<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A3
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the year ended December 31, 1997
Commission File Number: 1-13424
DATA SYSTEMS NETWORK CORPORATION
(Exact name of Registrant as specified in its charter)
Michigan 38-2649874
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
34705 West Twelve Mile Road, Suite 300
Farmington Hills, Michigan 48331
(Address of principal executive offices) (Zip Code)
Registrant's telephone no. including area code: (248) 489-8700
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
Common Stock, $.01 par value Pacific Stock Exchange and
Nasdaq Stock Market's
SmallCap Market
Securities registered pursuant to Section 12(g) of the Act: None
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 NO X
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 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. [ ]
The aggregate market value of the voting stock of the registrant held by
non-affiliates(3,196,221 shares) on March 31, 1998 was $20,176,145. For purposes
of this computation only, all executive officers, directors and beneficial
owners of more than 5% of the outstanding shares of common stock are assumed to
be affiliates.
Indicate the number of shares outstanding of each of the Registrant's classes of
Common Stock as of the latest practicable date: 4,859,224 shares of Common Stock
outstanding as of March 31, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
None.
<PAGE> 2
PART I
ITEM 1. BUSINESS.
Recent Developments
On February 24, 1998, Data Systems Network Corporation (the "Company")
announced that it had discovered accounting irregularities which it believed
resulted in an overstatement of certain previously released earnings. Its
independent auditors issued a letter withdrawing their report on the audited
financial statements for the years ended December 31, 1995 and 1996, and the
Company's treasurer and chief financial officer resigned. A special committee of
the outside members of the Company's Board of Directors was established to
investigate the matter.
This Amendment No. 3 to the Company's Form 10-K for the year ended
December 31, 1997 includes audited consolidated balance sheets as of December
31, 1997 and 1996, and consolidated statements of operations, stockholders'
equity and cash flows for the years ending December 31, 1997 and 1996. In
addition this Amendment includes unaudited 1995 consolidated financial
statements. The Company is currently planning to complete an audit for the year
ended December 31, 1995, and will promptly file an amendment to this report
upon completion of such audit and receipt of the requisite reports thereon. See
Independent Auditors Report and "Note 15 of Notes to Consolidated Financial
Statements."
General
The Company, incorporated in Michigan in 1986, provides computer
network integration and data management services in the distributed computing
marketplace. The Company's broad array of services includes designing,
installing, and managing networks of personal computers, workstations and
mainframes linked with communications hardware and software and peripheral
equipment, selling network components, training users and administrators of
networks and providing technical, expansion and maintenance services. Marketing
efforts are directed at Fortune 1000 and middle market corporations, state and
local governments, and institutional users such as hospitals and universities.
In November 1994, the Company completed its initial offering of
1,270,000 shares of Common Stock and 1,270,000 Redeemable Common Stock Purchase
Warrants (the "Warrants") to the public. Upon completion of the offering, the
Common Stock and the Warrants became qualified for trading on the Nasdaq Stock
Market's SmallCap Market and the Pacific Stock Exchange. In February 1997, the
Company called all of its then outstanding Warrants for redemption as of March
10, 1997 pursuant to the Warrant Agreement, dated October 28, 1994, setting
forth the terms of the Warrants. Approximately 99% of the Warrants were
exercised on or prior to the date of redemption at a price of $6.25 per Warrant,
resulting in net proceeds of approximately $7,300,000.
In February 1996, the Company acquired 70% of the common stock of
Unified Network Services, Inc. ("UNS"), a start-up network management operation
based in Raleigh, North Carolina for $7,000 in cash. The Company also acquired
the Network Systems Group ("NSG") of SofTech, Inc. in September 1996 for 540,000
shares of the Company's Common Stock and $890,000 in cash. From September 1996
through December 1997, the Company has opened in excess of 10 new locations in
the eastern, mid-Atlantic, and southern areas of the United States. On June 17,
1998 the Company executed an agreement to sell its interest in UNS, effective
June 1, 1998.
Business Strategy
The Company's primary objective is to be the principal "network
integration and management company" for business, governmental, and
institutional customers throughout the United States. To achieve its objective,
the Company intends to expand through internal growth and to explore
opportunities to acquire other businesses serving its target markets.
During 1997, the Company has continued to make major changes to its
operations in order to reposition the Company in terms of mix of business, type
of customer, and geographical area served. In terms of mix of business,
<PAGE> 3
the Company is focusing on a higher level of service-to-product revenue mix,
emphasizing those high end services, such as network management services and
products that enable the control of complex distributed computing environments,
where the Company believes it has a competitive advantage. The Company's
marketing focus has changed to include not only commercial accounts, but also
governmental accounts and the Company has expanded its geographical coverage to
include significant sales and service coverage of the eastern United States.
