SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Fiscal Year Ended December 31, 1998
or
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File Number: 000-27376
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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)
Securities Registered pursuant to Section 12(b) of the Act:
None
Securities Registered pursuant to Section 12(g) of the Act:
Name of exchange
Title of each class on which registered
------------------- --------------------
Common Stock, $.01 par value NASDAQ
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant based on the closing price of such stock on The Nasdaq Stock
Market on March 23, 1999, was approximately $65,528,000. For purposes of this
disclosure only, the registrant has assumed that its directors, executive
officers, and beneficial owners of 10% or more of the registrant's common stock
are affiliates of the registrant.
The registrant had 27,416,000 shares of common stock, $.01 par value,
outstanding as of March 23, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for the 1999 annual
meeting of stockholders of Elcom International, Inc. are incorporated by
reference into Part III of this report.
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PART I
Item 1. Business
Overview
Elcom International, Inc. (the "Company") develops and licenses
automated procurement software applications enabling the conduct of interactive
electronic commerce and, through its PC remarketing subsidiaries, uses versions
of its technology as well as Internet-based technology to support the sale and
marketing of PC products, the source of substantially all of the Company's net
sales since inception. Through elcom.com, inc., its technology subsidiary, the
Company developed its PECOS(R) (Personal Electronic Catalog and Ordering System)
technologies which enable companies to communicate, market, sell and buy various
goods and services electronically. The Company licenses its PECOS technology
product line to companies in a broad range of industries.
elcom.com, inc.
The software division of elcom.com, inc. ("elcom.com", formerly Elcom
Systems, Inc.) the Company's technology and Internet-based sales subsidiary,
develops and licenses standalone, intranet and Internet-based applications which
automate internal and external purchasing systems for businesses through the
computerization of front-end electronic catalogs and ordering as well as
multiple back-office purchasing processes. Beginning in March 1999, elcom.com
began operating an Internet on-line storefront where it markets and sells over
62,000 PC products to businesses and consumers. During 1999, elcom.com also
intends to launch an integrated Internet auction site at www.elcom.com and also
to add office supplies and other business supply-oriented products to its
product offerings. elcom.com intends to capitalize on the Company's experience
in electronic commerce to become a leading Internet-based supplier of these
multiple commodity-type products to businesses in the U.S. elcom.com is a
wholly-owned subsidiary of Elcom Services Group, Inc. (formerly Catalink Direct,
Inc.), itself a wholly-owned subsidiary of Elcom International, Inc.
(Nasdaq:ELCO).
elcom.com has introduced and continues to develop electronic commerce
applications to meet the business objectives of organizations seeking to
leverage electronic commerce to extend market reach, reduce operating expenses
and enable new service offerings. These applications direct and manage
electronic communications between trading partners' systems for the buying and
selling of goods and services and are built upon the Company's PECOS distributed
processing framework which provides secure and reliable transaction processing
over networks including intranets, extranets and the Internet. The Company's
PECOS product line has been designed to be year 2000 compliant and can support
large numbers of end-user customers, products, suppliers and transactions. The
Company's transaction server middleware provides a fully scaleable foundation
for robust system performance and high transaction capacity.
elcom.com's original PECOS technology, PECOS Commerce Manager
("PECOS.cm") provides selling organizations with the ability to support direct
electronic linkages with their customers, providing automation of sales order
processing utilizing personal computers and networking infrastructure. PECOS.cm
supports a number of deployment alternatives that include Windows, Java or HTML
operating in conjunction with standard browser applications. The Windows-based
client combines a convenient, easy-to-use, interactive, graphical user interface
and robust front-end client, with an integrated back-end information and order
transaction processing server system operating on UNIX or NT-based platforms. In
the third quarter of 1998, the Company discontinued general maintenance of
PECOS.cm and introduced PECOS.web, an Internet-based ordering and information
system with a majority of the functionality of PECOS.cm, to its customers.
elcom.com's buy-side solution, PECOS Procurement Manager ("PECOS.pm"), was
announced in 1997 and enhanced during 1998 to provide companies with the ability
to automate internal procurement processes related to commodity products.
PECOS.pm assists organizations in their implementation of procurement best
practices, which can result in reduced order processing costs, consolidation of
vendors, and the implementation of new service capabilities, such as desktop
ordering and just-in-time purchasing. PECOS.pm is deployed as an intranet-based
technology, which interfaces with a company's existing management information
system infrastructure and enables electronic ordering with participating
vendors. Based upon customer-defined controls, PECOS.pm supports workflow
processes as
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requisition routing and approval, electronic order placement and automated
payment processing. PECOS.pm version 3.0 is under license at several customer
sites, and the Company intends to accelerate further development of PECOS.pm.
Elcom Services Group
The Company uses its PECOS technologies through Elcom Services Group,
Inc.(R) ("Elcom Services Group", formerly Catalink Direct, Inc.), to market and
sell PC-related products to business customers and has generated substantially
all of the Company's net sales. Elcom Services Group's use of PECOS.cm
represented the first utilization of this technology and the Company believes
that its PECOS.cm and PECOS.web systems differentiate Elcom Services Group from
other PC remarketers. Elcom Services Group commenced operations in December
1993, and experienced rapid growth through the end of 1997. The Company achieved
its growth by offering its PECOS.cm technology to its Elcom Services Group
customers and by various marketing efforts, including the expansion of its
direct sales force nationwide and by the acquisition of six PC remarketers. The
Company's PC remarketer acquisition strategy included utilizing an acquired
company's sales force to offer PECOS.cm to prospective customers in those new
markets and, over time, to transition the acquired company's customers to the
PECOS.cm system, thereby generating increasing revenues transacted through the
PECOS.cm system. A portion of the Company's revenues continue to be generated by
several companies acquired by the Company which have not converted their
customers' orders to transact through PECOS.cm or PECOS.web and these entities
continue to use, in whole or in part, traditional methods of selling and order
taking.
In addition to PECOS.cm and PECOS.web, during 1999, Elcom Services
Group intends to offer its customers PECOS.pm, the Company's automated
procurement system, thereby providing its corporate customers with the ability
to consolidate suppliers and reengineer their internal procurement practices for
commodity items including PCs and related products and services. Although there
can be no assurances as to the ultimate timing, capabilities, or success of the
PECOS.pm technology, management believes that by providing PECOS.pm to existing
and prospective customers, Elcom Services Group's sales force can be empowered
with a significant competitive differentiation in the PC remarketing marketplace
with the intent to improve Elcom Services Group's customer penetration as well
as providing service-oriented solutions to its business partners' needs.
Elcom Services Group offers over 23,000 products manufactured by
leading companies such as Compaq, IBM, Toshiba, Hewlett-Packard and Apple
through PECOS.cm and 62,000 products through PECOS.web. The Company is currently
finalizing development of a version of PECOS.web for use by its United Kingdom
subsidiary. Several product manufacturers have paid marketing fees to Elcom
Services Group to advertise their products in PECOS.cm and PECOS.web. Orders
placed through PECOS.cm and PECOS.web for products which are in stock generally
are fulfilled from the inventory of Elcom Services Group or one of Elcom
Services Group's Distribution Fulfillment Partners ("DFPs"), which include
Ingram Micro, Inc., and Tech Data Corporation, two of the largest PC product
distributors in the world (See "- Fulfillment/Logistics/Information Systems").
Elcom Services Group also offers a wide range of professional services to its
customers, and has recently increased its focus on attempting to grow this
business segment. Elcom Services Group operates seven Field Sales and Support
Offices ("FSSO") in the U.S. and seven in the U.K., and maintains configuration
and distribution facilities in Canton, MA; Irvine, CA; and Langley, Berkshire,
U.K. The Company also utilizes an outsourced facility in Hartford, CT, and
maintains a distribution warehouse in Hounslow, Middlesex, U.K.
Shoplink Incorporated
In 1996, the Company licensed its technology to ShopLink Incorporated
("ShopLink") and invested a nominal amount in it. ShopLink is a provider of
PC-based shopping services whereby consumers are able to use PECOS technology to
conveniently purchase groceries, health and beauty care products and other home
consumable products and services and receive direct deliveries from ShopLink's
product consolidation center or product fulfillment partners to their homes or
other specified locations. As further discussed in the Notes to Consolidated
Financial Statements contained elsewhere herein, in
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September 1997, the Company sold options to acquire its 5% equity ownership
interest in ShopLink, which can be exercised through March 31, 1999.
Electronic Commerce Overview
Electronic commerce involves the automation of business transactions
through the use of telecommunications and computers to exchange and process
commercial information and to conduct and record transactions electronically.
Historically, the vast majority of electronic commerce has been conducted using
electronic data interchange ("EDI") technologies, which typically has involved
the interchange of information between large trading partners and can be both
complex and expensive to establish. More recently, PC-based and network
technologies have enabled electronic commerce to be conducted through PCs using
common carrier networks such as those operated by AT&T, MCI WORLDCOM, Inc.,
Sprint Communications Company, L.P., and others, or over a public network such
as the Internet. The Company believes interest in conducting business through
Internet-based commerce is rapidly growing as the marketplace becomes more aware
of emerging Internet technology and of the advantages that can be offered to
businesses and consumers in the form of low cost communications, reduced
transaction time, and widespread user access.
The Company's PECOS product line currently operates on common carrier
networks, intranets and over the Internet. The commercial market for electronic
commerce-oriented products and services designed for use with internetworks
(i.e. intranet, Internet, extranet) has recently started to expand.
elcom.com, inc.
The Elcom Systems division of elcom.com, inc., develops and licenses
intranet and Internet-based applications which automate the external and
internal purchasing systems for businesses through the computerization of
front-end ordering and back-office purchasing processes. Beginning in March
1999, elcom.com launched an Internet on-line storefront site at www.elcom.com
where it markets and sells over 62,000 PC products to businesses and consumers,
and intends to offer office supplies and other products, 24 hours a day, seven
days a week and be a leading supplier of these multiple commodity-type products,
primarily to businesses. elcom.com also plans to launch an auction site as part
of its Internet-based business-to-business storefront.
In 1999, Elcom International transferred various assets and personnel
to elcom.com to ensure that all technology resides in one company and to provide
a substantial hardware platform on which to host its Internet-based on-line
storefront and provide an information systems foundation for its planned hosting
of web-based automated procurement systems for businesses, targeted to be
introduced during 1999.
As acceptance of the Internet continues to accelerate as an electronic
medium to purchase products on-line and as intranets are used more by companies
to disseminate information internally, companies are seeking to streamline their
procurement and purchasing processes to achieve internal cost savings while
concurrently increasing productivity. Companies are looking to "employee facing"
browser-based applications to provide empowerment on the desktop to allow
employees to automate the purchasing processes for commodity-type products with
virtually no paperwork involved. Companies can now deploy applications on
intranets available to all corporate personnel, that connect them to the
company's suppliers' information, vendors and other providers through a single
"one-stop-shop" intranet-based system such as the Company's PECOS.pm system.
Through its Elcom Systems software division, elcom.com's business
strategy includes being a provider of "buy-side" Internet and intranet-based
automated procurement systems ("APS"). The Company also intends to license
PECOS.pm to customers of Elcom Services Group and other companies and currently
has PECOS.pm technology licenses with three companies.
Internet-based on-line sales of products are rapidly expanding. While
forecasts vary, one international research firm estimates that $43 billion of
products were sold over the Internet in 1998 with several firms forecasting
substantial growth over the next several years. When the Internet becomes
readily
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available to virtually all PC users over the next several years, many
forecasters expect on-line purchasing to become a widespread sales channel for
many products sold worldwide.
elcom.com's Internet sales site became operational during March 1999,
and the Company intends to transition as much of the organization's
commodity-type PC remarketer customers as possible to elcom.com which will
operate using an Internet-based model supported by the Company's existing
customer support infrastructure; however, the Company also intends to service
its traditional customers, which require a full range of services through its
remarketer subsidiaries. elcom.com intends to outsource much of its
support-oriented infrastructure requirements to the Company's full-service
remarketer subsidiaries and believes that its future personnel needs will be
drawn first from these entities.
elcom.com will leverage the Company's proprietary automated sourcing
technology which, in the U.S., connects with Ingram Micro and Tech Data, two of
the world's largest PC distributors. This automated sourcing technology allows
the Company to have a multi-billion dollar on-line inventory available to its
customers and to offer one of the broadest selections of personal computer
products in the industry, with same-day shipping for most non-configured
systems. The Company expects to investigate outsourcing many of its activities
to third parties such as Ingram Micro or Tech Data.
elcom.com expects to generate revenues from multiple sources, including
sales from its Internet reselling site with products generally drop shipped to
customers by the Company's DFPs; product and manufacturer advertising on its web
site; licensing of PECOS.pm to companies and associated professional services;
and through consulting and hosting services.
elcom.com Technologies
PECOS.pm enables intranet-based automated purchasing at the desktop by
individual users and creates a "full-circle" procurement system which automates
electronic catalog and product presentation from multiple suppliers, electronic
ordering, and also automates the internal, typically manual processes, required
to identify and select products, check pricing and availability, and place
orders with approved suppliers. In addition, PECOS.pm can provide an automated
internal routing and approval process, with audit trail, for tracking orders.
For companies which support Electronic Data Interchange ("EDI"), PECOS.pm
provides for three-way purchase order, invoice and receipt matching and
EDI-based financial settlement. By automating paper-based, manual systems in the
purchasing process, PECOS.pm can significantly reduce a customer's internal
costs and product delivery cycle times, while increasing efficiencies and
productivity. PECOS.pm also allows clients to negotiate vendor discounts by
aggregating purchases with preferred strategic suppliers. The Company believes
that companies spend as much as $125 or more to process a purchase order through
delivery of product, but can reduce that expense to as little as $10 to $20
through automation via PECOS.pm.
PECOS.cm, the Company's original client/server technology, preceded
PECOS.pm (which utilizes some of the same technology) and was licensed to 11
customers between 1994 and 1998 in countries ranging from Australia to the
Netherlands. The PECOS.cm technology represented the technological foundation
for the Company and the Company holds one patent on certain aspects of this
technology.
Elcom Services Group
Elcom Services Group, Inc. (formerly Catalink Direct, Inc.), the
Company's full service PC remarketer and professional services subsidiary,
utilizes the PECOS.cm and PECOS.web technologies to support the sale and
marketing of PC-related products and services electronically. The Company
commenced commercial operations in December 1993, and consummated the
acquisitions of Catalink Direct (Connecticut), Inc. (formerly known as Computer
Specialties, Inc.) ("CDCI") in 1994, and Catalink Direct (Pennsylvania), Inc.
(formerly known as Computerware, Inc.) ("Computerware") and a group of companies
which owned a U.K. remarketer of PC products known as Lantec Information
Services ("Elcom Group U.K.") in 1995, each of which initially operated as a
wholly-owned subsidiary of Elcom Services Group. CDCI (as of December 31,1995)
and Computerware (as of December 31, 1997) were merged into Elcom Services
Group, and are no longer separate entities. In February 1996, the Company
completed the
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acquisition of AMA (U.K.) Limited ("AMA"), a U.K.-based remarketer of PC
products, which was accounted for as a pooling of interests. In December 1996,
Elcom Services Group acquired Prophet Group Limited, a U.K.-based PC remarketer,
which was accounted for as a purchase. On February 21, 1997, Elcom Services
Group acquired Data Supplies Limited, a U.K.-based PC remarketer, which was
accounted for as a purchase. Elcom Services Group's acquisition strategy is to
utilize an acquired company's sales force to offer its PECOS technology to
prospective customers in those new markets and to transition an acquired
company's customers, over time, to its PECOS technology.
Elcom Services Group's PECOS.cm and PECOS.web Systems. Elcom Services
Group's PECOS.cm system is a proprietary, Windows-based interactive and
integrated electronic catalog and interactive ordering system that takes
advantage of Windows' graphical user interface. PECOS.cm is loaded on the hard
disk drive of the customer's PC and "senses" the hardware and color display
capabilities of the customer's PC system and displays one or more messages, if
necessary, to allow the customer to maximize the sound (if available) and color
display capabilities of their PC system to enhance displayed images. PECOS.cm
operates in a client/server architecture as an "electronic" catalog with
interactive and integrated communications and ordering capabilities. Click-on
icon commands allow customers to "browse" through visual display pages to view
product images and information in varying levels of detail or to search the
product pricing and description databases and, using various parameters and
criteria, compare and select products. When combined with the Company's
transaction-based, back-end server systems, which communicate with the Company's
and its primary DFPs' inventory systems, PECOS.cm is a "full-circle" electronic
commerce system. In order to take better advantage of the Internet, Elcom
Services Group has discontinued general maintenance of, and de-emphasized,
PECOS.cm, although it continues to be fully operational, and is now focusing on
its PECOS.web Internet ordering and information system. Introduced in August
1998, PECOS.web offers many of the same benefits as PECOS.cm, but does not
impose any technology requirements other than Internet access which allows Elcom
Services Group's customers to more easily conduct electronic commerce with the
Company. The Company is currently finalizing development of a version of
PECOS.web for use by its United Kingdom subsidiary.
Products selected for purchase are copied automatically to a purchase
list or requisition form with all pertinent information and when finalized,
PECOS.cm and PECOS.web can display the order in purchase order format, listing
all product information, part numbers, and related information. After customers
have reviewed and compiled their requisitions or orders (and optionally,
circulated them internally for approval using their electronic mail system),
customers can then electronically place those orders directly to Elcom Services
Group's computer system using PECOS.cm or PECOS.web. For orders to be fulfilled
through the Company or its primary DFPs, PECOS.cm and PECOS.web concurrently
communicate with the applicable computer system(s), checking product
availability and other information, and displays this information and confirms
the order to the customer in real-time.
To initiate an order, the customer enters his or her confidential
password authorization, and PECOS.cm automatically initiates a communications
link ("Commlink") via modem over a toll-free number or the Internet to Elcom
Services Group's back-end transaction server system allowing information to be
exchanged in real-time between the client (the front-end client interface on the
customer's PC) and the server (the back-end transaction server systems at the
Company). Commlinks using PECOS.cm typically last one to three minutes,
depending on the extent of product data updates which are necessary, with
order-oriented information being exchanged concurrently between the computer
systems of the Company and/or its primary DFPs. Elcom Services Group utilizes
comprehensive electronic links with its primary DFPs and electronic links are
being pursued with other DFPs. During periodic Commlinks using PECOS.cm, product
information on the customer's hard drive also is updated automatically to
reflect changes, such as new products and pricing revisions, new PECOS.cm
electronic mail messages, and other information updates, unless it has been so
long since that customer's last Commlink that it is determined that it would be
more expedient to send that customer a new set of PECOS.cm disks, or urge the
customer to use PECOS.web.
