain current
state income taxes payable in the United States.
Net Loss. The Company reported a net loss for the nine months ended
September 30, 1998 as a consequence of the results of the factors described
herein, primarily due to the restructuring and other related charges.
Liquidity and Capital Resources
Net cash provided by operating activities for the nine month period ended
September 30, 1998 was $15.4 million and reflects a depreciation charge of $16.7
million, a net increase in current liabilities of $3.3 million and an $18.1
million decrease in inventory, and is net of a $10.7 million increase in
accounts receivable. Net cash used for investing activities was $9.0 million,
consisting primarily of additions to property, equipment and software, and
increases in deferred tax assets. Net cash used in financing activities was
$20.0 million, consisting primarily of repayments under lines of credit. The
decrease in cash balances from year end 1997 and June 30, 1998 primarily relates
to the timing of payments of certain operational liabilities.
Net cash provided by operating activities for the nine month period ended
September 30, 1997 was $2.2 million, and reflects a net increase in current
liabilities of $18.4 million (primarily related to the timing of certain
payments) and is net of both a $21.0 million increase in accounts receivable,
resulting from the Company's increase in net sales during the 1997 period, and a
$10.6 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 September 30, 1998, the Company's principal sources of liquidity
included cash and cash equivalents of approximately $20.0 million, accounts
receivable and floor plan lines of credit from Deutsche Financial Services
Corporation ("DFSC"). The United States DFSC facility provides for aggregate
borrowings of up to $120 million, with interest payable at prime (8.25% at
September 30, 1998) minus 1%. Availability of United States borrowings is based
on DFSC's determination as to eligible accounts receivable and inventory. As of
September 30, 1998, the Company's borrowings from DFSC on its United States
floor plan line of credit were $103.3 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 (pounds)30 million, or
approximately $50
12
<PAGE>
million, as of September 30, 1998. Availability of United Kingdom borrowings is
based upon DFSC's determination of eligible accounts receivable and amounts
outstanding bear interest at the Base Rate of National Westminster Bank plc
(7.25% at September 30, 1998) plus 1.25%. The United Kingdom DFSC facility
replaced four separate facilities previously maintained in the United Kingdom.
As of September 30, 1998, the Company's borrowings under its United Kingdom DFSC
facility were (pounds)19.4 million, or $32.9 million, which approximated the
Company's availability thereunder.
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 September 30, 1998, the
Company had no borrowings outstanding from IBMCC on this floor plan line of
credit.
As of September 30, 1998, the Company had borrowings aggregating
approximately $136.2 million outstanding under these borrowing facilities, which
approximated its availability thereunder.
Based upon ongoing analyses, and therequirement that it establish a direct
purchasing relationship with a major PC manufacturer to support fulfillment
requirements under a contract awarded in 1996, the Company began purchasing
selected products directly from certain manufacturers in late 1996. Although the
Company's inventory investment imposes certain costs and risks and has increased
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 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 direct purchasing
volume and the policies of manufacturers in the first nine months 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. During 1998, the Company has reduced its inventory
levels, particularly in the United States, where manufacturers have modified
various policies regarding returns and limiting the time frame and/or
availability of price protection on products held in inventory. Accordingly, the
Company is reevaluating the levels of products it purchases directly and holds
in inventory in the United States versus the incremental cost to electronically
source items from its primary distribution fulfillment partner for direct
shipment to customers or to a Company location. The Company believes that it can
substantially mitigate the risks associated with its 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 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 135,109 shares under this authorization through September 30, 1998 and
anticipates that it may acquire additional shares 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, capital leases, and restructuring related
liabilities. Future growth of the Company will require ongoing investment in
property, equipment and software.
13
<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 working capital
and/or other financing, short-term interest rate fluctuations, customers'
acceptance and usage of the Company's electronic commerce software systems, the
impact of competitive technology products, professional service providers, and
PC product pricing, control of expenses, levels of gross profits, revenue
growth, changes in manufacturer's 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.