In addition, the Company continues to make a substantial investment in
a remote network management facility in Raleigh, North Carolina. The Network
Center has been completed and has been operational since the first quarter 1997.
In connection with the Network Center, the Company has developed a
multi-functional software product which has been trademarked "ENCOR" that
performs remote management at a client location. The Company also has a
telephone support center located near its headquarters in Michigan, which it
intends to integrate into its remote network management offering during 1998.
Products and Services
The Company's principal business is to provide computer network
services and products that allow companies to control their complex distributed
computing environments. Such services include the design, sale and service of
local area networks ("LANs") and wide area networks ("WANs"). The Company
generates revenues by providing consulting and network installation services,
selling add-on hardware components to existing clients and providing
after-installation service and support, training services and network management
services. The Company is an authorized dealer, reseller or integrator for the
products of many major vendors, including, but not limited to: IBM, Compaq, Sun
Microsystems, Dell, Bay Networks, Hewlett-Packard, Novell, Microsoft, Cisco,
Meridian Data, 3COM, Intel, and Oracle. The Company has developed applications
for remote network management and sells private label computer systems,
primarily to state governments. In addition, the Company provides application
development services in database development, web site and Internet development,
and imaging systems.
Resellers who meet specified qualifications receive customer referrals
and recommendations and advanced technical assistance and support from certain
manufacturers, giving the qualifying resellers a competitive advantage over
other resellers in the market. These qualifications vary from manufacturer to
manufacturer and typically include some or all of the following components:
specific training for technical personnel, specific training for sales
personnel, possession of certain advanced equipment, ongoing training
requirements, and minimum purchase targets. The process of obtaining and
maintaining these manufacturer authorizations is both time consuming and
expensive, with the cost of obtaining and maintaining a single authorization
ranging from $5,000 to approximately $250,000. These costs include, but are not
limited to, acquisition of hardware, software, facilities and spare parts,
training fees, personnel and travel expenses and fees paid to the manufacturer
for certification. Some authorizations for which the Company has qualified are:
Novell Platinum Reseller, Microsoft Solutions Provider, and Banyan Premier
Provider.
Equipment is generally sold by the Company only in conjunction with the
Company's higher margin network engineering services. These services include
design, consulting, installation and network administration for both LANs and
WANs. The Company provides turnkey implementation and support services and, for
some customers, on-site support personnel who work in conjunction with the
customer's personnel on a continuous basis.
The Company also provides on-going technical and maintenance support
through a variety of service programs tailored to fit each specific customer's
service needs and budget. These programs include a two-hour response service for
critical network components and a "guaranteed spares" program for
self-maintaining clients. Warranties provided by manufacturers are generally
passed through to the purchaser by the Company. The Company offers no warranty
separate from manufacturers' warranties.
<PAGE> 4
Marketing and Customers
The Company markets its products and services through its internal
sales force. The Company has sales service personnel in the following states:
Connecticut, Florida, Georgia, Illinois, Louisiana, Massachusetts, Michigan, New
Jersey, New York, North Carolina, Ohio, Pennsylvania, and South Carolina. The
Company adds and deletes locations on the basis of business opportunities. The
Company is able to perform work outside of its locations based upon the
locations of its customers' projects. The Company has no retail sales outlets
and has no intentions of entering the retail markets.
Marketing efforts are directed at Fortune 1000 and middle market
corporations, state and local governments, and institutional users such as
hospitals and universities. Although the Company intends to expand its
geographical coverage, current marketing efforts are generally focused on
customers located in the states in which the Company has offices.
The State of Michigan accounted for 29.6% and 23.6% of revenues in 1997
and 1996, respectively. This business resulted from the contract which was
assigned in connection with the NSG acquisition in September 1996. Revenues in
previous years from the State of Michigan were minimal. Purchases by agencies of
the State of Michigan were made pursuant to a blanket agreement which has been
extended and currently expires in September 1998. There are no assurances that
this contract can be extended further or that, if rebid, the Company will be
awarded an additional contract under the same terms and conditions. The loss of
this contract would have a material adverse affect on the Midwest region
revenues, however, the Company believes that this adverse affect would, in part,
be offset by the new customer base that has been developed in the eastern United
States.