In the case of PECOS.web, a customer logs into the appropriate Internet
site and uses their confidential password to establish a Commlink (computer
connection) with the Company's server systems. Thereafter, they are working
on-line with real time information and ordering. PECOS.web, using the
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Internet, accomplishes most interactive functions in seconds. PECOS.cm is
currently supporting over $2.5 million in sales at Elcom Services Group per
month in the U.S. and U.K. PECOS.web, Elcom Services Group's Internet ordering
and information system which was introduced in the third quarter of 1998, is
currently supporting over $1.5 million in sales per month in the U.S.
In addition to introducing PECOS.web to its customers during 1999,
Elcom Services Group intends to further differentiate itself by offering an
Elcom Services Group version of elcom.com's PECOS.pm APS to its customers. Elcom
Services Group believes that, as was the case with PECOS.cm, its "sell-side"
electronic commerce solution, PECOS.pm may provide a significant competitive
advantage in the area of electronic commerce that will enable Elcom Services
Group to continue to differentiate itself from its competitors with a "buy-side"
electronic commerce solution. Management believes that use of PECOS.pm will
empower its customers to achieve process reengineering and best practice
objectives, as well as leveraging the system to order other desired supplier's
products via a fully integrated electronic procurement system. There can be no
assurances as to when PECOS.pm will be made available to Elcom Services Group,
and after delivery, whether PECOS.pm will be accepted and used by customers.
The Company believes that its various technologies also will provide
certain advantages to Elcom Services Group associated with changes that have, or
are beginning to occur in the PC remarketer channel. Recent reductions by
manufacturers in the availability of price protection as well as further
limitations as to the products that may be returned to vendors, have focused the
Company on reducing the amount of inventory that it holds. The Company's
electronic sourcing capabilities allow it to be responsive to customer orders
while simultaneously reducing its inventory positions. In addition, to the
extent certain manufacturers elect to deal directly with customers and
compensate the Company as an agent, the Company's technologies can be utilized
to parse and appropriately route orders to the appropriate suppliers based on
the specifics of an order. The Company is currently in discussions with a major
manufacturer to support this type of arrangement.
Products and Pricing
Products. Elcom Services Group offers over 23,000 products from a wide
variety of manufacturers through PECOS.cm and over 62,000 products through
PECOS.web. In the U.S., Elcom Services Group currently purchases selected
products directly from certain manufacturers, including Compaq Computer
Corporation, with the balance of its products being purchased from DFPs, while
in the U.K., the substantial majority of products are purchased directly from
manufacturers on net terms. Elcom Services Group provides customers with a large
product selection, including personal computer systems, monitors, printers,
peripherals, software, accessories and supplies, as well as a broad range of
professional services. The level of products purchased by Elcom Services Group
directly from manufacturers in the U.S. declined substantially between 1997 and
1998, due to a variety of policy changes by manufacturers, principally a
reduction in price protection programs and a reduced ability to return product
as well as reductions in incremental discounts made available by manufacturers.
Elcom Services Group markets products sold by the following manufacturers, among
others:
PERSONAL COMPUTERS
Compaq IBM Apple
NEC Gateway Toshiba
Hewlett-Packard Dell Panasonic
PRINTERS
Hewlett-Packard Canon Lexmark
Epson Xerox Tektronics
PERIPHERALS
NEC Sony Cisco
Intel Xircom Kingston
Viewsonic 3Com Iomega
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SOFTWARE
Microsoft Lotus Corel
Seagate Novell Computer Associates
Adobe Claris Symantec
In the U.S., Elcom Services Group has established electronic purchasing
and supply relationships with Ingram Micro and Tech Data, as well as traditional
relationships with several other large, national PC product suppliers. Elcom
Services Group's purchasing relationships with DFP suppliers are pursuant to
industry-standard arrangements with negotiated pricing based on either a
percentage of all orders being offered electronically to a supplier or
anticipated volume levels, with payment generally being made through existing
floor plan financing arrangements.
In the U.K., Elcom Services Group also is an authorized product
fulfillment aggregator for IBM and Compaq products, and is in discussions with
Ingram Micro (U.K.) on methods to access their inventory electronically. There
can be no assurances that any DFP arrangement or electronic links will be
negotiated or developed with Ingram Micro (U.K.), or if so, on what terms or
timing.
Pricing. Elcom Services Group believes that its product pricing is
competitive with other remarketers. Elcom Services Group offers larger corporate
customers a higher discount than other customers, reflecting the economies of a
higher level of purchases by such customers. The Company uses a specially
designed, customized and automated pricing system for its customers through
PECOS.cm's and PECOS.web's back-end server system which supports and tracks a
variety of pricing methodologies, including the ability to provide customized
pricing for each customer, by product. PECOS.cm and PECOS.web are designed so
that each time a customer Commlinks, Elcom Services Group can optionally change
pricing on selected products in real-time, as appropriate.
Professional Services
Elcom Services Group offers a wide range of professional services in
both the U.S. and the U.K. Professional services offerings to customers in the
U.S. and U.K. include advising on project and roll-out management, providing
on-site engineers for network integration and systems support, responsive "Help"
desk and break/fix services. The Company also offers national dispatch service
for warranty and repair contracts. In the U.K., Elcom Services Group provides
additional service offerings, including offering customers complete PC lifecycle
management from purchase to disposal, high-end technical consulting, as well as
designing and overseeing implementations of complex applications. The Company's
service-oriented revenues increased in 1998 to approximately $34 million, from
$32 million in 1997, and the Company believes that there is a significant
opportunity to expand its service operations in the future. Accordingly, the
Company expects to continue its focus on attempting to grow this higher margin
segment of its business in both the U.S. and U.K.
Fulfillment/Logistics/Information Systems
Fulfillment. In the U.K., Elcom Services Group sources the substantial
majority of its products directly from manufacturers, while in the U.S., Elcom
Services Group sources the majority of its products from a number of DFPs,
including Ingram Micro and Tech Data, its primary DFPs, from which it
electronically sources a majority of domestically purchased PC products which
are not sourced directly through purchasing arrangements with Compaq and certain
other manufacturers. Ingram Micro and Tech Data are the two largest PC product
distributors in the world, with combined annual sales in excess of $34 billion.
Augmented by its DFPs, Elcom Services Group U.S. draws from inventories which
the Company believes are well in excess of $3 billion. In the U.K., in addition
to its direct purchasing arrangements, Elcom Services Group also maintains
relationships with several DFPs. Elcom Services Group's customers can typically
expect products that are in stock and that do not require configuration to be
immediately available for shipment directly to the customer.
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For computer systems that require configuration, the Company operates
two configuration facilities in the U.S. and one in the U.K. and also utilizes
an additional outsourced facility in the U.S. Products requiring configuration
are typically shipped to these facilities. Although the Company believes that
both its DFPs and Elcom Services Group are given due consideration regarding
supply of products by manufacturers and that Elcom Services Group is given due
consideration regarding supply of products by its DFPs, manufacturer constraints
on the availability of certain products have been a historical problem in the PC
channel and there can be no assurance that such periodic constraints may not
have an adverse effect on the Company's business in the future. At the end of
1998, the Company did not have a significant amount of product on back order
and, accordingly, the Company did not have a material backlog of customer
orders.
In the U.S., the electronic links between PECOS.cm's client and between
PECOS.web's browser, both interact with Elcom Services Group's back-end
transaction server system (and its primary DFPs' computer systems), providing
the customer with seamless order processing and shipment, as if a customer's
order was shipped directly from Elcom Services Group. Using PECOS.cm or
PECOS.web, when a customer clicks and accepts an order, as applicable, a "pick
ticket" is automatically printed out in a distribution facility for the product
to be picked for direct shipment to the customer or to one of Elcom Services
Group's configuration centers. PECOS' back-end automatic sourcing technology
also can automatically select one of the Company's configuration and
distribution facilities in the U.S. as the source and print a "pick ticket"
there for fulfillment. In order to provide similar electronic links with other
suppliers, Elcom Services Group is in the process of pursuing electronic price
and availability links with secondary DFPs, which are primarily aggregators, for
electronic inquiry of product price and availability (although there can be no
assurances that any such electronic links will be finalized and implemented or,
if so, what the timing or terms thereof will be). The Company also is in
discussions regarding an electronic link with a major manufacturer that it
believes can be used to support direct relationships between the manufacturer
and customers of the Company, where the Company would function as a sales agent
of the manufacturer, for a fee. Until these electronic link(s) are fully
established, Elcom Services Group obtains some of its product to fulfill
customer orders from these suppliers, including manufacturers, using direct
order entry systems provided by these companies and by telephone and facsimile
transmissions. These traditional product fulfillment methods involve expenses
associated with ordering, invoicing and product tracking being performed
manually.
PC Configuration Capabilities. Elcom Services Group offers customized
configuration services to its customers, whereby a customer can request, by
clicking on an option in PECOS.cm or PECOS.web, that Elcom Services Group
configure their PC system, load software and test the PC system for
functionality prior to shipment. The configuration services are offered
generally on a fee basis and currently are performed primarily by Elcom Services
Group at its Canton, MA and Irvine, CA facilities and in an outsourced facility
in Hartford, CT. In addition, Elcom Services Group maintains a product
distribution and configuration facility in Langley, Berkshire in the U.K. and a
warehouse location at Hounslow, Middlesex, in the U.K. Elcom Services Group's
technical support staff reviews the viability of configuration orders before the
order is released for fulfillment, or on demand via PECOS.cm's and PECOS.web's
Analyze Custom Configuration function.
Information System. During 1997 and 1998, in the U.S., the Company
licensed and installed Year 2000 compliant software from Oracle Corporation and
other software firms as its Information Technology ("IT") system to improve
management's ability to monitor and manage the Company. The Company's IT system
installation went "live" in the U.S. in November of 1997. This system
incorporates modules supporting general ledger, accounts payable, purchasing,
accounts receivable, inventory and order entry. The IT design is a unique
implementation of Oracle software applications that are being and/or have been
enhanced and extended to provide functionality not found in the standard system,
including the ability to:
- Accept electronically delivered sales orders such as PECOS and EDI
orders, as well as converted quotations;
- automatically source product from the Company's or its DFPs'
inventories based on variable parameters; and
8
<PAGE>
- automatically create purchase orders, electronically transmit them,
and electronically confirm shipments by DFPs to enable invoicing or
anticipate receipt as the case may be.
During 1998, the Company continued to enhance its U.S. IT system and is
Year 2000 compliant, subject to additional "patches" which Oracle may introduce
to make its modules(s) Year 2000 compliant. During 1998, in the U.K., the
Company implemented a Year 2000 compliant upgrade to its Computer Associates
International, Inc. software system which operates on an IBM AS-400 hardware
platform. The Company has been assured by its electronic trading partners that
their information systems applications either are, or will be, Year 2000
compliant before issues may arise, however, there can be no assurance by the
Company that its electronic trading partners will not experience Year 2000
oriented problems which could effect the supply of products to the Company. The
Company is dependent on its IT system and any problems with its ongoing
development and enhancement, or any interruption in its functional availability
may have an adverse effect on sales to customers and/or customer satisfaction.
Although the Company believes that its technology and operating systems will be
adequate for its current needs, such systems will undoubtedly require ongoing
modification and enhancement as the Company expands and evolves. See "-
Managements' Discussion and Analysis of Financial Condition and Results of
Operations - Year 2000 Compliance".
Marketing and Sales
Elcom Services Group Targeted Customer Segments. Elcom Services Group
uses its telemarketing and direct sales forces in the U.S. and U.K. to sell to
targeted business and corporate accounts, its educational and government
customer base and, in the U.K., to its value-added reseller customers. As of
December 31, 1998, Elcom Services Group employed approximately 248 sales
representatives, account executives, telemarketers and related support personnel
to service those customer segments.
As of December 31, 1998, Elcom Services Groups' sales and support
personnel operated from Field Support and Sales offices (FSSO's) in seven
metropolitan areas in the U.S. as well as seven locations in the U.K. Elcom
Services Group's primary locations and FSSO's are listed below:
UNITED STATES
---------------
- Bristol, PA(Philadelphia) - Phoenix, AZ
- Irvine, CA - San Diego, CA
- New York City, NY - Stamford, CT
- Norwood, MA (Boston)(Headquarters)
UNITED KINGDOM
----------------
- Basingstoke, Hampshire - London (City of)
- Birmingham - Manchester
- Glasgow (Scotland) - Slough, Berkshire
- Langley, Berkshire
At the end of 1998, the Company closed six FSSO's, reduced the size of
its sales force, and provided certain sales personnel with the technology to
operate from a home office environment. The Company is continuing to focus on
better aligning the costs of Elcom Services Group's sales organization and
operational infrastructure in a manner intended to compensate for the reduced
level of gross profit available in the current PC remarketer environment, and
additional steps may need to be taken in this regard.
Corporate and Business Accounts. Elcom Services Group's primary target
customers are large corporations that wish to make their PC product procurement
functions more efficient. Corporate accounts typically employ purchasing agents
or buyers with above-average product knowledge who view most PC products as
commodities. Business accounts targeted by Elcom Services Group range from
divisions of
9
<PAGE>
large corporations to businesses with as few as fifty employees. These companies
will also be targeted customers for PECOS.pm, the Company's automated
procurement system. Elcom Services Group penetrates the corporate market with
both direct sales efforts and telemarketing. The Company targets business
customers using a defined business telemarketing staff operating from certain of
its U.S. and U.K. locations whose mission is to introduce Elcom Services Group
to businesses which would not otherwise be cost-effectively penetrated by Elcom
Services Group's direct corporate sales force. Elcom Services Group's direct
sales efforts include on-site presentations, as well as demonstrations to
potential corporate customers of PECOS.cm, PECOS.web and later during 1999,
PECOS.pm. Telemarketers also assist the sales professionals by contacting and
pre-qualifying accounts for follow-up and on-site visits by the direct sales
force if appropriate. Customer support representatives and entry-level corporate
sales representatives provide day-to-day administrative and operational support
in order to maximize the selling time of the direct sales force.
Educational and Governmental Accounts. The Company restructured Elcom
Services Group's government and education sales operations in September 1998 and
intends to concentrate on building an educational sales force focused on
providing Windows and Intel-based ("Wintel") solutions to the education market
in the U.S. The Company decided to leverage its experience in cabling and
network integration of classrooms and schools derived from its previous Apple
Educational Sales Agent relationship, to promote this new division as it focuses
on a larger potential market.
Fulfillment Accounts. In the U.K., Elcom Services Group also operates as a
product aggregator for IBM and Compaq products, typically serving small- to
medium-sized value-added resellers and remarketers that do not maintain
significant inventory themselves. These customers demand competitive pricing and
typically require next-day delivery anywhere in the U.K. The Company believes
that although its product fulfillment business is to a different market than its
core remarketer business, this fulfillment business, which Elcom Services Group
U.K. has been operating for many years, can provide the Company with the ability
to generate incremental revenues over a fixed cost structure.
Customer and Technical Services
Elcom Services Group provides a wide range of customer service and
technical support, including nationwide toll-free pre-sale and post-sale
telephone-based support. Elcom Services Group believes that maintaining a direct
customer and technical support link with its customers is an important
competitive factor and promotes customer satisfaction. In addition, certain
manufacturers require their remarketers to provide certain levels of technical
support as an ongoing condition to authorizing the remarketers to sell their
products.
Product Warranty and Service Policies
In addition to providing its customers with manufacturers' warranties,
Elcom Services Group offers its customers certain return privileges for products
which have not been used or damaged. Typically, such products can be returned
within a certain time to Elcom Services Group for a refund or credit. Elcom
Services Group believes that its product return policies are competitive with
those offered by other remarketers. Historically, product returns have not
generally represented a material exposure to the Company. Typically,
manufacturer warranties are included as part of, and are packaged with, the
product. When available from manufacturers, Elcom Services Group also offers
on-site and extended-term warranty and/or service policies as ancillary products
available for sale through the PECOS.cm or PECOS.web systems. In addition to
Elcom Services Group's telephone-based technical support and manufacturer
programs, Elcom Services Group offers a full range of on-site and depot warranty
and post-warranty service options in the U.S., generally through nationwide
outsourcing agreements with third party service providers. Product returns are
centralized at the Company's facilities, where the various tasks are performed
that are necessary to either return products to inventory, to one of the
Company's DFPs or to a manufacturer for credit, or to liquidate non-returnable
items.
10
<PAGE>
Competition
Electronic Commerce Systems Marketplace. The market for interactive
electronic commerce software is relatively new and rapidly evolving and the
Company expects competition in this market to intensify in the future. Among
other factors, before licensing an electronic commerce system, the Company
believes potential customers consider the level of features and functions
available in electronic commerce applications and the cost to acquire, implement
and maintain the system, as well as the length of time to implement a system
and, as applicable, integrate it with a company's existing information
technology system. The Company competes with vendors of prepackaged electronic
commerce software, vendors of software tools for developing electronic commerce
applications, and systems integrators. The Company's competitors include Ariba
Technologies, Inc., Commerce One, Inc., Concur Technologies, Inc., and Trade'ex
Electronic Commerce Systems. The Company expects additional competition from
other emerging and established companies, including Microsoft Corp., IBM, SAP AG
and Oracle Corporation, all of which have announced products for Internet-based
electronic commerce. The Company's potential competitors also include systems
integrators such as Electronic Data Systems (EDS) and a number of EDI solution
vendors, including Sterling Commerce, Inc.
Certain of these and other competitors have longer operating histories and
significantly greater financial, technical, marketing and other resources than
the Company and thus may be able to develop or respond more quickly to new or
changing opportunities, technologies and customer requirements. Also, many
current and potential competitors have greater name recognition and more
extensive customer bases that could be leveraged, thereby gaining market share
to the Company's detriment. Such competitors may be able to undertake more
extensive promotional activities, adopt more aggressive pricing policies and
offer more attractive terms to purchasers than the Company and to bundle their
products in a manner that may discourage users from purchasing products offered
by the Company. In addition, current and potential competitors have established
or may establish cooperative relationships among themselves or with third
parties to enhance their products. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. There can be no assurance that the Company will be
able to compete effectively with competitors or that the competitive pressures
faced by the Company will not have an adverse effect on the Company's business,
results of operations and/or financial condition. See "--Electronic Commerce
Overview".