14
<PAGE>
Part II - Other Information
Item 5. Other Information
On September 17, 1998, the Company's Board of Directors voted unanimously
to elect James G. Jameson as a Director of Elcom International, Inc. Mr.
Jameson's election to the Board of Directors fills the vacancy left upon the
June 30, 1998 resignation of former Director, J. Richard Cordsen. Mr. Jameson is
also the President and Chief Executive Officer of Elcom Services Group's United
States operations.
A vote for union representation covering approximately 25 employees at
Elcom Services Group's Eastern configuration and distribution center was held on
August 20, 1998. The results of the vote were 17 votes against union
representation and 7 votes for union representation. Accordingly, union
representation was not approved.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
(10.43) Salomon Smith Barney Extension and Termination. (x)
(27.1) Financial Data Schedule. (x)
(27.2) Restated Financial Data Schedule - Nine months ended
September 30, 1997. (x)
- ------------------
(x) Filed herewith.
(*) Management contract or compensatory plan or arrangement.
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: November 12, 1998 By: /s/ Laurence F. Mulhern
----------------------------------
Laurence F. Mulhern
Chief Financial Officer and Treasurer
15
EXHIBIT 10.43
August 3, 1998
Elcom International, Inc.
10 Oceana Way
Norwood, MA 02062
Attention: Robert J. Crowell
Chairman & CEO
Gentlemen:
Reference is made to the engagement letter (the "Engagement Letter") dated
July 21, 1997, by and between Smith Barney, Inc. ("Smith Barney") and Elcom
International, Inc. (the "Company"). As you are aware, Smith Barney is now
affiliated with Salomon Brothers Inc. ("Salomon Brothers"), and together with
Salomon Brothers is doing business as Salomon Smith Barney (collectively,
"Salomon Smith Barney"). Defined terms used herein shall have the meanings given
such terms in the Engagement Letter. This letter is to confirm certain
amendments to the terms of the Engagement Letter, as follows:
1. The term of the Engagement Letter is hereby extended until
November 30, 1998.
2. Salomon Smith Barney will act as exclusive financial advisor
to the Company on the terms set forth in the Engagement Letter, as
amended by this letter. References in the Engagement Letter to
Smith Barney shall hereafter be deemed to refer to Salomon Smith
Barney.
3. Except as expressly modified by this letter, the Engagement
Letter shall remain in full force and effect.
Please confirm that the foregoing is in accordance with your understandings
and agreements with Salomon Smith Barney by signing and returning to us the
duplicate of this letter enclosed herewith.
Very truly yours,
SALOMON BROTHERS INC
SMITH BARNEY INC.
By: Smith Barney Inc.
/s/ Robert Martin
By:----------------------------
Managing Director
ACCEPTED AND AGREED:
ELCOM INTERNATIONAL, INC.
/s/ Robert J. Crowell
By: --------------------------
Robert J. Crowell
Chairman & CEO
EXHIBIT 10.43
September 17, 1998
Mr. Robert Martin
Managing Director
Salomon Smith Barney
7 World Trade Center
31st Floor
New York, NY 10048
Dear Mr. Martin:
Please be advised that this letter represents formal notification of the
termination of our engagement with Salomon Smith Barney for the purpose of
evaluating strategic alternatives to increase stockholder value.
I would also like to take this opportunity to commend Salomon Smith Barney, and
all the personnel involved, on representing Elcom International diligently in
the marketplace and with a very high level of professionalism.
Even though we were unable to find a strategic alternative that actually
increased stockholder value, I am confident that Elcom International will
continue to have a very strong relationship with your firm going forward.
Please feel free to use me as a personal reference for new clients (especially
small companies thinking of a merger or acquisition), and you can count on an
excellent recommendation.
Thank you again for all your hard work and efforts on our behalf. We will keep
in periodic contact to update you if any discussions continue and become
significant.
Regards,
ELCOM INTERNATIONAL, INC.
/s/ Robert J. Crowell
Robert J. Crowell
Chairman and CEO
RJC/lbs
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