Vendors
The Company purchases the microcomputers and related products it sells
directly from certain vendors and indirectly through distributors, such as
Inacom Corporation and Ingram Micro Corporation ("Ingram Micro"). In general,
the Company must be authorized by a vendor in order to sell certain of its
products, whether the products are purchased from distributors or directly from
the vendors. The Company is an authorized reseller for microcomputers,
workstations, and related products of over 50 manufacturers. Sales by the
Company of products manufactured by Compaq, Dell, Hewlett-Packard and IBM
accounted for between 45% to 55% of revenues during each of the last three
fiscal years. Typically, vendor agreements provide that the Company has been
appointed, on a non-exclusive basis, as an authorized reseller of specified
products at specified locations. The agreements generally are terminable on 30
to 90 days notice or immediately upon the occurrence of certain events and are
subject to periodic renewal. The loss of a major manufacturer or the
deterioration of the Company's relationship with a major manufacturer could have
a material adverse effect on the Company's business as certain product offerings
that are requested by customers would not be available to the Company.
The Company determines whether to purchase products from distributors
or directly from manufacturers by surveying prices and product availability
among the manufacturers and the distributors with whom it has contractual
relationships. Distributors, which purchase products in large quantities, often
are able to offer a better price on products due to volume discounts granted by
manufacturers. The Company's contract with Ingram Micro, through which it
purchased 15.8% of its product purchases in 1997, provides competitive pricing
and inventory and asset management terms and conditions. While the loss of all
of the Company's relationships with distributors would result in higher product
prices to the Company and potentially reduce the Company's profit margins, the
Company believes that the loss of its relationship with any particular
distributor would not have a material adverse effect on the Company's results of
operations or financial condition due to the availability of other sources of
supply. As is customary in the industry, the Company does not have any long-term
agreements or commitments, because competitive sources of supply are generally
available for such products.
<PAGE> 5
During 1997, the Company has signed an agreement with Ingram Micro to
provide remote network management services to Ingram Micro's Ingram Systems
Group ("ISG"). The ISG is a group of companies which represent the top 40
customers of Ingram Micro and who do not have the capabilities or capacities to
provide their customers with the high-end services such as remote network
management. Though no significant revenues have yet been recorded, the Company
believes that this alliance will provide important business opportunities in the
future.
Competition
The network integration market is highly competitive. The Company
competes with different classes of competitors, depending on the type of
business opportunity. For project-oriented sales, the Company competes with
system integrators and with computer hardware manufacturers. The Company also
competes with a wide variety of local, regional and national hardware resellers
for add-on equipment sales. Because the Company is not as price-aggressive as
some of these competitors, the Company relies on its sales force to provide
superior servicing and post-sale technical support to maintain its customer
relationships. Depending on the customer, the Company competes on the basis of
technological capability, price, breadth of product offerings and quality of
service. Competitors also vary project to project depending upon the geographic
location of the work to be performed.
Although many of its competitors are larger and have significantly
greater financial, marketing and human resources and geographic coverage than
the Company, the Company believes that it can compete effectively against these
competitors on the basis of its extensive experience in the network integration
and management market, authorization to sell a broad range of products and
established infrastructure.
Historically, manufacturers, which generally target customers desiring
products from only the particular manufacturer, and computer retail chains,
which focus principally on product sales, have not consistently served the
Company's market component. The entry of such competitors into the Company's
market component could have a material adverse effect on the Company.
Employees
As of December 31, 1997, the Company employed approximately 285
persons, 71 of whom were sales personnel, 160 of whom were service personnel and
the remainder of whom were administrative or management personnel. The Company's
employees have no union affiliations and the Company believes its relationship
with its employees is good.
<PAGE> 6
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS
As of December 31, 1997 the Company's Common Stock was traded on the
Nasdaq Stock Market's SmallCap Market under the symbol "DSYS" and on the Pacific
Stock Exchange under the symbol "DSY". The high and low sales prices for the
Common Stock on the Nasdaq SmallCap Market during the period from January 1,
1996, through the end of 1997 are set forth in the following table.
<TABLE>
<CAPTION>
1996 High Low
<S> <C> <C>
1st Quarter $3.00 $1.50
2nd Quarter $5.56 $2.00
3rd Quarter $7.25 $2.88
4th Quarter $11.88 $6.18
<CAPTION>
1997 High Low
1st Quarter $10.25 $7.00
2nd Quarter $14.00 $6.88
3rd Quarter $16.88 $9.38
4th Quarter $15.25 $8.75
<CAPTION>
1998 High Low
<S> <C> <C>
1st Quarter $14.25 $6.13
</TABLE>
As of April 9, 1998 the approximate number of record holders and
beneficial owners of the Common Stock was 3,397, based upon securities position
listings information available to the Company and the records of the Company's
transfer agent.