PC Products Marketplace. The Company has invested substantial effort
and capital to develop and implement its proprietary PECOS.cm and PECOS.web
front- and back-end systems, as well as for the associated hardware and
electronic links with its primary DFPs. The overall market of companies which
sell PC products is highly fragmented and Elcom Services Group operates in an
extremely competitive environment which is continuously evolving and subject to
rapid technological change. Of the more than 10,000 total outlets, the Company
believes that there are more than 1,000 significant PC product remarketers of
various types in the U.S. and U.K. In response to competitive pressures and
declining margins, traditional computer remarketers are cutting costs and
acquiring or merging with other remarketers to increase scale and efficiency. A
prospective purchaser of personal computer products has the option to purchase
directly from a manufacturer (e.g., IBM, Compaq, Dell Computer Corp.), from a
major remarketer (e.g., Entex Information Systems, Inc., MicroAge, Inc., Inacom
Corp., CompuCom Systems, Inc.), from a computer mail order company (e.g., CDW
Computer Centers, Inc., Creative Computers Inc., Micro Warehouse Inc.), from a
systems integrator (e.g., Andersen Consulting, EDS), from computer superstores
(e.g., CompUSA Inc.), from Internet-based companies (e.g. Cyberian Outpost,
Inc., Insight Enterprises, Inc.), from electronics superstores and local
computer stores, among others. Elcom Services Group competes with all of these
entities for the sale of its PC products. Each of these entities in the PC
distribution channel competes on a wide variety of capabilities including price,
delivery performance, breadth of products, services offered, overall
convenience, and in some cases specialized and distinct capabilities. The advent
and boom of the Internet-based sales companies has added substantial additional
pressure to price competition in the marketplace and is impacting gross profits.
Certain of the companies noted above and other potential competitors have
substantially greater financial, technical and marketing resources than the
Company and greater name recognition and more extensive customer bases.
11
<PAGE>
Intellectual Property
The Company's success and ability to compete are dependent, in part,
upon its proprietary technology. While the Company relies to a certain extent on
trademark, trade secret, patent and copyright law to protect its technology, the
Company believes that factors such as the technological and creative skills of
its personnel, new product developments, frequent product enhancements, name
recognition and reliable product availability and distribution are of equal
importance for establishing and maintaining a leadership position. Although the
Company has received a patent on certain, specific aspects of its PECOS
technology, there can be no assurance that other entities will not develop, or
have not developed, technologies that are similar or superior to the Company's
technology. The source code for the Company's proprietary software also is
protected both as a trade secret and as an unregistered copyrighted work.
Despite these precautions, it may be possible for a third party to copy or
otherwise obtain and use some portions of the Company's products or technology
without authorization, or to develop similar technology independently. In
addition, effective copyright and trade secret protection may be unavailable or
limited in certain foreign countries, and the global nature of the Internet
makes it virtually impossible to control the ultimate destination of the
front-end client portion of the PECOS technology.
The Company generally enters into confidentiality or license agreements
with its employees, consultants, licensees and certain of its vendors, and
generally attempts to control access to and distribution of its proprietary
software, documentation and other information. In connection with the
distribution of Elcom Services Group's PECOS.cm front-end client, Elcom Services
Group employs licenses that generally are not paid for, or manually signed by,
the end-user and, therefore, could in certain circumstances, be found
unenforceable under the laws of certain jurisdictions. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's proprietary system or to obtain and use
information that the Company regards as proprietary. Policing unauthorized use
of the Company's products is difficult. There can be no assurance that the steps
taken by the Company will prevent misappropriation of its technology or that
such agreements will be enforceable. In addition, litigation may be necessary in
the future to enforce the Company's intellectual property rights, to protect the
Company's trade secrets, to determine the validity and scope of the proprietary
rights of others, or to defend against claims of infringement or invalidity.
Such litigation could result in substantial costs and diversion of resources and
could have a material adverse effect on the Company's business, operating
results or financial condition. The Company believes that each of the following
are proprietary features of its "front-end" client interface: the architecture
allowing for easy custom modification by the Company or its licensees, the
capabilities for display of certain business forms and catalog page screens, and
the interfaces to the "back-end". However, the Company believes that the most
critical and proprietary elements of its PECOS technology are the "back-end"
transaction servers, order sourcing and processing, customer authentication, and
catalog updating modules, which reside within the computer systems in the
Company's or licensee's facilities and are not available to end-users.
Government Regulation
The Company is not currently subject to direct regulation by any
government agency, other than regulations applicable to businesses generally,
and there are currently few laws or regulations directly applicable to access to
or commerce between personal computers, among local area networks or on the
Internet. However, due to the increasing popularity and use of personal
computers and the Internet, it is possible that a number of laws and regulations
may be adopted with respect thereto, covering issues such as user privacy,
pricing and characteristics and quality of products and services. The adoption
of any such laws or regulations may decrease the growth of electronic commerce
and/or the Internet, which could in turn decrease the demand for the Company's
products and increase the Company's cost of doing business or otherwise have an
adverse effect on the Company's business, operating results or financial
condition. Moreover, the applicability to the Internet of existing laws
governing issues such as property ownership, libel and personal privacy is
uncertain.
12
<PAGE>
Environmental Matters
Based on the Company's experience to date, the cost of compliance with
environmental matters has been immaterial and the Company believes that it is in
material compliance with applicable environmental laws and regulations.
Personnel
As of December 31, 1998, the Company had a total of 989 personnel,
including 946 salaried and 43 hourly personnel. The Company's personnel are not
represented by any labor union and the Company believes that its personnel
relations are good. The Company's future success depends, in significant part,
upon the continued service of its key technical and senior management personnel
and its continuing ability to attract and retain highly qualified technical and
managerial personnel, including its sales force. Competition for highly
qualified personnel is intense and there can be no assurance that the Company
can retain its key managerial and technical personnel or that it will be able to
attract or retain additional highly qualified technical and managerial personnel
in the future.
The rapid execution necessary for the Company to fully exploit the
opportunities for its products and services, especially on the Internet, has
presented a significant challenge to the Company's personnel and management
resources. To manage its expected growth, the Company will continue to implement
and improve its information systems and solicit key candidates for open
positions as well as continuing to train its personnel base.
Company Trade Names and Trademarks
The Company has referred to a variety of other entities and products in
this Annual Report on Form 10-K, certain of which are tradenames or trademarks.
Such tradenames or trademarks are the property of the respective companies
owning such tradenames and trademarks.
Item 2. Properties
As of December 31, 1998, the Company leased the properties set forth
below, and rented seven other smaller field sales and support offices ("FSSOs")
as well as a professional services office in Edison, N.J. The following leases
vary in length remaining, from two years to 15 years for the Langley, Berkshire
facility and, in some cases, include options to extend the lease terms (see also
Note 6 to the Company's Consolidated Financial Statements, included elsewhere in
this Annual Report on Form 10-K).
APPROXIMATE
SQUARE
LOCATION FOOTAGE USE
- -------------------------- ----------- ------------------------------------
Norwood, Massachusetts 36,000 Headquarters; Elcom Services Group
Boston-area FSSO
Westwood, Massachusetts 24,000 elcom.com's Headquarters
Canton, Massachusetts 84,000 Elcom Services Group Configuration
and Distribution
Irvine, California 34,000 Elcom Services Group FSSO,
Configuration and Distribution
Bristol, Pennsylvania 35,000 Elcom Services Group Administrative
and FSSO
Langley, Berkshire (U.K.) 40,000 United Kingdom Headquarters;
Elcom Services Group FSSO,
Configuration and Distribution
13
<PAGE>
APPROXIMATE
SQUARE
LOCATION FOOTAGE USE
- -------------------------- ----------- ------------------------------------
Hounslow, Middlesex (U.K.) 25,000 Elcom Services Group Distribution
and Warehouse
Slough, Berkshire (U.K.) 7,800 Elcom Services Group FSSO
Basingstoke, Hampshire (U.K.) 7,500 Elcom Services Group Administrative
and FSSO
In addition to the leased properties noted above, the Company also
owns, through its Prophet Group Limited subsidiary, land and a building in
Redditch, Hereford, United Kingdom, comprising administrative and FSSO
facilities of approximately 20,000 square feet.
Subject to ongoing review, the Company considers its facilities to be
generally sufficient to meet its near-term space requirements in light of its
current plans. The Company's operations are dependent in part upon its ability
to protect its network infrastructure in its Norwood, MA and Langley, Berkshire
U.K. facilities against damage from physical break-ins, natural disasters,
operational disruptions and other events.
Item 3. Legal Proceedings
The Company is a party to various claims, disputes and other
proceedings relating to former employees and other matters arising in the normal
course of its business. In the opinion of management, the outcome of these
matters will not have a material adverse effect on the consolidated financial
condition or results of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Price Range of Common Stock
The Company's Common Stock trades on The Nasdaq Stock Market(R) under
the symbol ELCO. As of December 31, 1998, there were approximately 200
stockholders of record of the Company's Common Stock. This number does not
reflect persons or entities who hold their stock in nominee or "street name"
through various brokerage firms. The high and low closing sales prices reported
by The Nasdaq Stock Market for each of the quarters in the two year period ended
December 31, 1998 are set forth in the table below. For the period from January
1, 1999 to March 23, 1999, such high and low closing sales prices were: high:
$4.06 and low: $1.59.
Quarter Ended 1998 1997
-------------------- --------------------- -----------------------
High Low High Low
--------- -------- --------- ----------
March 31, $6.69 $5.00 $9.00 $5.63
June 30, 6.06 3.44 7.31 4.56
September 30, 4.13 1.19 7.00 5.81
December 31, 3.13 1.16 8.00 5.63
The Company has never declared or paid cash dividends on its Common
Stock. The Company currently does not anticipate paying any dividends in the
foreseeable future. Any payment of future dividends will be at the discretion of
the Board of Directors and will depend upon, among other things, the Company's
earnings, financial condition, capital requirements, level of indebtedness,
contractual restrictions with respect to the payment of dividends and other
factors that the Company's Board of Directors deems relevant.
14
<PAGE>
Item 6. Selected Financial Data
The following table sets forth selected consolidated financial data for
the Company for the years ended December 31, 1994 through December 31, 1998. The
historical financial data are derived from the consolidated financial statements
of the Company audited by Arthur Andersen LLP, independent public accountants.
This information should be read in conjunction with the Company's Consolidated
Financial Statements and related Notes thereto and with "Management's Discussion
and Analysis of Financial Condition and Results of Operations", which are
included elsewhere in this Annual Report. The data for the periods presented are
not necessarily comparable because of acquisitions consummated at various times
during the periods presented.
<TABLE>
<CAPTION>
(in thousands, except per share data)
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
1994 1995 1996 1997 1998
------------ ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA (1):
Net Sales $57,712 $311,423 $620,115 $760,136 $763,600
============ =========== =========== =========== ==========
Gross profit 8,778 39,382 70,039 90,394 76,942
Selling, general and administrative expenses 10,364 36,016 57,551 70,200 80,285
Research and development expenses 1,166 1,122 1,200 1,275 1,178
Restructuring, impairment and other related
charges - - - - 12,892
------------ ----------- ----------- ----------- ----------
Operating profit (loss) (2,752) 2,244 11,288 18,919 (17,413)
Interest and other income (expense), net (146) (1,909) (2,303) (4,142) (7,664)
------------ ----------- ----------- ----------- ----------
Income (loss) before income taxes (2,898) 335 8,985 14,777 (25,077)
Provision for income taxes 564 1,239 3,410 4,489 484
------------ ----------- ----------- ----------- ----------
Net income (loss) $(3,462) $ (904) $ 5,575 $ 10,288 $ (25,561)
============ =========== =========== =========== ==========
Basic net income (loss) per share $ (0.37) $ (0.05) $ 0.21 $ 0.38 $ (0.94)
============ =========== =========== =========== ==========
Basic weighted average shares outstanding 9,247 18,195 26,363 26,937 27,322
============ =========== =========== =========== ==========
Diluted net income (loss) per share $ (0.37) $ (0.05) $ 0.19 $ 0.35 $ (0.94)
============ =========== =========== =========== ==========
Diluted weighted average shares outstanding 9,247 18,195 29,739 29,461 27,322
============ =========== =========== =========== ==========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ----- ---- ----
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA (1):
Total current assets $20,313 $136,781 $210,185 $277,806 $220,415
Total assets 22,356 174,231 260,769 332,068 261,851
Total current liabilities 13,997 89,290 161,158 218,300 175,929
Long-term liabilities, net of current portion 236 91 1,008 3,465 905
Total stockholders' equity 8,123 84,850 98,603 110,303 85,017
</TABLE>
(1) The information presented for all periods includes the results of
operations and financial condition of CDCI, which was acquired in October
1994 and AMA, which was acquired in February 1996. The acquisitions of CDCI
and AMA were both accounted for on a pooling of interests basis. As a
result, the Company's results of operations have been restated back to the
Company's inception in September 1992 to include the results of operations
of CDCI and AMA.
15
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
OVERVIEW
The Company was founded in 1992, commenced selling PC products in
December 1993, and experienced rapid growth for several years. 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. and its respective subsidiaries in the United States and
United Kingdom ("Elcom Services Group"), 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 another subsidiary, elcom.com, inc. (formerly
Elcom Systems, Inc.), licenses its PECOS technologies and provides
implementation and consulting services, and commencing in 1999, operates an
Internet on-line site selling PC's and related products.
In mid-1998, the Company changed the name of its PC remarketer
subsidiary, Catalink Direct, Inc., to Elcom Services Group, Inc. The change in
name more closely identifies the subsidiary with the Company's corporate name
and is more descriptive of the Company's business focus, which includes an
expanded 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.
In December 1998, the Company established elcom.com, inc. and, in January
1999 merged Elcom Systems, Inc. with and into elcom.com, inc. whereby the
surviving entity is named elcom.com and is now a wholly-owned subsidiary of
Elcom Services Group.
Elcom Services Group
In October 1994, the Company completed the acquisition of a
Connecticut-based PC products remarketer ("CDCI"), 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
increase its revenue volume if it is to sustain its level of gross profit
dollars. Although the Company's unit volume of PCs shipped to customers showed
significant growth in 1998 compared to 1997, these price decreases had a
significant effect on the average unit price of PCs sold and the Company's net
sales, when compared to last year. Further, the Company experienced a softening
of demand from its customers beginning in September 1998, which the
16
<PAGE>
Company has attributed to the Asian financial crisis and subsequent
fluctuations, and related uncertainties in the worldwide financial markets, that
impacted many of the Company's customers.
During the third quarter of 1998, the Company restructured certain of
its Elcom Services Group United States operations. The primary objectives of
this restructuring were to centralize and better leverage Elcom Services Group's
customer relations support functions. In addition, the Company also elected to
not pursue renewal of its Apple Educational Sales Agent contract, as management
intends to focus on a broader educational market.
At the end of the fourth quarter of 1998, Elcom Services Group
"rightsized" its operations, reducing its work force by 133 positions worldwide
and closing six field support and sales offices in the United States. The
rightsizing primarily focused on reengineering and streamlining the Company's
sales force and operating infrastructure in a manner intended to better align
its costs with the revenues and margin expected to be generated by Elcom
Services Group. The Company continues to evaluate the results of this
rightsizing, and additional steps may be taken.
elcom.com, inc.
On a stand-alone basis, for the years ended December 31, 1998 and
December 31, 1997, revenues generated by the Elcom Systems software division of
elcom.com ("Elcom Systems") from licenses, including associated professional
services and maintenance fees, were approximately $2.6 million and $4.8 million,
respectively. Consequently, because Elcom Systems' expenses were relatively
stable in both periods, its consolidated operating loss (excluding
restructuring, impairment and other related charges) increased $2.0 million to
$3.1 million during 1998 versus an operating loss of $1.1 million in 1997. The
decline in Elcom Systems' revenues reflects the shift in the Company's focus
from its PECOS Commerce Manager ("PECOS.cm") technology to PECOS Procurement
Manager ("PECOS.pm"), its recently introduced intranet-based automated
procurement management system. In the third quarter of 1998, Elcom Systems was
restructured to serve as an electronic commerce-oriented systems integration arm
of Elcom Services Group, the Company's PC-remarketing and professional services
subsidiary. In addition, beginning in March 1999, elcom.com launched an Internet
on-line storefront site at www.elcom.com where it markets and sells over 62,000
PC products to businesses and consumers, and intends to offer office supplies
and other products, 24 hours a day, seven days a week and be a leading supplier
of these multiple commodity-type products, primarily to businesses. elcom.com
also plans to launch an auction site as part of its Internet-based
business-to-business storefront.
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 alternatives intended to take advantage of this strength, including
potential separate transactions for the Company's United Kingdom and United
States remarketer businesses.
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 the Company's
stockholders. The Board of Directors decided, in light of the proposals
discussed during the engagement,
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that the interests of the stockholders would best be served by the Company
continuing to develop its business as a standalone company.
After disengaging from Salomon Smith Barney, the Company has had
periodic discussions with several companies. However, the Company is not engaged
currently in any substantive negotiations, although it intends to continue 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 until late 1999 in the event
that a transaction is consummated with certain parties.
Year 2000 Compliance
As further described elsewhere herein, the Company has implemented an
Oracle-based Year 2000 compliant Information Technology System ("IT System") 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. The Company also has delayed
implementation of a new warehousing system in the United States and is currently
using its Oracle-based Year 2000 compliant, inventory system. During 1999, the
Company will reassess implementation of its Oracle-based system in the United
Kingdom. The Company's near term IT System 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 Year 2000 compliance issues. The Company has been assured by,
and is confident that, its key electronic trading partners' information systems
applications either are, or will be, Year 2000 compliant in sufficient time to
avoid material problems, however, there can be no assurance by the Company that
its electronic trading partners will not experience Year 2000 oriented problems
which could effect the supply of products to the Company. The Company's PECOS
electronic commerce technology applications have been developed in a Year 2000
compliant fashion.
The following is a discussion of the Year 2000 date issue as it could
affect the Company. The Year 2000 issue arises from the fact that many computer
programs and embedded chips in other forms of technology use only the last two
digits to identify a year in a date field.
The Company's state of readiness. The Company currently believes that its
potential exposure to problems arising from the Year 2000 issue could primarily
be in two areas:
- The Company's internal operating systems which include both Information
Technology ("IT") and non-IT components (such as computer chips
imbedded in hardware).
- Compliance with the Year 2000 issue by third parties with whom the
Company has a material relationship.
Internal operating systems. The Company is heavily dependent upon its
complex IT System for all phases of its operations, which include electronic
(PECOS) and other forms of order entry, sales, distribution, billing and
accounting. The Company began addressing potential Year 2000 issues in 1996 and
has completed an assessment of its principal IT Systems and modules. The Company
has determined that these systems and modules are Year 2000 compliant based on
systematic testing conducted by Company personnel and outside consultants,
however, there may be some non-IT technology or non-critical applications that
are not Year 2000 compliant.
The Company is completing a multi-phase program to identify and resolve its
potential exposure as follows:
- To the extent practical, systematically test and verify equipment and
facility systems that contain non-IT components.
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- Test non-critical applications and assess whether any non-compliant
applications should be replaced, upgraded or discontinued.Continue to
test and verify that the Company's principal IT Systems and modules
are Year 2000 compliant.
- Use internal programmers and outside consultants to upgrade or replace
any non-compliant applications and to upgrade any other systems and
modules determined to be non-compliant.
- Replace non-IT components that are not Year 2000 compliant.
The Company estimates that it will complete its assessment of non-IT
technology and non-critical applications for its IT technology by the end of the
first quarter of fiscal 1999, and expects to address any issues identified;
although until this assessment is completed, and the results thereof assembled
and analyzed, no assurances can be given as to the Company's ability to address
such issues, if any, that are identified.
Third party relationships. The Company is continuing to assess the Year
2000 issue with respect to its third party relationships. Although the Company
is rarely dependent on a single source of supply for the products it sells or
for its own IT and non-IT components, the failure of a particular supplier to
timely deliver Year 2000 compliant IT and non-IT components could jeopardize the
Company's ability to meet its delivery schedules.
The Company is pursuing a program to identify and resolve Year 2000
exposure from third parties as follows:
- Develop and execute Year 2000 compliance tests with its key electronic
trading partners and verify such partners are Year 2000 compliant.
- Develop a supplier compliance warranty for incorporation in all
purchase orders requiring suppliers selling IT and non-IT components
to the Company to certify that items delivered are Year 2000 compliant
and require them to correct or replace any such item found to be
non-compliant. The Company estimates that it will complete its
assessment relating to third party suppliers and development of its
supplier compliance warranty by the end of the first quarter of fiscal
1999.
- Develop alternative sources for IT and non-IT components that are Year
2000 compliant in the event that existing suppliers are not able to
meet compliance requirements.
- The Company also is dependent on third party service providers, such
as telephone companies, banks and insurance carriers; however, the
Company does not believe that it has significant Year 2000 exposure
from those providers and has not implemented any requirements to
assure Year 2000 compliance by them.
Costs to address the Company's Year 2000 issues. Other than time spent
by the Company's internal information technology and other personnel, the
Company has not incurred any significant costs in identifying Year 2000 issues.
The Company does not anticipate any significant costs to make its internal
systems Year 2000 compliant because no significant remediation is expected to be
required. Because no material Year 2000 issues have yet been identified in
connection with third party relationships, the Company cannot reasonably
estimate costs which may be required for remediation or for implementation of
contingency plans. As the Company gathers additional information relating to
Year 2000 issues and the readiness of its third party providers, the Company
will reevaluate its ability to estimate costs associated with Year 2000 issues.
There can be no assurance that, as additional Year 2000 issues are addressed,
the Company's costs to remediate such issues will not be material.
Potential risks of the Company's Year 2000 issues. The Company believes
that the most reasonably likely worst case Year 2000 scenario would include a
combination of some or all of the following:
- Internal IT modules or systems may fail to operate or may give
erroneous information. Such failure could result in shipping delays,
inability to generate or delays in generation of financial
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reports and statements, inability of the Company to communicate with
its branch offices, and computer network downtime resulting in
numerous inefficiencies and higher payroll expenses.
- Non-IT components in lighting, telephone, security and similar
systems might fail and cause the entire IT System to fail.
- Communications with customers that depend upon IT or non-IT
technology, such as EDI (including automatic ordering by and for
customers), and obtaining current pricing from vendors, may fail
or give erroneous information. These types of problems could
result in such difficulties as the inability to receive or
process customer orders, shipping delays, or sale of products at
erroneous prices.
- Product being unavailable as a result of Year 2000 problems
experienced by one or more vendors of the Company, or as a result
of a Year 2000 problem with certain of their suppliers, and/or
the inability of the Company to develop alternative sources for
products.
- Products sold to some of the Company's customers could fail to
perform some or all of their intended functions. In such
situations, the Company's maximum obligation would be to repair
or replace the defective products to the extent the Company is
required to do so under a manufacturer's warranty, at the
manufacturer's expense.
The Company's contingency plans. The Company believes that its plans
for addressing the Year 2000 issue as outlined above are adequate to handle even
the most reasonably likely worst case scenario. The Company does not believe
that it will incur a material financial cost from the potential risk of failure,
or from the costs associated with assessing the potential risks of failure,
arising from the Year 2000 issue. Consequently, the Company does not intend to
create a contingency plan other than the Company's plans as set forth above. If
it is determined that a key electronic trading partner is not Year 2000
compliant, the Company can adjust its IT System to transact business with a key
partner that is Year 2000 compliant. In addition, if the Company's assessment of
its vendors, when completed, indicates that certain product shortages can be
anticipated, the Company has the capacity to maintain additional levels of
inventory and may adjust its plans accordingly.
RESULTS OF OPERATIONS
The following table sets forth various items as a percentage of net
sales for each of the years in the three year period ended December 31, 1998:
Year Ended December 31,
1996 1997 1998
---- ---- ----
Net sales.................................... 100% 100% 100%
Gross profit................................. 11 12 10
Selling, general and
administrative expenses..................... 9 9 11
Research and development expenses............ -- -- --
Restructuring, impairment and other
related charges............................. -- -- 1
Operating profit (loss)...................... 2 3 (2)
Interest expense............................. 1 1 1
Interest income and other, net............... 1 -- --
Provision for income taxes................... 1 1 --
Net income (loss)............................ 1 1 (3)
Year ended December 31, 1998 compared to the year ended December 31, 1997
Net Sales. Net sales for the year ended December 31, 1998 increased to
$763.6 million from $760.1 million in the year ended December 31, 1997, an
increase of $3.5 million or 0.5%. Net sales in the United States decreased to
$449.8 million in 1998 from $473.8 million in 1997, a 5.1% decrease, which
reflects the impact of several factors, including substantial manufacturer price
decreases, increased price competition in the marketplace, as well as overall
softer demand from the Company's domestic customers for PC products in 1998. Net
sales of the Company's United Kingdom-based operations increased to
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$313.8 million in 1998 from $286.3 million in 1997, an increase of 9.6%, which
generally reflects an increase in the level of distribution sales (to other
resellers) in 1998 over 1997.
Gross Profit. Gross profit for the year ended December 31, 1998 decreased
to $76.9 million from $90.4 million in the year ended December 31, 1997, a
decrease of $13.5 million, or 15%. Gross profit as a percent of net sales
decreased from 11.9% in 1997 to 10.1% in 1998. The decrease in gross profit
percentage in 1998 reflects a significant decrease in the level of direct
purchases from manufacturers in the United States and a substantial decrease in
manufacturer funding and incremental discounts available to the Company. The
decline in the gross profit percentage also reflects a higher proportion of the
Company's sales being to its larger customers in the United States, which
typically generate higher than average volume, but at lower gross profit margins
than other customers. The Company anticipates some level of continued pressure
on its gross profit margin. The United Kingdom group is authorized to
"distribute" certain product lines to other PC remarketers through its
distribution entity and these sales, which are at lower margins than sales to
end users, have increased in 1998 over 1997 levels, thereby lowering overall
gross profit margins. Increases in professional services sales, which are
generally at higher margins than product sales, were not significant enough to
offset the above described factors.
Selling, General and Administrative Expenses. Selling, general and
administrative ("S,G&A") expenses for the year ended December 31, 1998 increased
to $80.3 million from $70.2 million in the year ended December 31, 1997, an
increase of $10.1 million or 14%. This increase is attributable primarily to the
Company's investment in sales and technical services personnel, as well as
associated operational and administrative infrastructure to support the
anticipated growth of the Company's traditional remarketer and professional
services business. The level of sales personnel and associated infrastructure
put in place by the Company in 1998 anticipated a significantly higher level of
net sales and gross profit than was generated by the Company in 1998.
Accordingly, at the end of 1998, the Company took certain steps to "rightsize"
its workforce to mitigate this situation. See "- Restructuring, Impairment and
Other Related Charges".
Overall, S,G&A expenses increased as a percentage of net sales for the
year ended December 31, 1998 to 10.5% from 9.2% in 1997, reflecting the combined
impact of the Company's 1998 investment in sales and other personnel and
infrastructure, while sales remained essentially flat with 1997.
Research and Development Expense. Research and development expense
remained essentially flat in 1998 compared with 1997. The Company's research and
development expenses are focused on developing incremental functionality and
features for its PECOS product line, including developing the PECOS.pm
technology acquired in 1997 in current, state-of-the-art code, as well as
modifications to allow its PECOS technologies to communicate and operate using
the Internet and the continued development of its browser-based and Java-enabled
version of its PECOS technologies for license to other companies. The Company
expects to continue to increase its investment in research and development in
the future.
Restructuring, Impairment 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 $3.7 million, consisting of
$.8 million of severance costs, a write-down of $2.1 million to estimated net
realizable value relating to the impairment of certain intangible assets, and
approximately $.8 million in other estimated expenses and asset write-downs. The
impaired intangible assets generally consist of the value assigned to the
original client server coding and architecture of PECOS.pm, which is no longer
competitive with alternatives now available. The Company has, and continues to,
develop PECOS.pm in current, state-of-the-art code, especially for use on the
Internet.
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
$.1 million of severance costs, a write-down of $7.0 million to estimated net
realizable value relating to the impairment of certain intangible assets and
approximately $1.0 million in other related
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expenses and asset write-downs. The impaired intangible assets generally consist
of the unamortized goodwill associated with the February 1995 acquisition of
Computerware, because the Company has determined that there are no longer any
identifiable or significant cash flows specifically associated with this
acquisition, ultimately due to the non-renewal of the Apple Educational Sales
Agent contract.
In December, 1998, the Company streamlined its business model, focusing
primarily on reengineering its sales force and operating infrastructure in a
manner intended to better align the Company's costs with revenues and margin
expected to be generated by the Company. This rightsizing affected 133 positions
worldwide, and the Company recorded a total charge of $1.1 million, primarily
associated with personnel severance and estimated costs related to closing six
United States field support and sales offices.
Interest Expense. Interest expense for the year ended December 31, 1998
increased to $8.4 million from $5.2 million in 1997. Interest expense in both
years primarily results from borrowings in support of the Company's accounts
receivable and inventory and is reflective of the substantial increases in such
assets which began in the second half of 1997 and continued during substantially
all of 1998, prior to the Company's significant reduction of both its inventory
and accounts receivable balances in the fourth quarter of 1998. The increase in
interest expense also reflects higher interest rates in the United Kingdom in
1998 compared to 1997.
Interest Income and Other, Net. Interest income and other, net, for the
year ended December 31, 1998 decreased to $.7 million from $1.1 million in 1997
and reflects a reduction in average on-hand balances of cash and cash
equivalents available for investment. Interest income and other, net in 1997
includes a gain of $.4 million resulting from the sale of the Bristol, PA rental
division in March 1997, net of certain redundant operating and severance
expenses of certain Computerware operations, which were phased-out and
consolidated into the Company's headquarters and East Coast configuration and
distribution facility which was opened in Canton, MA late in the first quarter
of 1997.
Income Tax Provision. The income tax provisions in 1998 and 1997 primarily
relate to the income taxes of the Company's United Kingdom-based operations, as
well as certain current federal (alternative minimum tax) and state income taxes
provided by the Company, partially offset by the tax benefit associated with
reversal of the 1997 United States deferred tax liability due to the Company's
tax loss in 1998. Because of the uncertainty related to realizability of the
Company's net operating loss carryforward, the Company has recorded a full
valuation allowance against its United States deferred tax assets.
Net Income. The Company reported a net loss of $25.6 million for the year
ended December 31, 1998, versus net income of $10.3 million in 1997, as a result
of the factors described herein.
Year ended December 31, 1997 compared to the year ended December 31, 1996
Net Sales. Net sales for the year ended December 31, 1997 increased to
$760.1 million from $620.1 million in the year ended December 31, 1996, an
increase of $140 million or 22.6%. Net sales in the United States increased to
$473.8 million in 1997 from $435.1 million in 1996, an 8.9% increase, which
reflected management's decision to defer significant expansion of its domestic
sales force and focus its efforts on consolidation of certain general and
administrative functions of acquisitions and implementation of its new
management information system. Such implementation adversely impacted net sales
in the United States in the fourth quarter of 1997. Net sales of the Company's
United Kingdom based operations increased to $286.3 million in 1997 from $185.0
million in 1996, an increase of 54.8%. Net sales for the year ended December 31,
1997 in the United Kingdom include an aggregate of $51.1 million generated by
Prophet Group Limited (acquired in December, 1996) and Data Supplies Limited
(acquired in February, 1997).
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Gross Profit. Gross profit for the year ended December 31, 1997 increased
to $90.4 million from $70.0 million in the year ended December 31, 1996, an
increase of $20.4 million, or 29.1%. The increase in gross profit dollars
resulted primarily from the substantial growth in net sales, including sales
generated by recent acquisitions. Gross profit, including the contribution from
acquisitions, as a percent of net sales increased from 11.3% in 1996 to 11.9% in
1997. The gross profit percentage was higher in 1997 principally due to new
direct purchasing programs implemented with several major manufacturers in the
United States, coupled with an increase in the portion of revenues generated by
the Company's United Kingdom operations, and from an increase in higher margin
professional services revenues in both countries.
Selling, General and Administrative Expenses. S,G&A expenses for the year
ended December 31, 1997 increased to $70.2 million from $57.6 million in the
year ended December 31, 1996, an increase of $12.6 million or 22%. This increase
is attributable primarily to the cost of the Company's larger work force and
other expenses of the acquired companies. Other S,G&A expenses also increased as
the Company continued to invest in administrative infrastructure to support its
current and future growth, including the development and implementation of its
Oracle-based, Year 2000 compliant management information system.
Overall, S,G&A expenses decreased as a percentage of net sales for the year
ended December 31, 1997 to 9.2% from 9.3% in 1996, reflecting the impact of
slower overall expense growth relative to the increase in net sales, and also is
reflective of the increase in manufacturer funding/reimbursement of certain
S,G&A expenses, resulting from the Company's increased volume of direct
purchasing in 1997.
Research and Development Expense. Research and development expense
increased slightly from $1.2 million in 1996 to $1.3 million in 1997. The
Company's research and development expenses are focused on developing
incremental functionality and features for its PECOS technologies, including the
aspects of the PECOS.pm technology acquired in 1997, as well as modifications to
allow its PECOS technologies to communicate using the Internet and the continued
development of a browser compliant and Java-enabled version of its PECOS
technologies for license to other companies. The Company expects to continue
investing significant amounts in research and development.
Interest Expense. Interest expense for the year ended December 31, 1997
increased to $5.2 million from $3.8 million in 1996. Interest expense in both
years primarily results from borrowings in support of the Company's accounts
receivable and inventory and is reflective of the substantial increases in such
assets, net of reductions in the applicable interest rate on the principal
United States credit facility from prime plus 1% in the first six months of
1996, to the prime rate as of July 1, 1996, and a further reduction to prime
minus 1% as of March 1, 1997.
Interest Income and Other, Net. Interest income and other, net, for the
year ended December 31, 1997 decreased to $1.1 million from $1.5 million in 1996
and reflects a reduction in average on hand balances of cash and cash
equivalents available for investment. Interest income and other, net in 1997
includes a gain 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 certain Computerware operations, 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 late in the first quarter
of 1997.
Income Tax Provision. The income tax provisions in 1997 and 1996 primarily
relate to the income taxes of the Company's United Kingdom-based operations, as
well as certain current federal (alternative minimum tax) and state income taxes
provided by the Company.
Net Income. The Company reported net income of $10.3 million for the year
ended December 31, 1997, versus net income of $5.6 million in 1996, as a result
of the factors described herein.
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Liquidity and Capital Resources
Net cash provided by operating activities for the year ended December 31,
1998 was $38.8 million, which primarily reflects a total of $20.3 million in
depreciation, amortization and impairment of intangible assets, as well as a
decrease in inventory of $20.9 million, and a $12.3 million decrease in accounts
receivable. Net cash used in investing activities was $6.8 million, consisting
primarily of additions to property, equipment and software. Net cash used in
financing activities was $51.1 million, including a $50.0 million net decrease
in borrowings under floor plan lines of credit.
Net cash used in operating activities for the year ended December 31, 1997
was $44.2 million, which is primarily due to an increase in accounts receivable
of $30.2 million, resulting primarily from the Company's increase in net sales
during 1997, and a $26.1 million increase in inventory which is related to the
Company's direct purchasing arrangements with manufacturers which were
instituted in the United States in 1997. Net cash used in investing activities
was $11.3 million, consisting primarily of $7.7 million in additions to
property, equipment and software and $3.3 million related to acquisitions. Net
cash provided by financing activities was $65.6 million, including a $64.6
million net increase in borrowings under floor plan lines of credit and $1.8
million in proceeds from the exercise of stock options and related tax benefits.
At December 31, 1998, the Company's principal sources of liquidity included
cash and cash equivalents of $14.3 million, accounts receivable and floor plan
lines of credit from Deutsche Financial Services Corporation ("DFSC"). During
1998, the United States DFSC facility provided for borrowings of up to $120
million. The facility was amended in connection with its March 1999 renewal to
provide for aggregate borrowings of up to $80 million, and as of April 1, 1999,
the interest rate will increase from the prime rate minus 1% to prime minus .5%.
In addition, the Company has agreed that its interest rate will increase .25%
for each quarter that it reports a loss, as defined in the DFSC agreements.
Availability of United States borrowings is based on DFSC's determination as to
eligible accounts receivable and inventory. As of December 31, 1998, the
Company's borrowings from DFSC on its United States floor plan line of credit
were $66.7 million, which approximated the Company's availability based on
eligible accounts receivable and inventory at that date. During the first half
of 1996, interest was payable monthly at the prime rate plus 1%, and thereafter
at the prime rate, although approximately one-half of the Company's initial
United States borrowings do not bear interest until after interest-free periods
of 30 to 60 days have lapsed. As of March 1, 1997, the interest rate was reduced
to prime (8.5% at December 31, 1998) minus 1%. The United States DFSC line of
credit is secured primarily 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 December 31, 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
(7.5% at December 31, 1998) plus 1.25%. The United Kingdom DFSC facility
replaced four separate facilities previously maintained in the United Kingdom.
As of December 31, 1998, the Company's borrowings under its United Kingdom DFSC
facility were (pound)23 million, or $38.1 million, which approximated the
Company's availability thereunder.
The Company is dependent upon the DFSC lines of credit to finance its
eligible accounts receivable arising from sales of PC products as well as its
United States inventory purchases. The DFSC lines of credit limit borrowings to
defined percentages of eligible inventory (in the United States) and accounts
receivable and contain customary covenants, including financial covenants with
respect to the Company's net income, net worth and debt-to-equity ratios, as
defined in the agreements, and customary default provisions related to
non-payment of principal and interest, default under other debt agreements and
bankruptcy. After receiving a waiver from DFSC concerning the net income
covenant for 1998, the Company was in compliance with all other covenants of the
facility as of December 31, 1998. 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.