The Company has never declared or paid any dividends on its capital
stock. The Company currently anticipates that all of its earnings will be
retained for development of the Company's business, and does not anticipate
paying any cash dividends in the foreseeable future. Future cash dividends, if
any, will be at the discretion of the Company's Board of Directors and will
depend upon, among other things, the Company's future earnings, operations,
capital requirements and surplus, general financial condition, contractual
restrictions, and such other factors as the Board of Directors may deem
relevant.
<PAGE> 7
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below, as of December 31, 1997
and 1996 and for the years ended December 31, 1997, 1996 and 1995, are derived
from the Company's audited and unaudited consolidated financial statements
included in this report, and should be read in conjunction with the financial
statements and notes thereto and "Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS". The selected financial data
as of December 31, 1995 are derived from unaudited consolidated financial
statements of the Company which are not included in this report. The selected
financial data as of December 31, 1994 and 1993 and for the years ended
December 31, 1994 and 1993 are derived from audited consolidated financial
statements of the Company which are not included in this report.
<TABLE>
<CAPTION>
Restated
1997 1996 1995
STATEMENT OF OPERATIONS DATA: (unaudited) 1994 1993
(in thousands
except per share data)
<S> <C> <C> <C> <C> <C>
Total revenues $88,011 $33,550 $30,506 $22,870 $26,172
Cost of revenues (1) 75,445 28,792 27,933 19,572 22,383
------ ------ ------ ------ ------
Gross profit 12,566 4,758 2,573 3,298 3,789
Operating expenses 16,788 8,489 3,228 2,725 2,797
Other expenses 752 188 280 864 569
------ ------ ------ ------ ------
Income (loss) before income
taxes, minority interest and
extraordinary items (4,974) (3,919) (935) (291) 423
Income tax (benefit) - - - - -
----------------------------------------------------------
Income (loss) before minority
interest and extraordinary items (4,974) (3,919) (935) (291) 423
Minority interest - 3 - - -
Extraordinary items (2) - 75 322 - -
----------------------------------------------------------
Net income (loss) $ (4,974) $(3,841) $ (613) $ (291) $ 423
==========================================================
<CAPTION>
<S> <C> <C> <C> <C>
Net (loss) per
common share (3) $ (1.15) (1.41) $ (0.24) $(0.22)
===============================================
Pro forma income per
common share (4) $ 0.30
======
Weighted average common shares
outstanding (4) 4,324 2,719 2,560 1,328 1,400
======================================================
<CAPTION>
BALANCE SHEET DATA (AT PERIOD
END):
Restated
1996 1995
1997 (unaudited) 1994 1993
(in thousands)
<S> <C> <C> <C> <C> <C>
Total assets $43,214 $21,259 $11,938 $11,175 $7,421
Working capital (deficiency) (2,089) (5,682) 2,040 3,043 (735)
Current liabilities 36,812 18,788 8,361 6,359 6,562
Long-term debt 0 75 100 234 423
Stockholders' equity 6,244 2,396 3,477 4,581 436
</TABLE>
(1) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Note 15 of Notes to the Consolidated Financial
Statements" for a discussion of the effect of accounting changes in
policies and estimates which are related to and consistent with the
restatement of prior financial statements.
(2) See "Note 13 of Notes to Consolidated Financial Statements" for a
discussion of the effect of the Company's 1996 and 1995 gains on
extinguishment of debt.
(3) See "Note 15 of Notes to Consolidated Financial Statements" for a
discussion of subsequent events and the restatement of prior financial
statements.
(4) Amounts in 1993, 1994, 1995, and 1996 do not include 300,000 issued and
outstanding shares which were placed in escrow at the closing of the
Company's initial public offering and released from escrow in 1997. The
pro forma amount in 1993 includes shares issuable upon exercise of
warrants issued in 1992 in connection with the Company's bankruptcy
reorganization.
<PAGE> 8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis compares the financial results for the
three year period ending December 31, 1997 and should be read in conjunction
with the Company's financial statements and notes thereto. The Company's
financial statements include audited 1997 and 1996 financial statements and
unaudited 1995 financial statements. The investigation into the Company's
accounting irregularities, coupled with the subsequent resignation of the
Company's independent auditing firm on March 13, 1998, and the engagement of a
new independent auditing firm on March 25, 1998 have resulted in the inability
of the new auditors to complete their audit of all of the Company's financial
statements included herein and issue the requisite report thereon in time for
inclusion in this report. The Company is planning to complete the audit of the
1995 financial statements and will promptly file an amendment to this report
upon completion of such audit and receipt of the requisite reports thereon. See
Independent Auditors Report and "Note 15 of Notes to Consolidated Financial
Statements."
The following discussion and analysis contain a number of "forward
looking statements" within the meaning of the Securities Exchange Act of 1934
and are subject to a number of risks and uncertainties. These include general
business conditions, continuing favorable economic conditions, the failure of
the Company's customers to fulfill contractual commitments, the ability of the
Company to recruit and retain qualified personnel, the ability of the Company
to develop and sustain new customers in geographic areas in which the Company
has recently begun to operate, the ability of management to implement new
systems to manage the Company's growth effectively and efficiently, the impact
of undetected errors or defects associated with year 2000 date functions on the
Company's current products and internal systems, the willingness of the
Company's bank lender to continue to lend under the credit facility or the
Company's ability to secure alternative working capital financing, the
relative uncertainties in the market direction of emerging technologies, the
ability of the Company to recruit and retain qualified personnel and the
potential loss of key personnel within the new regions, the Company's ability
to retain its commercial and governmental contracts (including the State of
Michigan contract) and a lack of market acceptance of the Company's products
and services.
RESULTS OF OPERATIONS
A significant part of a competitive strategy adopted by the Company
in 1995 was to focus the Company's resources in two areas: accelerating the
Company's growth rate, and expanding its network management support services
offerings. The results of operations for 1996 and 1997 reflect the
implementation of this strategy.
<PAGE> 9
For the periods indicated, the following table sets forth selected items
from the Company's Consolidated Statements of Operations included in this
Report, expressed as a percentage of total revenues:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1997 1996 1995
<S> <C> <C> <C>
Revenues:
Net sales 78.3% 80.9% 92.5%
Service revenues 21.7% 19.1% 7.5%
---------------------------------------
Total revenues 100% 100% 100%
---------------------------------------
Cost of Revenues:
Cost of sales 68.0% 70.1% 87.7%
Cost of service revenue 17.7% 15.7% 3.8%
---------------------------------------
Total cost of revenues 85.7% 85.8% 91.5%
---------------------------------------
Gross profit 14.3% 14.2% 8.5%
Operating expenses 19.1% 25.3% 10.6%
Other expenses 0.9% 0.6% 1.0%
---------------------------------------
Loss before income taxes,
minority interest and extraordinary
item 5.7% 11.7% 3.1%
Income taxes - - -
---------------------------------------
Loss before minority
interest and extraordinary item 5.7% 11.7% 3.1%
Minority interest
Extraordinary item - (0.2%) (1.1%)
---------------------------------------
Net Loss 5.7% 11.5% 2.0%
=======================================
</TABLE>
<PAGE> 10
YEAR ENDED DECEMBER 31, 1997
COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES.
The Company's total revenues rose by 262% to $88.0 million in 1997,
compared to $33.5 million in 1996, primarily due to the full year impact of the
Company's acquisition of NSG (which was acquired in September 1996) and, to a
lesser extent, due to the expansion into the eastern region of the United
States. The NSG acquisition resulted in the assignment of the State of Michigan
contract which directly contributed 30% of 1997 total revenues. The Company's
direct product sales component of the business grew 254% or $41.7 million in
1997 and service revenue grew 298% as management continued to focus on new
account penetration through the offering of services in conjunction with
product sales. The Company was able to secure certain net sales by leveraging
its strategic vendor alliances and partnering with these vendors in
manufacturer direct sales efforts. Net product sales are expected to level out
on a year to year basis as the Company continues its strategic shift towards
increasing the higher margin service revenue. As a result of the
comprehensive accounting review and year end audit, a number of adjustments
have been made which have negatively affected the results for 1997 and 1996,
including a general reserve against net sales for credit memos and sales
allowances of $.5 million in 1997, which was established to consistently
account for customer returns on a year to year basis.
Service revenues increased $12.7 million in 1997 to 21.7% of total
revenues compared to 19.1% in 1996. This increase is primarily due to the
allocation of additional resources to further develop the Company's capabilities
to deliver advanced service and remote and on-site network management offerings.
COST OF REVENUES.