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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 December 31, 1998, the
Company had no borrowings outstanding from IBMCC on its floor plan line of
credit.
As of December 31, 1998, the Company had borrowings aggregating
approximately $104.8 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 manufacturers in late 1996. Although the
Company's inventory investment imposes certain costs and risks and, at the end
of 1998, increased 14% since December 31, 1996, the Company believes that this
investment improves its delivery time to customers and the quality control of
configured systems. The Company also 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. 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 related to sales to certain
large customers. Nonetheless, during 1998 the Company reduced its inventory
levels 34% from its 1997 year-end position, particularly in the United States,
where manufacturers have substantially modified various policies to limit the
time frame and/or availability of price protection on products held in inventory
and the Company's ability to return products also has been curtailed.
Accordingly, the Company is continuing to evaluate the levels of products that
it purchases directly and holds in inventory in the United States, versus the
incremental cost to source the product from its DFPs for shipment to a Company
location or directly to a customer. The Company is currently seeking to minimize
the level of inventory it stocks. As a result of the Company's policy changes,
as well as manufacturer revisions to their rebate and incremental discount
programs, the Company received substantially reduced manufacturer funding
support in 1998 versus 1997, and there can be no assurance that the Company will
be in a position to purchase the levels of product necessary in order to
continue to receive even these reduced levels of funding support in the future,
or that manufacturers will continue to make such support available. Further
reductions in manufacturer funding support would reduce the Company's gross
profit. The Company intends to continue to maintain logistical and traditional
relationships with selected distributors and/or aggregators and is investigating
outsourcing certain activities.
As of September 30, 1997, the Company sold options to acquire its interest
in ShopLink Incorporated, which now represents approximately a 5% ownership
position. The Company received $418,000 in payment for the options, which may be
exercised through March 31, 1999. The Company has included the $418,000 received
in payment for the options in other deferred liabilities, and does not
anticipate that these options will be exercised.
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. In addition, the Company
will require ongoing investment in property, equipment and software.
The Company believes that its cash, cash equivalents, and accounts
receivable, together with its existing sources of liquidity and cash generated
from operations, 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, there can be no assurance
the Company's lines of credit will continue to be available to the Company or
that replacement financing could be arranged if necessary, or that the Company
will be able to timely collect its accounts receivable. Moreover, there can be
no assurance that the Company can arrange appropriate financing to allow a
substantial increase in its marketing expenditures in order to support the
branding of PECOS.pm and its Internet-based sales subsidiary, elcom.com.
25
<PAGE>
SEASONALITY AND IMPACT OF INFLATION
The Company historically has not experienced observable seasonality in its
business. Generally, however, sales in the PC remarketer industry slow in the
summer months and, in the United States, are stronger in the fourth calendar
quarter and somewhat weaker in the first calendar quarter, while sales are
generally strong in the first calendar quarter in the United Kingdom. Due to its
current size and the nature of its customer base, it is likely that the sales of
the Company will be impacted by general industry seasonality in the future.
Inflation has been relatively low in recent years and accordingly, the
Company has not been significantly impacted by the effects of general inflation.
However, since the latter half of 1996, the Company has been increasingly
impacted by the low unemployment rate in certain of its markets, particularly in
the Northeastern United States and the United Kingdom, which has resulted in
significant increases in salaries for a variety of personnel (particularly
technical personnel) in order for the Company to remain competitive in the
employment marketplace.
The Company's revenues are effected by general price reductions by PC
manufacturers, which have been substantial, particularly in 1997 and 1998. Such
price reductions require that the Company increase its base unit volumes and
associated peripheral product sales to existing and newly acquired customers in
order to overcome the effect of this price cutting and increase its net sales.
Consequently, in order to increase revenues, such unit volumes of sales are
required to increase substantially, which amplifies the impact of any slowdown
in corporate customer demand on the Company's revenues.
STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
Except for the historical information contained herein, the matters
discussed in this Annual Report on Form 10-K could 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," "intends," "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, or will be, correct. These forward-looking
statements involve a number of risks and uncertainties which could cause the
Company's future results to differ materially from those anticipated, including:
availability and terms of appropriate working capital and/or other financing,
customer's acceptance and usage of electronic commerce software systems, the
impact of competitive technologies, products and pricing, control of expenses,
levels of gross margins, revenue growth, overall business conditions, price
decreases of PC products, corporate demand for and availability of PC products,
changes in manufacturer policies reducing price protection, returns and other
policies, the success and timing of implementing the Company's new management
information system, risks associated with acquisitions of companies, the
consequent results of operations given the aforementioned factors, and other
risks detailed from time to time in this Annual Report on Form 10-K (including
without limitation, under Item 1 and this Item 7) and in the Company's other SEC
reports, 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.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risk from changes in inventory values,
interest rates and exchange rates, which could affect its future results of
operations and financial condition. The Company's risk associated with inventory
values is discussed elsewhere in this Form 10-K.
The Company's cash and cash equivalents, lines of credit and long term debt
are sensitive to interest rate fluctuations. Changes in interest rates would
result in changes in interest income and interest expense resulting from the
difference between historical interest rates on these financial instruments and
the interest rates that these variable-rate instruments may adjust to in the
future. Based on December 31,
26
<PAGE>
1998 balances, the Company estimates that a 1% change in interest rates would
have an effect of approximately $1 million on income before income taxes.
The Company's investment in its United Kingdom subsidiaries is sensitive to
fluctuations in the exchange rate between the United States dollar and the
United Kingdom pound sterling. The effect of such fluctuations is included in
accumulated other comprehensive income in the Consolidated Statements of
Stockholders' Equity. To date, such fluctuations have amounted to a positive
accumulated amount of $845,000.
Item 8. Financial Statements and Supplementary Data
See the Consolidated Financial Statements beginning on page F-1.
Supplemental earnings per share and quarterly financial information for the
Company are included in Notes 11 and 12, respectively, of the Notes to
Consolidated Financial Statements.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Part III
Item 10. Directors and Executive Officers of the Registrant
The information concerning the directors of the Company is set forth in
the definitive Proxy Statement ("the Proxy Statement") to be sent to
stockholders in connection with the Company's 1999 Annual Meeting of
Stockholders to be held May 12, 1999, under the heading "Election of Directors",
which information is incorporated herein by reference. Information concerning
each executive officer of the Company is set forth in the Proxy Statement under
the heading "Management - Executive Officers", which information is incorporated
herein by reference.
Item 11. Executive Compensation
The information concerning executive compensation is set forth in the
Proxy Statement under the heading "Executive Compensation", which information is
incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information concerning security ownership of certain beneficial
owners and management is set forth in the Proxy Statement under the heading
"Principal Stockholders and Management Ownership", which information is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
The information concerning certain relationships and related
transactions is set forth in the Proxy Statement under the heading "Certain
Transactions", which information is incorporated herein by reference.
27
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
The following documents are filed as part of this Annual Report on Form 10-K:
(a) (1) Consolidated Financial Statements:
See Index to Consolidated Financial Statements on page F-1.
(2) Consolidated Financial Statement Schedule for each of the
Three Years in the Period Ended December 31, 1998:
Report of Independent Public Accountants
Schedule II - Valuation and Qualifying Accounts
See Index to Schedule on page S-1.
All other schedules for which provision is made in the
applicable accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable, and therefore
have been omitted.
(3) Index to Exhibits:
The exhibits filed as part of this Form 10-K are listed on the
Index to Exhibits beginning on page E-1, which Index to Exhibits is incorporated
herein by reference. The Company's current management contracts and executive
compensation plans and arrangements are listed in the Index to Exhibits,
incorporated herein by reference, at exhibit numbers 10.1; 10.2; 10.3; 10.19;
10.22; 10.29; 10.36; 10.37, 10.38, 10.39 and 10.40.
(b) Reports on Form 8-K:
None.
(c) Exhibits:
See Index to Exhibits beginning on page E-1.
------------------------------------------------------
The Company will provide copies of the Consolidated Financial Statement Schedule
and Index to Exhibits to stockholders upon request. Such request can be made to:
Chief Financial Officer, Elcom International, Inc., 10 Oceana Way, Norwood, MA
02062.
28
<PAGE>
SIGNATURES
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: March 29, 1999 By: /s/ Robert J. Crowell
-----------------------
Robert J. Crowell
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
Signatures Title Date
/s/ Robert J. Crowell Chairman of the March 29, 1999
- ----------------------------- Board of Directors
Robert J. Crowell and Chief Executive Officer
(Principal Executive Officer)
/s/ Laurence F. Mulhern Corporate Executive March 29, 1999
- ----------------------------- Vice President,
Laurence F. Mulhern Chief Financial Officer, Treasurer
and Secretary (Principal Financial
and Accounting Officer)
/s/ William W. Smith Vice Chairman and Director March 29, 1999
- -----------------------------
William W. Smith
/s/James Rousou Corporate Executive March 29, 1999
- ----------------------------- Vice President and Director
James Rousou
/s/ Richard J. Harries, Jr. Director March 29, 1999
- -----------------------------
Richard J. Harries, Jr.
/s/ John W. Ortiz Director March 29, 1999
- -----------------------------
John W. Ortiz
29
<PAGE>
ELCOM INTERNATIONAL, INC.
1998 ANNUAL REPORT ON FORM 10-K
INDEX TO EXHIBITS
Exhibit No. Description
- ---------- -----------
2.1 Agreement for the sale and purchase of shares in the capital of Prophet
Group Limited dated December 6, 1996, by and among Lantec (Management)
Limited (a subsidiary of the Registrant) and the Vendors (as defined
therein). (3)
2.5 Agreement for the sale and purchase of shares in the capital of
Data Supplies Limited dated February 21, 1997, by and among Elcom
Group Limited (a subsidiary of the Registrant), the Vendor (as defined
therein) and Mr. Savage. (4)
3.3 Second Restated Certificate of Incorporation of the Registrant. (5)
3.4 By-Laws of the Registrant, amended as of November 6, 1995. (1)
4.4 Specimen certificate of the Registrant's Common Stock. (1)
4.5 Form of 8% Series A Cumulative Convertible Preferred ("Series A") Stock
Purchase Agreement, with attached list of purchasers and number of
shares purchased, as of December 10, 1993. (1)
4.8 Form of Series B Preferred Stock Purchase Agreement for Closings held
on April 15, June 21 and August 11, 1994, with attached list of
purchasers and number of shares purchased. (1)
4.9 Form of Series B Preferred Stock Purchase Agreement for Closings held
on December 30, 1994 and February 6, 1995, with attached list of
purchasers and number of shares purchased. (1)
4.10 Form of Series C Preferred Stock Purchase Agreement for Closings held
on June 22 and June 30, 1995, with attached list of purchasers and
number of shares purchased. (1)
4.12 Securities Agreement, dated September 1, 1993, as amended February 1,
1994, by and among the Registrant, Robert J. Crowell, and 19 other
listed purchasers, as of June 2, 1995 (1), and list of other assignees
of certain registration rights thereunder. (14)
4.13 Securities Agreement, dated October 28, 1994, by and among
the former stockholders of CSI and the Registrant. (1)
4.14 Computerware Stockholders' Agreement, dated February 6, 1995, by
and among the Registrant, Robert J.Crowell and the former shareholders
of Computerware. (1)
4.15 Amended and Restated Lantec Stockholders' Agreement, dated April 6,
1996, by and among the Registrant, Robert J. Crowell and the former
shareholders of Lantec. (6)
4.16 Form of Lantec Warrant Agreement, dated June 22, 1995 (1), with
attached First Amended List of Holders of Warrants to Purchase Common
Shares of the Registrant. (10)
4.17 AMA Securities Agreement, dated February 29, 1996, by and among the
Registrant and the former stockholders of AMA (UK) Limited. (9)
4.18 Final Agreement of Settlement and Mutual Release of All Claims and
Demands, dated March 26, 1997, by and among the Registrant and certain
of its subsidiaries, and the Former Shareholders of Computerware
Business Trust. (13)
E-1
<PAGE>
Exhibit No. Description
- ---------- ------------
10.1 Form of Indemnity Agreement for Executive Officers and/or Directors of
the Registrant (1), with attached list of Director and/or Executive
Officer Indemnitees. (15) (*)
10.2 Stock Option Plan of the Registrant dated February 23, 1993, as
amended June 3, 1994 and November 6, 1995. (1) (*)
10.3 1995 (Computerware) Stock Option Plan of the Registrant, dated
February 6, 1995 (1), as amended by Amendment No. 1 dated August 19,
1996. (9)(*)
10.4 $120,000,000 Business Credit and Security Agreement Dated as
of March 1, 1997 among Elcom Services Group, Inc. and Deutsche
Financial Services Corporation (9), and Amendments to Business Credit
and Security Agreement. (12)(15)
10.5 Lease Agreement for the Registrant's Headquarters, dated July 5, 1993,
by and among Oceana Way Associates and the Registrant (1), and
Agreement of Amendment thereto, dated October 20, 1997. (14)
10.6 Lease Agreements for Lantec Headquarters, among Allied Dunbar Assurance
PLC to Businessland (UK) Limited and Businessland Inc., dated November
23, 1988, with Licenses to Assign to Lantec Information Services Ltd.,
and Supplemental Deed dated November 4, 1993. (1)
10.13 Lock Box Agreement, dated May 1, 1994, by and among Deutsche, Fleet
Bank of Massachusetts and the Registrant; and Storage Agreement by and
between Ingram Micro and Deutsche. (1)
10.15 Guaranty by the Registrant in favor of Deutsche Financial Services
Corporation (UK) LTD., dated December 1, 1997, guarantying Elcom Group
Limited's indebtedness to Deutsche. (14)
10.19 Amended Employment Agreement by and between the Registrant and Robert
J. Crowell dated June 1, 1997 (11), and Form of Consulting Agreement
appended thereto as Exhibit A. (12) (*)
10.22 Employment Agreement by and between the Registrant and James Rousou,
dated April 1, 1996 (7), and First Amendment to Employment Agreement,
dated November 5, 1997. (14) (*)
10.24 Standard Conditions for the Sale and Purchase of Debts, dated December
3, 1997, between Elcom Group Limited and Deutsche Financial Services
(UK) LTD. (14)
10.25 Agreement for the Sale and Purchase of Debts dated December 3, 1997,
between Elcom Group Limited and Deutsche Financial Services (UK) LTD.
(14)
10.29 1995 Non-Employee Director Stock Option Plan of the Registrant,
dated October 9, 1995 (1), and Amendment No. 1 thereto. (11) (*)
10.33 Guaranty by the Registrant in favor of Deutsche Financial Services
Corporation, dated November 6, 1995, guarantying Elcom Services Group,
Inc.'s indebtedness to Deutsche. (1)
10.36 The 1996 Stock Option Plan of Elcom International, Inc. (8) (*)
10.37 Amended Employment Agreement by and between the Registrant and Laurence
F. Mulhern dated June 1, 1997 (11), and Form of Consulting Agreement
appended thereto as Exhibit A. (12) (*)
10.38 The 1997 Stock Option Plan of Elcom International, Inc. (11), and
Amendments One and Two thereto. (14) (x) (*)
E-2
<PAGE>
Exhibit No. Description
- ---------- -----------
10.39 Elcom International, Inc. Executive Profit Performance
Bonus Plan for Executive Officers dated September 4, 1997. (12) (*)
10.40 Elcom International, Inc. Key Personnel Profit Performance Bonus
Plan dated September 4, 1997. (12) (*)
10.41 Engagement letter between the Registrant and Salomon Smith Barney Inc.
dated July 21, 1997.(12), and Extension and Termination thereof. (16)
21.1 List of the Registrant's Subsidiaries. (x)
23.1 Consent of Arthur Andersen LLP. (x)
23.2 Consent of Deloitte & Touche. (x)
27 Financial Data Schedule. (x)
- -------------------------------------------------------------------------------
(1) Previously filed as an exhibit to Registration Statement No. 33-98866 on
Form S-1 and incorporated herein by reference.
(2) Previously filed as an exhibit to Current Report on Form 8-K (date of
report February 29, 1996) filed March 14, 1996, and incorporated herein by
reference.
(3) Previously filed as an exhibit to Current Report on Form 8-K (date of
report December 6, 1996) filed December 19, 1996, and incorporated herein
by reference.
(4) Previously filed as an exhibit to Current Report on Form 8-K (date of
report February 21, 1997) filed March 6, 1997, and incorporated herein by
reference.
(5) Previously filed as an exhibit to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995, and incorporated herein by reference.
(6) Previously filed as an exhibit to Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1996, and incorporated herein by
reference.
(7) Previously filed as an exhibit to Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1996, and incorporated herein by
reference.
(8) Previously filed as an exhibit to Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1996, and incorporated herein by
reference.
(9) Previously filed as an exhibit to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996, and incorporated herein by reference.
(10) Previously filed as an exhibit to Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1997, and incorporated herein by
reference.
(11) Previously filed as an exhibit to Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997, and incorporated herein by
reference.
(12) Previously filed as an exhibit to Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997, and incorporated herein by
reference.
(13) Previously filed as an exhibit to Registrant's Current Report on Form 8-K
dated March 26, 1997 and incorporated herein by reference.
E-3
<PAGE>
(14) Previously filed as an exhibit to Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997, and incorporated herein by reference.
(15) Previously filed as an exhibit to Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1998, and incorporated herein by
reference.
(16) Previously filed as an exhibit to Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1998, and incorporated herein by
reference.
(x) Filed herewith.
(*) Management contract or compensatory plan or arrangement.
E-4
<PAGE>
CONSOLIDATED FINANCIAL STATEMENTS
ELCOM INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
The following consolidated financial statements of Elcom
International, Inc. are included in response to Item 8:
Page
Report of Independent Public Accountants F-2
Reports of Other Auditors F-3 to F-4
Consolidated Balance Sheets as of December 31, 1997 and 1998 F-5
Consolidated Statements of Operations and Other Comprehensive
Income for the years ended December 31, 1996, 1997 and 1998 F-6
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1996, 1997 and 1998 F-7
Consolidated Statements of Cash Flows for the years ended
December 31,1996, 1997 and 1998 F-8
Notes to Consolidated Financial Statements F-9 to F-23
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Elcom International, Inc.:
We have audited the accompanying consolidated balance sheets of Elcom
International, Inc. (a Delaware corporation) and subsidiaries as of December 31,
1997 and 1998, and the related consolidated statements of operations and other
comprehensive income, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1998. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the 1996 financial statements of Elcom
International Limited and AMA (UK) Limited, both of which are wholly-owned
subsidiaries, which statements, in the aggregate, reflect net income of
$4,301,000 of the 1996 consolidated financial statement totals. Those statements
were audited by other auditors whose reports have been furnished to us, and our
opinion, insofar as it relates to amounts included for Elcom International
Limited and AMA (UK) Limited is based solely upon the reports of the other
auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits, and the reports of other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Elcom International, Inc. and
subsidiaries as of December 31, 1997 and 1998 and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Boston, Massachusetts
March 23, 1999
F-2
<PAGE>
REPORT OF OTHER AUDITORS
AUDITORS' REPORT TO THE DIRECTORS OF
ELCOM INTERNATIONAL LIMITED
(formerly Elcom Holdings Limited)
(formerly PCO 138 Limited)
We have audited the financial statements of Elcom International Limited (not
separately presented herein) which have been prepared under the accounting
policies set out in the notes to the accounts.
Respective responsibilities of directors and auditors
As described on page 3 of the financial statements the company's directors are
responsible for the preparation of financial statements. It is our
responsibility to form an independent opinion, based on our audit, on those
statements and to report our opinion to you.
Basis of opinion
We conducted our audit in accordance with Auditing Standards issued by the
Auditing Practices Board. An audit includes examination, on a test basis, of
evidence relevant to the amounts and disclosures in the financial statements. It
also includes an assessment of the significant estimates and judgments made by
the directors in the preparation of the financial statements and of whether the
accounting policies are appropriate to the company's circumstances, consistently
applied and adequately disclosed.
We planned and performed our audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance that the financial statements
are free from material misstatement, whether caused by fraud or other
irregularity or error. In forming our opinion we also evaluated the overall
adequacy of the presentation of information in the financial statements.
Opinion
In our opinion the financial statements give a true and fair view of the state
of the company's affairs as at 31 December 1996 and 1995 and of its profit for
the years then ended.
/s/ DELOITTE & TOUCHE
Chartered Accountants
London
21 March 1997
F-3
<PAGE>
REPORT OF OTHER AUDITORS
AUDITORS' REPORT TO THE DIRECTORS OF
AMA (UK) LIMITED
We have audited the financial statements of AMA (UK) Limited (not separately
presented herein) which have been prepared under the accounting policies set out
in the notes to the accounts.
Respective responsibilities of directors and auditors
As described on page 2 of the financial statements the company's directors are
responsible for the preparation of financial statements. It is our
responsibility to form an independent opinion, based on our audit, on those
statements and to report our opinion to you.
Basis of opinion
We conducted our audit in accordance with Auditing Standards issued by the
Auditing Practices Board. An audit includes examination, on a test basis, of
evidence relevant to the amounts and disclosures in the financial statements. It
also includes an assessment of the significant estimates and judgments made by
the directors in the preparation of the financial statements and of whether the
accounting policies are appropriate to the company's circumstances, consistently
applied and adequately disclosed.
We planned and performed our audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance that the financial statements
are free from material misstatement, whether caused by fraud or other
irregularity or error. In forming our opinion we also evaluated the overall
adequacy of the presentation of information in the financial statements.
Opinion
In our opinion the financial statements give a true and fair view of the state
of the company's affairs as at 31 December 1996 and 1995 and of its profit for
each of the three years in the period ended 31 December 1996.
/s/ DELOITTE & TOUCHE
Chartered Accountants
London
21 March 1997
F-4
<PAGE>
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
December 31,
1997 1998
----------- ----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 33,165 $ 14,315
Accounts receivable:
Trade 154,223 134,753
Other 32,200 36,068
----------- ----------
186,423 170,821
Less--Allowance for doubtful accounts 5,474 6,796
----------- ----------
Accounts receivable, net 180,949 164,025
Inventory 60,437 39,617
Prepaids and other current assets 3,255 2,458
----------- ----------
Total current assets 277,806 220,415
----------- ----------
PROPERTY, EQUIPMENT AND SOFTWARE, AT COST:
Computer hardware and software 22,118 26,556
Land, buildings and leasehold improvements 3,402 3,507
Furniture, fixtures and equipment 8,579 9,228
----------- ----------
34,099 39,291
Less -- Accumulated depreciation and amortization 17,649 25,034
----------- ----------
16,450 14,257
----------- ----------
GOODWILL AND OTHER ASSETS, NET OF ACCUMULATED AMORTIZATION 37,812 27,179
----------- ----------
$332,068 $261,851
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Lines of credit $154,714 $104,772
Accounts payable 43,271 49,341
Accrued expenses and other current liabilities 19,557 20,747
Current portion of capital lease obligations 680 991
Current portion of long-term debt 78 78
----------- ----------
Total current liabilities 218,300 175,929
----------- ----------
OTHER DEFERRED LIABILITIES 2,213 418
CAPITAL LEASE OBLIGATIONS, NET OF CURRENT PORTION 920 191
LONG-TERM DEBT, NET OF CURRENT PORTION 332 296
----------- ----------
3,465 905
----------- ----------
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY:
Preferred stock,$.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 (accumulated deficit) 9,369 (16,192)
Treasury stock, at cost -- 56,319 and 236,338 shares (549) (1,182)
Accumulated other comprehensive income 485 845
----------- ----------
Total stockholders' equity 110,303 85,017
----------- ----------
$332,068 $261,851
=========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
F-5
<PAGE>
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND OTHER COMPREHENSIVE INCOME
(in thousands, except per share data)
<TABLE>
<CAPTION>
For Years Ended December 31,
1996 1997 1998
----------- ----------- ----------
<S> <C> <C> <C>
Net sales $ 620,115 $ 760,136 $ 763,600
Cost of sales 550,076 669,742 686,658
----------- ----------- ----------
Gross profit 70,039 90,394 76,942
Expenses:
Selling, general and adminstrative 57,551 70,200 80,285
Research and development 1,200 1,275 1,178
Restructuring, impairment and other related charges - - 12,892
----------- ----------- ----------
Total expenses 58,751 71,475 94,355
----------- ----------- ----------
Operating profit (loss) 11,288 18,919 (17,413)
Interest expense (3,837) (5,203) (8,355)
Interest income and other, net 1,534 1,061 691
----------- ----------- ----------
Income (loss) before income taxes 8,985 14,777 (25,077)
Provision for income taxes 3,410 4,489 484
----------- ----------- ----------
Net income (loss) $ 5,575 $ 10,288 $(25,561)
=========== =========== ==========
Basic net income (loss) per share $ 0.21 $ 0.38 $ (0.94)
=========== =========== ==========
Basic weighted average shares outstanding 26,363 26,937 27,322
=========== =========== ==========
Diluted net income (loss) per share $ 0.19 $ 0.35 $ (0.94)
=========== =========== ==========
Diluted weighted average shares outstanding 29,739 29,461 27,322
=========== =========== ==========
Other comprehensive income, net of tax:
Net income (loss) $ 5,575 $ 10,288 $(25,561)
Foreign currency translation adjustments 1,162 (653) 360
----------- ----------- ----------
Comprehensive income (loss) $ 6,737 $ 9,635 $(25,201)
=========== =========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
F-6
<PAGE>
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except number of shares)
<TABLE>
<CAPTION>
Common Stock Retained Accumulated
---------------------- Additonal Earnings Treasury Other Total
Number $.01 Par Paid in (Accumulated Stock, Comprehensive Stockholders'
Of Share Value Capital Deficit) At cost Income Equity
---------------------- ---------- ------------ ----------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 25,510,297 $ 255 $ 91,113 $ (6,494) $ - $ (24) $ 84,850
Proceeds from sale of common stock,
net of offering costs of
approximately $200 629,489 6 6,234 - - - 6,240
Exercise of common stock options 523,726 6 920 - (366) - 560
Tax effect of AMA (U.K.)Limited pooling - - 216 - - - 216
Net income - - - 5,575 - - 5,575
Cumulative translation adjustment - - - - - 1,162 1,162
----------- --------- ---------- ----------- ---------- -------------- -------------
BALANCE, DECEMBER 31, 1996 26,663,512 267 98,483 (919) (366) 1,138 98,603
Exercise of common stock options,
including related tax benefit of
approximately $450 505,447 5 1,954 - (183) - 1,776
Purchase of procurement technology 49,280 - 289 - - - 289
Net income - - - 10,288 - - 10,288
Cumulative translation adjustment - - - - - (653) (653)
----------- ---------- --------- ------------ ----------- ------------- --------------
BALANCE, DECEMBER 31, 1997 27,218,239 272 100,726 9,369 (549) 485 110,303
Exercise of common stock options 328,822 3 545 - - - 548
Purchase of treasury stock - - - - (633) - (633)
Net loss - - - (25,561) - - (25,561)
Cumulative translation adjustment - - - - - 360 360
----------- ---------- --------- ----------- ---------- -------------- -------------
BALANCE, DECEMBER 31, 1998 27,547,061 $ 275 $101,271 $ (16,192) $ (1,182) $ 845 $ 85,017
=========== ========== ========== =========== ========== ============== ============
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
F-7
<PAGE>
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
For Years Ended December 31,
1996 1997 1998
----------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 5,575 $ 10,288 $ (25,561)
Adjustments to reconcile net income(loss)to net cash
provided by (used in) operating activities --
Depreciation , amortization andimpairment of intangible assets 6,704 8,795 20,343
Provision for doubtful accounts 2,586 3,058 4,975
Changes in current assets and liabilities,
net of purchase acquisitions --
Accounts receivable (71,095) (30,168) 12,266
Inventory (13,955) (26,088) 20,939
Prepaids and other current assets 1,064 (1,995) 799
Accounts payable (6,858) 5,088 5,860
Accrued expenses and other current liabilities 19,695 (15,356) 1,013
Increase (decrease) in other deferred liabilities (11) 2,183 (1,795)
--------- --------- -----------
Net cash provided by (used in) operating activities (56,295) (44,195) 38,839
--------- --------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, equipment and software (6,506) (7,723) (7,284)
(Increase) decrease in other assets and deferred costs (795) (321) 527
Tax effect of AMA (U.K.) Limited pooling 216 - -
Purchase of Prophet Group, net of cash acquired (8,331) (625) -
Purchase of Data Supplies, net of cash acquired - (2,660) -
--------- -------- ---------
Net cash (used in) investing activities (15,416) (11,329) (6,757)
--------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) under lines of credit 43,009 64,570 (50,041)
Sale of common stock, net of offering costs 6,240 - -
Repayment of capital lease obligations and long-term debt (215) (731) (965)
Exercise of common stock options including
related tax benefit 560 1,776 548
Purchase of treasury stock - - (633)
--------- -------- ---------
Net cash provided by (used in)financing activities 49,594 65,615 (51,091)
--------- -------- ---------
FOREIGN EXCHANGE EFFECT ON CASH 399 (185) 159
--------- -------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (21,718) 9,906 (18,850)
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 44,977 23,259 33,165
========= ========= =========
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 23,259 $ 33,165 $ 14,315
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION:
Interest paid $ 3,711 $ 5,141 $ 8,232
========= ========= =========
Income taxes paid $ 523 $ 1,620 $ 636
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Increase in capital lease obligations $ 787 $ 1,488 $ 510
========= ========= =========
Purchase of procurement technology $ - $ 289 $ -
========= ========= =========
Acquisitions of businesses (Note 2):
Fair value of assets acquired $ 16,931 $ 6,332 $ -
Less cash paid 8,600 1,600 -
--------- --------- ---------
Liabilities assumed $ 8,331 $ 4,732 $ -
========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
F-8
<PAGE>
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Elcom International, Inc. (the "Company") develops and licenses
automated procurement software applications which enable the conduct of
interactive electronic commerce and, through its PC remarketing subsidiary, uses
a version of the technology (primarily the Personal Electronic Catalog and
Ordering System, hereinafter referred to as "PECOS"), as well as certain
Web-based technologies to support the sale and marketing of PC products, the
source of substantially all of the Company's net sales since inception. The
Company commenced development operations in September 1992, and began commercial
operations in December 1993, as a remarketer of personal computer products.
(a) Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of the Company and its subsidiaries. The accounting and reporting policies of
the Company conform with generally accepted accounting principles. All material
intercompany transactions and balances have been eliminated in consolidation.
(b) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results may differ from such
estimates.
(c) Cash and Cash Equivalents
Cash and cash equivalents at December 31, 1997 and 1998 consists of
deposits with banks and financial institutions which are unrestricted as to
withdrawal or use, and which have original maturities of three months or less.
Interest earned on all cash equivalents is included in interest income and
other, net in the Consolidated Statements of Operations and Other Comprehensive
Income.
(d) Inventory
Inventory consists of purchased personal computer products, peripherals
and accessories available for resale. Inventories are stated at the lower of
cost (first-in, first-out) or market. The Company periodically reviews its
inventory for potential excess, slow-moving, nonsaleable or obsolete inventory.
(e) Prepaids and Other Current Assets
Consistent with the provisions of the American Institute of Certified
Public Accountants' Statement of Position (SOP) No. 93-7, Reporting on
Advertising Costs, the costs of maintaining, reproducing and mailing the
Company's PECOS front-end software, which constitute direct-response advertising
costs, are deferred and charged to operations over the estimated periods during
which related sales are expected to be realized, which is estimated to be five
months. Such net capitalized costs totaled $114,000 and $55,000 at December 31,
1997 and 1998, respectively. The Company charged approximately $839,000,
$590,000 and $227,000, in 1996, 1997 and 1998, respectively, of these costs to
operations, none of which represented write-downs to net realizable value of the
capitalized costs.
F-9
<PAGE>
(f) Depreciation and Amortization
The Company provides for depreciation and amortization using the
straight-line method by charges to operations in amounts that allocate the cost
of property, equipment and software over their estimated useful lives of three
to five years. Buildings are depreciated over a useful life of 50 years. The
capitalized cost of leased equipment and leasehold improvements are amortized
over the shorter of the estimated life of the related assets or related lease
instrument.
(g) Software, Goodwill and Other Assets
In March 1998 the American Institute of Certified Public Accountants
issued SOP 98-1, Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use which provides guidance on accounting for such costs.
SOP 98-1 requires computer software costs that are incurred in the preliminary
project stage to be expensed as incurred. Once the capitalization criteria of
SOP 98-1 have been met, directly attributable development costs should be
capitalized. It also provides that upgrade and maintenance costs should be
expensed. The Company's treatment of such costs has historically been consistent
with SOP 98-1, with the costs capitalized being amortized over the expected
useful life of the software, ranging from two to five years.
The Company generally expenses research and development costs as
incurred. However, in accordance with SFAS No. 86, Accounting for Costs of
Computer Software to Be Sold, Leased or Otherwise Marketed, the Company
capitalizes certain software development costs, consisting primarily of
personnel costs, subsequent to the establishment of technological feasibility
until the product is available for general product release. Costs incurred prior
to the establishment of technological feasibility are charged to operations.
Development costs associated with product enhancements that extend the original
product's life or significantly improve the original product's marketability are
also capitalized, as incurred, after technological feasibility has been
achieved, as is the cost to acquire complementary technology. Capitalized
software development costs are amortized over an estimated useful life of 24 to
30 months. Net capitalized costs amounted to $1,853,000 (including approximately
$1.2 million related to the purchase of a procurement technology) and $0 as of
December 31, 1997 and 1998, respectively. Amortization expense amounted to
$195,000 in 1996, $325,000 in 1997 and $355,000 in 1998. In addition, in the
third quarter of 1998, the Company determined that certain of its technology
could be substantially enhanced by re-writing it using newly available coding
techniques. Accordingly, the Company determined that approximately $2.3 million
(including 1998 additions to capitalized software development costs) was not
realizable and the write-down of such costs is included in the restructuring,
impairment and other related charges line item in the Consolidated Statements of
Operations and Other Comprehensive Income. This item also is included in the
depreciation, amortization and impairment of intangible assets line item in the
Consolidated Statements of Cash Flows (See Note 7).
The excess of the purchase price over the fair value of net assets
acquired in each acquisition accounted for as a purchase is classified as
goodwill and included in the accompanying Consolidated Balance Sheets. Goodwill
is amortized on a straight-line basis over an estimated useful life of 15 years.
Goodwill (net of accumulated amortization of $5,715,000 and $6,405,000) was
$35,526,000 and $26,529,000 at December 31, 1997 and 1998, respectively. Other
intangible assets (net of accumulated amortization of $1,231,000 and $354,000)
associated with acquisitions amounted to $1,321,000 and $270,000 at December 31,
1997 and 1998, respectively, and have been assigned a five-year life.
Amortization of goodwill and such other intangibles amounted to $2,210,000,
$3,252,000 and $3,178,000 for the years ended December 31, 1996, 1997 and 1998,
respectively.
In accordance with SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, the Company
evaluates the realizability of goodwill based on profitability expectations,
using the undiscounted cash flow method, for each subsidiary having a material
goodwill balance. As a result of such an evaluation in the third quarter of
1998, the Company determined that approximately $7.0 million of goodwill
associated with its acquisition of Computerware, Inc. was not realizable and the
write-down of such goodwill is included in the restructuring, impairment and
other related charges line item in the Consolidated Statements of Operations and
Other Comprehensive Income. This item also is included in the depreciation,
F-10
<PAGE>
amortization and impairment of intangible assets line item in the Consolidated
Statements of Cash Flows (See Note 7). Based on its most recent analysis, the
Company believes that no additional impairment of the remaining goodwill exists
at December 31, 1998.
(h) Revenue Recognition
The Company derives substantially all of its revenue from sales of
personal computer products, peripherals and accessories. The Company provides
for estimated returns at the time of sale. Revenue from product sales is
recognized upon shipment.
The Company recognizes software license revenue in accordance with the
American Institute of Certified Public Accountants' Statement of Position
("SOP") No. 97-2, Software Revenue Recognition. Revenue from the licensing of
software is recognized upon shipment of the software if there are no significant
post-delivery obligations and collectibility of the revenue is assured. If an
acceptance period is required, revenues are recognized upon the earlier of
customer acceptance or the expiration of the acceptance period, unless an
additional performance target is mandated, in which case revenue is recognized
upon satisfaction of that target, in each case, as defined in the applicable
software license agreement.
The Company also offers maintenance contracts and training. Maintenance
and training revenues are recognized ratably over the terms of the related
contracts. Amounts received in advance for maintenance agreements are deferred
and included in accrued expenses and other current liabilities in the
accompanying consolidated balance sheets.
(i) Post Retirement Benefits
The Company has no material obligations for post retirement benefits. The
Company and an indirect U.K. subsidiary each maintain separate defined
contribution benefit plans covering all eligible employees, as defined. The
plans contain provisions allowing for discretionary Company contributions.
Discretionary Company contributions to the U.K. defined contribution plan for
the years ended December 31, 1996, 1997 and 1998 were $266,000, $263,000 and
$300,000, respectively.
(j) Foreign Currency Translation
The accounts of the Company's indirect U.K. subsidiaries are translated in
accordance with SFAS No. 52, Foreign Currency Translation. Accordingly, assets
and liabilities of the Company's indirect foreign subsidiaries are translated
into U.S. dollars using the exchange rate at each balance sheet date.Income and
expense accounts are translated using an average rate of exchange during the
period. Foreign currency translation adjustments are accumulated as a separate
component of stockholders' equity.
(k) Income Taxes
The Company provides for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes. Under the liability method specified by SFAS No.
109, a deferred tax asset or liability is determined based on the difference
between the financial statement and tax bases of assets and liabilities, as
measured by the enacted tax rates in effect when these differences are expected
to reverse. (See Note 9.)
(l) Stock Options
The Company accounts for its stock-based compensation plans under
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees. In October 1995, the Financial Accounting Standards Board issued SFAS
No. 123, Accounting for Stock-Based Compensation, which is currently effective.
SFAS No. 123 establishes a fair value based methodology for accounting for
stock-based compensation plans. The Company has adopted the disclosure-only
alternative under SFAS No. 123, which requires disclosure of the pro forma
effects on earnings and earnings per share as if SFAS No. 123 had been adopted,
as well as certain other information. (See Note 5.)
F-11
<PAGE>
(m) Net Income (Loss) Per Share
Net income (loss) per share is based on the weighted average number of
common and common equivalent shares outstanding during each period presented,
calculated in accordance with 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
for the period. SFAS No. 128 also requires presentation of diluted EPS on the
face of the Consolidated Statements of Operations and Other Comprehensive
Income. Diluted EPS gives effect to all potential common shares outstanding
during the period. In 1998, diluted EPS is the same as basic EPS because the
Company has reported a net loss, in which case dilutive securities are not
included in the determination of per share calculations. (See Note 11.)
(n) Fair Value of Financial Instruments
The Company's financial instruments consist mainly of cash and cash
equivalents, accounts receivable, lines of credit, accounts payable and
long-term debt. The carrying amounts of the Company's cash equivalents, accounts
receivable and accounts payable approximate fair value due to the short-term
nature of these instruments. Lines of credit and long-term debt bear interest at
variable market rates therefore, the carrying amounts approximate fair value.
(o) 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 consists of net income and foreign currency translation adjustments.
(2) ACQUISITIONS
The Company has consummated the following acquisitions:
Method of
Entity Date Consideration Accounting
- -------------------------- ------------ ---------------------- ----------
Computer Specialties, Inc. October 1994 510,345 shares of Pooling of
common stock Interests
Computerware, Inc. February 1995 1,326,417 shares of Purchase
common stock
Lantec June 1995 2,899,820 shares of Purchase
common stock and $6.4
million of cash
AMA (UK) Limited February 1996 3,247,371 shares of Pooling of
common stock Interests
Prophet Group Limited December 1996 $8.9 million of cash Purchase
Data Supplies Limited February 1997 $1.6 million of cash Purchase
and an interest bearing
note of $752,000
F-12
<PAGE>
For the acquisitions accounted for as poolings of interests, previously
issued financial information, including the financial position and results of
the operations of the Company, have been retroactively restated for all prior
periods presented to give effect to those acquisitions. For acquisitions
accounted for as purchases, the purchase prices were allocated based on the fair
value of the tangible and intangible assets acquired and liabilities assumed
(See Note 1(g)). Results of operations of those companies are included from
their respective dates of acquisition.
(3) LINES OF CREDIT
At December 31, 1998, the Company had a $120 million U.S. floor plan
and accounts receivable line of credit available from Deutsche Financial
Services Corporation ("DFSC"). On March 1, 1999, the U.S. DFSC line of credit
was renewed for an additional year and provides for direct payment by the lender
to certain Company vendors. In the case of certain U.S. product purchases, the
borrowings bear interest immediately, and the borrowings related to the
remaining purchases bear interest after the lapse of the applicable
interest-free periods, which vary generally from 30 to 60 days. The U.S. DFSC
line of credit limits the borrowings to defined percentages of eligible
inventories and accounts receivable. The U.S. DFSC line of credit agreement also
contains certain covenants relating to net income and debt-to-equity ratios. The
U.S. DFSC line of credit is secured primarily by the Company's U.S. inventory
and accounts receivable, although substantially all of the Company's other U.S.
assets also are pledged as collateral on the facility. After receiving a waiver
from DFSC concerning the net income covenant for 1998, the Company was in
compliance with all other covenants of the facility as of December 31, 1998.
Interest is payable monthly at the prime rate (7.75% at December 31, 1998) less
1%. As of December 31, 1998, the Company had $66.7 million outstanding under
this line of credit, which approximated the Company's availability as of that
date. As of December 31, 1998, the Company also had a $3,000,000 unsecured
demand note outstanding under its facility with DFSC on which interest is
payable monthly, at a rate of prime plus 1%. In January 1999, the unsecured
demand note was repaid.
In conjunction with the one-year renewal of the U.S. DFSC facility, the
Company has agreed to an $80 million facility with interest payable monthly at a
rate of prime minus .5%. In addition, the Company has agreed that its interest
rate will increase .25% for each quarter that it reports a loss, as defined in
the DFSC agreements. All other terms of the facility have remained substantially
the same.
The Company also has a $9.5 million floor plan financing agreement with
IBM Credit Corporation to support purchases of IBM products. The Company's
purchases under this arrangement bear interest at the prime rate (7.75% at
December 31, 1998) plus 6.25% after the lapse of interest-free periods, which
vary generally from 30 to 90 days. The Company typically repays this facility
upon the lapse of the interest-free periods. As of December 31, 1998, there were
no borrowings outstanding under this line of credit.
At December 31, 1998, Elcom Group Ltd. had a financing arrangement with
Deutsche Financial Services (U.K.) Ltd. which provides for borrowings of up to
(pound)30 million (approximately $49.8 million based on December 31, 1998
exchange rates) based upon DFSC U.K.'s determination of eligible accounts
receivable. The financing arrangement expires in December 1999. Borrowings bear
interest at a rate of 1.25% above the National Westminster Bank base rate (7.5%
at December 31, 1998), and are limited to defined percentages of and are secured
primarily by the Company's U.K. accounts receivable. The DFSC U.K. facility
incorporates the reporting and compliance covenants of the U.S. DFSC facility.
As of December 31, 1998, there was approximately $38.1 million ((pound)23
million) outstanding under this financing arrangement, which approximated the
Company's availability as of that date.
F-13
<PAGE>
(4) LONG-TERM DEBT
Long-term debt consists of the following:
December 31,
1997 1998
------------ -----------
Mortgage payable to a bank, interest at the
greater of the bank's base rate (7.50% at
December 31, 1998) plus 3% or 10.25%,
due in monthly installments of principal plus
interest through June 2005,
secured by certain land and buildings $410,000 $374,000
Less current portion 78,000 78,000
------------ -----------
$332,000 $296,000
============ ===========
(5) STOCKHOLDERS' EQUITY
(a) Common Stock
The Company has authorized 50,000,000 shares of $.01 par value common
stock.
(b) Preferred Stock
The Company has authorized 10,000,000 shares of $.01 par value
preferred stock, with the Board of Directors authorized to fix the rights,
privileges, preferences and restrictions of any series thereof as it may
designate.
(c) Stock Options
The Company's Board of Directors has adopted five stock option plans
and stockholders have approved the adoption of all five such stock option plans
(the "Option Plans"). As of December 31, 1998, the Option Plans provided that up
to an aggregate of 10,650,000 incentive stock options (ISOs) and nonqualified
options may be granted to key personnel, directors and consultants of the
Company, as determined by the Compensation Committee of the Board of Directors
(the "Compensation Committee"). Under the terms of the Option Plans, ISOs are
granted at not less than the estimated fair market value of the Company's common
stock on the date of grant. The Option Plans also provide that the options are
exercisable at varying dates, as determined by the Compensation Committee, and
have terms not to exceed 10 years.
One of the Option Plans, the 1995 Nonemployee Director Stock Option
Plan (the "1995 Nonemployee Director Plan") provides that an aggregate of up to
250,000 nonqualified stock options to acquire the Company's common stock are
reserved for grant to outside directors of the Company. Upon joining the Board
of Directors, any new nonemployee director is automatically granted 5,000
nonqualified stock options. All nonemployee directors are granted an additional
5,000 nonqualified stock options annually on each June 1 thereafter, while
remaining on the Board of Directors. The 1995 Nonemployee Director Plan provides
that options are granted at fair market value on date of grant, vest ratably
over three years, and have terms not to exceed 10 years.
F-14
<PAGE>
On April 29, 1997, the Board of Directors adopted and on February 17,
1998 and March 11, 1999 it amended, The 1997 Stock Option Plan of Elcom
International, Inc. (the "1997 Plan"). As of December 31, 1998, the 1997 Plan
provided that an aggregate of up to 2,000,000, and as amended on March 11, 1999,
up to 3,000,000 ISO's and nonqualified options to acquire the Company's common
stock may be granted to key personnel, directors and consultants of the Company
as determined by the Compensation Committee. Under the terms of the 1997 Plan,
ISO's are granted at not less than the fair market value of the Company's common
stock on the date of grant. The 1997 Plan also provides that the options are
exercisable at varying dates, as determined by the Compensation Committee, and
have terms not to exceed ten years. The March 11, 1999 amendment to the 1997
Plan will be submitted to a vote of stockholders at the Company's 1999 Annual
Meeting.
On April 3, 1997, the Board of Directors voted to reprice all
outstanding options (excluding those issued to executive officers of the
Company) with an exercise price in excess of $6.57 per share to an exercise
price of $6.57 per share. The repricing covered a total of 1,292,000 shares with
a weighted average exercise price of $7.95 per share. Such repricing is
reflected in the December 31, 1997 options outstanding in the table below.
Information relating to the Company's stock option plans during each of
the three years in the period ended December 31, 1998 is as follows:
Weighted
Average
Number Option Price Exercise
of Shares Per Share Price
------------ ------------- -----------
Outstanding, December 31, 1995.......... 4,174,326 $.11 - 10.28 $3.17
Granted............................... 3,101,975 5.31 - 14.25 6.63
Terminated............................ (323,461) .11 - 10.28 5.90
Exercised............................. (523,726) .11 - 5.99 1.77
------------ ------------- -----------
Outstanding, December 31, 1996.......... 6,429,114 $.11 - 14.25 $4.64
Granted................................ 2,073,275 5.03 - 8.80 5.84
Terminated............................. (266,517) 4.00 - 14.25 7.19
Exercised.............................. (505,447) .11 - 6.57 2.98
------------ ------------- -----------
Outstanding, December 31, 1997.......... 7,730,425 $.11 - 8.80 $4.73
Granted................................ 1,691,000 1.28 - 6.22 3.14
Terminated............................. (1,793,489) 1.44 - 7.69 5.30
Exercised.............................. (328,822) 0.11 - 5.99 1.67
=========== ============= ===========
Outstanding, December 31, 1998........ 7,299,114 $.11 - 8.80 $4.40
=========== ============= ===========
Exercisable, December 31, 1996........ 2,032,325 $.11 - 10.28 $2.72
=========== ============= ===========
Exercisable, December 31, 1997........ 3,665,547 $ 11 - 8.80 $3.86
=========== ============= ===========
Exercisable, December 31, 1998........ 4,538,781 $.11 - 8.80 $4.43
=========== ============= ===========
F-15
<PAGE>
The following table summarizes information about stock options
outstanding as of December 31, 1998:
Options Outstanding Options Exercisable
------------------------------------ ---------------------------
Weighted Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- ------------- ------------ ------------ -------- ------------- ----------
$0.11 - 1.31 850,591 4.31 years $ 0.26 825,591 $ 0.23
1.34 - 3.47 811,666 8.72 years 2.09 181,666 3.00
3.63 - 3.86 178,400 8.16 years 3.74 63,950 3.63
4.00 1,020,139 6.12 years 4.00 988,910 4.00
4.09 - 4.50 475,000 9.16 years 4.12 2,000 4.09
4.75 172,050 6.47 years 4.75 130,050 4.75
4.81 29,000 9.37 years 4.81 - -
5.03 1,198,375 8.33 years 5.03 525,179 5.03
5.06 - 5.81 1,237,105 7.61 years 5.61 849,127 5.57
5.88 - 8.80 1,326,788 7.45 years 6.99 972,308 7.16
============ ============= ==========
7,299,114 4,538,781 $ 4.43
============ ============= ==========
As of December 31, 1998, 9,282,042 shares of common stock have been
reserved for issuance under the Company's stock option plans and 750,000 shares
have been reserved for issuance pursuant to warrants issued in connection with
the Lantec purchase as described below.
As described in Note 1(l), the Company adopted the disclosure only
alternative under SFAS No. 123. Had compensation costs for awards in 1996, 1997
and 1998 under the Company's stock-based compensation plans been determined
based on the fair value at the grant dates consistent with the method set forth
in SFAS No. 123, the effect on the Company's net income and earnings per share
would have been as follows:
1996 1997 1998
------------ ----------- ------------
(in thousands, except per share data)
Net income (loss):...........
As reported.............. $5,575 $10,288 $(25,561)
Pro forma................ $3,330 $5,981 $(29,762)
Net income (loss) per share:
As reported - basic...... $0.21 $0.38 $(0.94)
Pro forma - basic........ $0.13 $0.22 $(1.09)
As reported - diluted.... $0.19 $0.35 $(0.94)
Pro forma - diluted....... $0.11 $0.20 $(1.09)
Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
expense may be greater as additional options are granted.
The fair value of each option grant is estimated on the grant date
using the Black-Scholes option pricing model with the following weighted average
assumptions:
1996 1997 1998
---------- ---------- -----------
Volatility..................... 53.52% 60.25% 60.25%
Risk-free interest rate........ 6.2% 5.94% 5.41%
Expected life of options ...... 5 years 5 years 5 years
Expected dividend yield........ 0% 0% 0%
F-16
<PAGE>
The weighted average fair value per share of options granted during 1996,
1997 and 1998 were $3.48, $3.28, and $1.76, respectively.
The Black-Scholes option pricing model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option pricing models require the input
of highly subjective assumptions. Because the Company's employee stock options
have characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
(d) Warrants
In June 1995, the Company issued warrants to purchase 750,000 shares of
the Company's common stock at $4.75 per share in connection with the purchase of
Lantec (see Note 2). As of December 31, 1998, all of these warrants are
outstanding and exercisable. The warrants expire in June 2005.
(e) Initial Public Offering and Underwriter Over-allotment Option
On December 19, 1995, the Company's S-1 registration statement was
declared effective and on December 26, 1995, the underwriters closed on the
purchase of 5,500,000 shares of the Company's common stock at $11 per share. Of
the shares sold, 4,000,000 were sold by the Company and 1,500,000 were sold by
certain stockholders of the Company. Net proceeds to the Company upon closing
were approximately $39.4 million.
On January 19, 1996, the underwriters of the Company's initial public
offering exercised their over-allotment option and purchased 800,000 shares of
common stock at $11 per share. Of the 800,000 shares sold, 629,489 were sold by
the Company and 170,511 were sold by certain stockholders of the Company. Net
proceeds to the Company as a result of this transaction amounted to
approximately $6.2 million.
(f) Open Market Stock Purchase Plan
On May 28, 1998, the Board of Directors of the Company authorized the
purchase of up to an aggregate of 800,000 shares of common stock to be held as
treasury stock targeted specifically for reissuance in connection with
acquisitions. Subject to legal requirements, the purchases may be made from time
to time in the open market based upon then-existing market conditions. During
1998, the Company purchased 180,019 shares of the Company's common stock at an
aggregate cost of $633,000 pursuant to this authorization.
(6) LEASES AND OTHER COMMITMENTS AND CONTINGENCIES
(a) Leases
The Company has entered into capital leases for various software,
furniture, computer, telephone and other equipment. The lease terms range from
three to four years and, upon expiration, all leases provide purchase options at
a nominal price. Property, equipment and software includes assets under capital
leases of $2,200,000 and $2,710,000 and related accumulated amortization of
$881,885 and $1,262,000 as of December 31, 1997 and 1998, respectively.
Amortization of leased assets is included in depreciation expense.
The Company has entered into operating leases for office and warehouse
space, software, computers, autos and other equipment. The period covered by the
leases ranges from one to 25 years. Certain leases for office and warehouse
space require payment by the Company of all related operating expenses of the
building, including real estate taxes and utilities.
F-17
<PAGE>
Future minimum rental payments as of December 31, 1998, are as follows:
Capital Operating
Year Ending December 31, Leases Leases
------------------------ -------------- -------------
1999.............................. $1,048,000 $4,408,000
2000.............................. 198,000 4,082,000
2001.............................. -- 2,675,000
2002.............................. -- 1,190,000
2003.............................. -- 867,000
Thereafter........................ -- 6,798,000
------------- --------------
Total minimum lease payments... $1,246,000 $20,020,000
==============
Less - Amounts representing interest 64,000
-------------
Present value of net minimum lease payments $1,182,000
Current portion.................. 991,000
=============
Long term portion................ $ 191,000
=============
Rent expense for operating leases for each of the three years ended
December 31, 1996, 1997 and 1998 amounted to approximately $2,808,000,
$4,042,000 and $4,312,000, respectively.
(b) Employment Contracts
The Company has employment contracts with certain key executives which
provide for annual salary and incentive payments as well as severance
arrangements.
(c) Contingencies
The Company is party to various litigation as both plaintiff and defendant
in cases related to contractual issues, employment matters and issues arising
out of the conduct of its business. The Company believes that, based on
discussions with its counsel, the estimable range of loss, if any, is not
material in relation to the financial statements.
(7) RESTRUCTURING, IMPAIRMENT 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 entailed a workforce reduction of approximately 35 of the
Company's U.S. employees.
As a result of this restructuring, ESI discontinued general maintenance
of its Commerce Manager technology and will focus the efforts of its software
division 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 is
concentrating instead on providing Windows and Intel-based ("Wintel") solutions
to the education market in the U.S.
In December 1998, the Company undertook a rightsizing of its
organization in both the U.S. and U.K, primarily focused on streamlining the
Company's sales organization. The Company deems these steps as necessary to
better align the Company's cost infrastructure and expense levels with its
revenue and gross profit margin generation. As a result, approximately 133
positions were affected, and the Company closed six sales offices in the U.S.
F-18
<PAGE>
The 1998 pre-tax charge of $12.9 million is comprised of $1.8 million
in severance costs, $.6 million of estimated liabilities related to 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 (see note 1(g)), and $.5
million of other charges, including costs related to lease terminations. The
Company estimates that the restructuring will entail cash expenditures of
approximately $2.3 million to be incurred on a declining basis from the fourth
quarter of 1998 through the end of 1999.
(8) INDUSTRY SEGMENT AND GEOGRAPHIC DATA
In 1998, the Company adopted the provisions of SFAS No. 131 Disclosures
About Segments of an Enterprise and Related Information. This statement
establishes the standards for reporting information about segments in annual and
interim financial statements. The statement introduces a new model for segment
reporting, the "management approach". The management approach is based on the
way the chief operating decision-maker organizes segments within a company for
making operating decisions and assessing performance. Reportable segments are
based on products and services, geography, legal structure, management structure
- - any manner in which management desegregates a company. The Company has
included the required disclosure under this standard. The Company believes that
substantially all of its material operations are part of the computer and
peripherals industry, and it currently reports as a single industry segment. The
Company's professional services and software licensing activities are deemed
immaterial in respect of segment reporting. Foreign operations are conducted in
the United Kingdom through the Company's wholly-owned subsidiaries. Geographic
segments are identified based upon the origin of shipment. Information relating
to the Company's geographic segment operations is set forth in the following
table.
Prior to the Company's acquisition of Lantec in June 1995 and AMA (UK)
Limited in February 1996, substantially all of the net sales, net income (loss)
and identifiable assets of the Company related to operations in the U.S. Net
sales, net income (loss) and identifiable assets (adjusted for allocation of
goodwill and related amortization for the Lantec acquisition) for the Company's
U.S. and U.K. operations for the years ended December 31, 1996, 1997 and 1998
are as follows (in thousands):
Year Ended United United
December 31, 1996 States Kingdom Consolidated
------------------------- ----------- ----------- ------------
Net sales............... $ 435,133 $ 184,982 $ 620,115
=========== =========== ============
Net income.............. $ 1,274 $ 4,301 $ 5,575
=========== =========== ============
Identifiable assets..... $ 161,890 $ 98,879 $ 260,769
=========== =========== ============
Year Ended
December 31, 1997
-------------------------
Net sales................ $ 473,806 $ 286,330 $ 760,136
============ ============ ============
Net income............... $ 5,627 $ 4,661 $ 10,288
============ ============ ============
Identifiable assets...... $ 224,718 $ 107,350 $ 332,068
============ ============ ============
F-19
<PAGE>
Year Ended United United
December 31, 1998 States Kingdom Consolidated
------------------------- ----------- ------------ ------------
Net sales................ $ 449,844 $ 313,756 $ 763,600
============ ============ ============
Net loss................. $ (25,528) $ (33) $ (25,561)
============ ============ ============
Identifiable assets...... $ 151,648 $ 110,203 $ 261,851
============ ============ ============
Substantially all revenues, net income and identifiable assets relate
to the remarketing of personal computer products and related services.
(9) INCOME TAXES
Income (loss) before provision for income taxes consisted of:
1996 1997 1998
----------- ----------- -----------
U.S. $1,992 $ 6,977 $(25,780)
Foreign 6,993 7,800 703
=========== =========== ===========
$8,985 $14,777 $(25,077)
=========== =========== ===========
The provision (benefit) for income taxes consisted of:
1996 1997 1998
---------- ---------- ----------
Current tax provision
U.S. federal.................. $ -- $ 250 $ 190
State......................... 718 375 701
Foreign....................... 2,692 2,400 276
---------- ---------- ----------
Total current tax provision (benefit).. $ 3,410 $ 3,025 $ 1,167
---------- ---------- ----------
Deferred tax provision (benefit)
U.S. federal.................. -- 468 (743)
State......................... -- 257 (400)
Foreign....................... -- 739 460
---------- ---------- ----------
Total deferred tax provision (benefit).. $ -- $ 1,464 $ (683)
---------- ---------- ----------
Provision for income taxes..... $ 3,410 $ 4,489 $ 484
========== ========== ==========
The following table summarizes the significant differences between the U.S.
federal statutory tax rate and the Company's effective tax rate for financial
statement purposes:
1996 1997 1998
-------- -------- -------
Statutory tax rate................................. 34.0% 34.0% (34.0%)
State taxes, net of U.S. federal tax benefit....... 5.3 2.8 (0.8)
Foreign taxes...................................... (0.8) (1.6) 0.1
Valuation reserve provided against (utilization of)
net operating loss carryforwards................. (29.5) (21.0) 24.3
Non deductible goodwill and other.................. 29.0 16.2 8.5
-------- -------- --------
38.0% 30.4% (1.9%)
-------- -------- --------
F-20
<PAGE>
Deferred tax assets (liabilities) consisted of the following as of December 31,
1996 1997 1998
----------- ------------- ------------
Deferred tax assets:
Depreciation.............................$ 228,000 $ - $ -
Nondeductible reserves................... 358,000 - 1,776,000
Capitalized inventory costs.............. - 497,000 178,000
State income taxes....................... - 101,000 578,000
Accrued expenses......................... - 632,000 801,000
Other temporary differences.............. 1,121,000 522,000 667,000
Foreign net operating loss carryforwards. - - -
Net federal and state operating loss
carryforwards.......................... 1,619,000 - 6,095,000
=========== ============= ============
3,326,000 1,752,000 10,095,000
=========== ============= ============
Deferred tax liabilities:
Depreciation.......................... - (374,000) (372,000)
Other intangible assets............... - (620,000) -
Catalog costs......................... - (1,067,000) (1,065,000)
Other temporary differences........... (671,000) (834,000) (556,000)
----------- ----------- ------------
(671,000) (2,895,000) (1,993,000)
----------- ----------- ------------
Valuation allowance...................... (2,655,000) - (8,102,000)
----------- ----------- ------------
Net deferred tax liabilities............. $ - $(1,143,000) $ -
============ ============ ============
Prior to 1997 and in 1998, due to the uncertainty surrounding the
realization of the benefit of its favorable tax attributes in future tax
returns, the Company placed a full valuation allowance against its net deferred
tax asset.
The federal and state net operating loss carryforwards relative to the
Company's U.S. operations cumulatively amount to approximately $15,200,000 at
December 31, 1998. Such net operating loss carryforwards are primarily
attributable to the Company's U.S. operating losses, as well as deductions for
nonqualifying stock option exercises and disqualifying dispositions of common
stock acquired upon the exercise of incentive stock options. The federal and
state net operating loss carryforwards will begin to expire in 2010.
U.S. income taxes have not been provided on the undistributed net
earnings of the foreign subsidiaries. The Company plans to reinvest
substantially all such earnings outside of the U.S., thus indefinitely
postponing the remittance of taxes, which would be reduced by available foreign
tax credits, on such earnings.
(10) RELATED PARTY TRANSACTIONS
(a) Transactions with Affiliated Company
As of December 31, 1998, the Company owns approximately 5% of ShopLink
Incorporated ("ShopLink"), a development stage company that licensed the PECOS
electronic commerce system to service the home grocery and consumables market.
The Company's financial statements do not reflect any investment in ShopLink, as
its $4,000 initial investment was expensed in a prior year. Accounts receivable
from ShopLink at December 31, 1997 and 1998 were $185,000 and $336,000,
respectively.
As of September 30, 1997, the Company sold options to acquire its
equity ownership interest in ShopLink. The Company received $418,000 in payment
for the options, which may be exercised through March 31, 1999. The Company has
included the $418,000 received in payment for the options in other deferred
liabilities, in the accompanying consolidated balance sheets. The Company does
not anticipate that these options will be exercised.
F-21
<PAGE>
(b) Employee Loans
In certain instances, the Company periodically makes loans to certain
of its officers and employees. These loans are included in accounts receivable
in the accompanying consolidated balance sheets and amounted to $1,082,000 and
$699,000 at December 31, 1997 and 1998, respectively. As of December 31, 1998,
these loans are collateralized by the employees' options to acquire common
stock, and accrue interest at a rate of prime plus 1%.
(11) EARNINGS PER SHARE (in thousands, except per share data)
Basic and diluted earnings per share were calculated as follows:
Basic 1996 1997 1998
- -------------------------------------- --------- --------- ---------
Net income (loss)..................... $5,575 $ 10,288 $(25,561)
========= ========= =========
Weighted average shares outstanding... 26,363 26,937 27,322
========= ========= =========
Basic net income (loss) per share..... $0.21 $0.38 $(0.94)
========= ========= =========
Diluted
- --------------------------------------
Net income (loss)..................... $5,575 $ 10,288 $(25,561)
========= ========= =========
Weighted average shares outstanding... 26,363 26,937 27,322
Dilutive effect of stock options...... 3,376 2,524 -
--------- --------- ---------
Weighted average shares as adjusted... 29,739 29,461 27,322
========= ========= =========
Diluted net income (loss) per share... $0.19 $0.35 $(0.94)
========= ========= =========
Options to purchase 536,000 shares of common stock at prices ranging
from $6.75 to $8.80 were outstanding at December 31, 1997 but were not included
in the computation of diluted earnings per share because the options' exercise
prices were greater than the average market price of the common shares in 1997.
Dilutive net loss per share in 1998 does not reflect the dilutive
effect of stock options and warrants, as the impact of including them is
antidilutive. Based on the average market price of the Company's common shares
in 1998, a net total of 917,000 shares covered by options would have been
dilutive, and 6,963,000 shares covered by options and warrants with per share
exercise prices ranging from $3.72 to $8.80, would not have been dilutive.
(12) QUARTERLY FINANCIAL DATA (UNAUDITED)
(in thousands, except per share data)
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1997
Net sales................................... $176,279 $198,157 $198,373 $187,327 $760,136
Gross profit................................ 20,202 22,692 24,036 23,464 90,394
Operating profit............................ 3,559 4,095 5,764 5,501 18,919
Net income.................................. 1,962 2,061 3,412 2,853 10,288
Basic net income per share.................. $.07 $.08 $.13 $.11 $.38
Basic weighted average shares outstanding... 26,739 26,869 27,017 27,117 26,937
Diluted net income per share................ $.07 $.07 $.11 $.10 $.35
Diluted weighted average shares outstanding. 29,519 28,847 29,481 29,907 29,461
</TABLE>
F-22
<PAGE>
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1998
Net sales................................... $190,048 $191,778 $194,993 $186,781 $763,600
Gross profit................................ 22,154 22,586 19,463 12,739 76,942
Operating profit (loss)..................... 4,021 3,234 (15,186) (9,482) (17,413)
Net income (loss)........................... 1,372 515 (15,036) (12,412) (25,561)
Basic net income (loss) per share........... $ .05 $ .02 $(.55) $(.46) $(.94)
Basic weighted average shares outstanding... 27,230 27,379 27,356 27,321 27,322
Diluted net income (loss) per share......... $ .05 $ .02 $(.55) $(.46) $(.94)
Diluted weighted average shares outstanding. 28,802 28,254 27,356 27,321 27,322
</TABLE>
F-23
<PAGE>
ELCOM INTERNATIONAL, INC. AND SUBSIDIARIES
1998 ANNUAL REPORT ON FORM 10-K
INDEX TO SCHEDULE
Page
Reference
-----------
Report of Independent Public Accounts S-2
Schedule II - Valuation and Qualifying Accounts for the Years Ended
December 31, 1996, 1997 and 1998 S-3
S-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Elcom International, Inc.:
We have audited, in accordance with generally accepted auditing
standards, the consolidated financial statements of Elcom International, Inc.
and subsidiaries included in this Form 10-K, and have issued our report thereon
dated March 23, 1999. Our audits were made for the purpose of forming an opinion
on the basic consolidated financial statements taken as a whole. The schedule
listed in the index of this Form 10-K is the responsibility of the Company's
management and is presented for purposes of complying with the Securities
and Exchange Commission's rules and is not part of the basic consolidated
financial statements. This schedule has been subjected to the auditing
procedures applied in our audits of the basic consolidated financial statements
and, in our opinion, fairly states, in all material respects, the financial data
required to be set forth therein in relation to the basic consolidated financial
statements taken as a whole.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Boston, Massachusetts
March 23, 1999
S-2
<PAGE>
SCHEDULE II
ELCOM INTERNATIONAL, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
For the years ended December 31, 1996, 1997 and 1998
(in thousands)
Balance, Balance,
Beginning Utilization/ End
Allowance for Doubtful Accounts of Period Additions Other (1) Of Period
- ------------------------------- --------- --------- ----------- ----------
Year ended December 31, 1996 $ 1,709 $ 2,586 $ 17 $ 4,312
========== ========== ============ ===========
Year ended December 31, 1997 $ 4,312 $ 3,058 $ (1,896) $ 5,474
========== ========== ============ ===========
Year ended December 31, 1998 $ 5,474 $ 4,975 $ (3,653) $ 6,796
========== ========== ============ ===========
(1) Includes allowances for doubtful accounts acquired through acquisition, net
of write-offs.
Balance, Balance,
Beginning End
Inventory Valuation Accounts of Period Additions Utilization of Period
- ------------------------------- ---------- --------- ----------- ----------
Year ended December 31, 1996 $ 1,340 $ 564 $ (546) $ 1,358
=========== =========== =========== ===========
Year ended December 31, 1997 $ 1,358 $ 1,796 $ (1,791) $ 1,363
=========== =========== =========== ===========
Year ended December 31, 1998 $ 1,363 $ 1,651 $ (1,022) $ 1,922
=========== =========== =========== ===========
Balance, Balance,
Beginning End
Deferred Tax Valuation Accounts of Period Additions Utilization of Period
- ------------------------------- ---------- --------- ----------- ---------
Year ended December 31, 1996 $ 4,359 $ - $ (1,704) $ 2,655
=========== =========== =========== ===========
Year ended December 31, 1997 $ 2,655 $ - $ (2,655) $ -
=========== =========== =========== ===========
Year ended December 31, 1998 $ - $ 8,102 $ - $ 8,102
=========== =========== =========== ===========
Balance, Balance,
Reserve for Restructuring and Beginning End
Other Related Charges of Period Additions Utilization of Period
- ------------------------------- ---------- --------- ----------- ----------
Year ended December 31, 1996 $ - $ - $ - $ -
=========== ========== =========== ===========
Year ended December 31, 1997 $ - $ - $ - $ -
=========== ========== =========== ===========
Year ended December 31, 1998 $ - $ 2,239 $ (321) $ 1,918
=========== ========== =========== ===========
S-3
Exhibit 10.38
AMENDMENT TWO
TO
THE 1997 STOCK OPTION PLAN
OF ELCOM INTERNATIONAL, INC.
WHEREAS, subject to stockholder approval, the Board of
Directors of Elcom International, Inc. (the "Company") approved the following
Amendment Two to The 1997 Stock Option Plan of Elcom International, Inc.,
effective March 11, 1999; and
WHEREAS, the undersigned officer is authorized, subject to
stockholder approval, to integrate this amendment into the Company's 1997 Stock
Option Plan and any officer is thereafter entitled to certify the same as the
true and complete copy of the amended Plan;
NOW, THEREFORE, The 1997 Stock Option Plan of Elcom
International, Inc. is hereby amended as follows:
A. The first sentence of Section 6, entitled "Shares Subject to the
Plan" is hereby deleted in its entirety, and replaced with the following:
"6. Shares Subject to the Plan. Subject to the provisions of the
next succeeding provisions of this Section 6, the aggregate number of shares of
Common Stock for which options may be granted under the Plan shall be 3,000,000
shares of Common Stock."
IN WITNESS WHEREOF, Elcom International, Inc., by the undersigned
officer duly authorized, has executed this document as of the 11th day of March,
1999.
THE COMPANY
ELCOM INTERNATIONAL, INC.
By: /s/ Laurence F. Mulhern
Laurence F. Mulhern
Its: Corporate Executive Vice President,
Chief Financial Officer, Treasurer and Secretary
Exhibit 21.1
ELCOM INTERNATIONAL, INC., AND SUBSIDIARIES
SUBSIDIARIES OF THE REGISTRANT AND STATE OF INCORPORATION
AS OF MARCH 23, 1999
Place of
Name Incorporation
- ---------------------------- --------------------
Elcom International, Inc. Delaware
Elcom Services Group, Inc. Delaware
elcom.com, inc. Delaware
Elcom International Limited United Kingdom
Elcom Systems Limited United Kingdom
Elcom Group Limited United Kingdom
AMA (UK) Limited United Kingdom
Elcom Holdings Limited United Kingdom
Rapid Recall Limited United Kingdom
Elcom Information Services Limited United Kingdom
Elite Computer Distribution Limited United Kingdom
Prophet Group Limited United Kingdom
Portable Computers Limited United Kingdom
Elcom Services Group Limited United Kingdom
Data Supplies Limited United Kingdom
Elcom .Com Limited United Kingdom
Lantec Information Services Limited United Kingdom
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
reports included in this Form 10-K, into the Company's previously filed
Registration Statement File Nos. 333-34193, 333-24809 and 333-00362.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Boston, Massachusetts
March 29, 1999
Exhibit 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
333-00362, 333-24809 and 333-34193 of Elcom International, Inc. on Forms S-8 of
our reports each dated 21 March, 1997 (relating to the 1996 and 1995 financial
statements of Elcom International Limited and AMA (UK) Limited), appearing in
this Annual Report on Form 10-K of Elcom International, Inc. for the year ended
December 31, 1998.
/s/ Deloitte & Touche
Deloitte & Touche
Chartered Accountants
London, England
29 March 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
Exhibit 27
This Schedule contains summary financial information extracted from the
consolidated financial statements of Elcom International, Inc.'s 10-k and is
qualified in its entirety by reference to such financial statements as set forth
on Pages F-1 through F-23
</LEGEND>
<CIK> 0000900096
<NAME> Elcom International, Inc.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 14,315
<SECURITIES> 0
<RECEIVABLES> 170,821
<ALLOWANCES> 6,796
<INVENTORY> 39,617
<CURRENT-ASSETS> 220,415
<PP&E> 39,291
<DEPRECIATION> 25,034
<TOTAL-ASSETS> 261,851
<CURRENT-LIABILITIES> 175,929
<BONDS> 0
0
0
<COMMON> 275
<OTHER-SE> 84,742
<TOTAL-LIABILITY-AND-EQUITY> 261,851
<SALES> 763,600
<TOTAL-REVENUES> 763,600
<CGS> 686,658
<TOTAL-COSTS> 94,355
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,355
<INCOME-PRETAX> (25,077)
<INCOME-TAX> 484
<INCOME-CONTINUING> (25,261)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (25,561)
<EPS-PRIMARY> (.94)
<EPS-DILUTED> (.94)
</TABLE>