Cost of net sales decreased as a percentage of total revenues to 68.0%
in 1997 compared to 70.1% in 1996. This decrease was primarily due to the
Company's continued focus on larger project installation sales and strategic
vendor pricing due to volume purchases, as well as its 1996 addition of private
label computer products and application development. Cost of net sales
increased in 1997 by $2.2 million and in 1996 by $2.6 million due to
adjustments to inventory and service parts inventory, made pursuant to the
Company's accounting review and year end audit. These adjustments relate to
obsolescence and the reconciliation of the book to physical and the
restatement to lower of cost or market. The cost of net sales as a
percentage of net sales revenue for 1997 was 87%, which was unchanged from
1996.
Cost of service revenues increased to 17.7% of total revenues in
1997 from 15.7% of total revenues in 1996, as management's focus on the
offering of services in conjunction with product sales continued. Cost of
service revenue as a percentage of service revenue decreased to 81.3% in 1997
from 82.3% in 1996. This decrease was primarily due to the employment of
significant technical resources in 1996 in anticipation of greater service
revenue opportunities in 1997 and the Company's increased use of the broader
base of in-house technical talent in 1997. Essentially, the Company began to
benefit in 1997 from investments the Company made in 1996 in NSG and additional
technical personnel.
<PAGE> 11
The Company also incurred significant expenses in connection with its
network management service offerings, as well as other infrastructure costs.
The Company believes that the market for its network management services is
characterized by rapid technological advancement. To maintain its competitive
position in the industry, the Company expects to continue to invest significant
resources in new hardware, software and processes, as well as in enhancements
to existing processes, including research and development efforts of the
Company and UNS, subject to constraints on working capital.
OPERATING EXPENSES.
Operating expenses decreased to 19.1% of total revenues in 1997 from
25.3% of total revenues in 1996 and sales expenses decreased to 12.5% of total
revenues in 1997 versus 14.4% of total revenues in 1996. Both declines were due
to better utilization of internal resources, cost controls and economies of
scale. General and administrative expense was 6.6% of total revenues in 1997
compared to 10.9% of total revenues in 1996. The 1996 numbers were due
primarily to start-up expenditures and the temporary duplicative expenses
resulting from the expansion of the operations through the acquisition of NSG
and the additional eastern region direct sales offices and, to a lesser extent,
a $425,000 increase in the reserve for uncollectible notes receivable. Certain
allowances for doubtful accounts receivables and non-trade receivables, made
as a result of the Company's accounting review and year end audit, accounted
for $1.7 million additional general and administrative expenses in 1997.
OTHER EXPENSES.
Other expenses increased $564,000 over 1996 to 0.9% of total revenues,
due primarily to the increase in interest expense which resulted from increased
utilization of the bank line of credit. Interest expense, net of interest income
from cash invested, was $1,243,560 and was partially offset by other income of
$491,638 which is primarily due to vendor rebate programs.
<PAGE> 12
YEAR ENDED DECEMBER 31, 1996
COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES.
The Company's total revenues rose by 10% to $33.5 million in 1996,
compared to $30.5 million in 1995, primarily due to the Company's acquisitions
of UNS and NSG and, to a lesser extent, due to the Company's expansion into the
eastern region of the United States. The NSG acquisition resulted in the
assignment of the State of Michigan contract which directly contributed 24% of
1996 total revenues. The Company's direct product sales component of
the business declined slightly from $28.2 million in 1995 to $27.1 million in
1996 as management continued to focus on new account penetration through the
offerings of services in conjunction with product sales. The Company was able
to secure certain net sales by leveraging its strategic vendor alliances and
partnering with these vendors in manufacturer direct sales efforts. However,
these efforts only partially offset the flat or decreasing sales that were
anticipated prior to the NSG acquisition and geographic expansion which
occurred late in the year. As a result of the Company's restatement of its
1996 financial statements, net sales were reduced by $1.1 million in accounts
receivable due to credit memos made in 1997 that relate to 1996 sales.
Service revenues increased $4.1 million in 1996 from 1995 to 19.1% of
net sales compared to 7.5% in 1995. This increase is primarily due to the
allocation of additional resources to further develop the Company's capabilities
to deliver advanced service and remote and on-site network management offerings.
COST OF REVENUES.
Cost of revenues in 1996 included the effects of the NSG and UNS
acquisitions and the Company's expansion into the eastern region of the United
States, which occurred late in the third quarter of 1996. Management
refocused the Company's business in conjunction with these changes by shifting
resources away from the lower margin direct product component of the Company,
in favor of the higher returns expected from the advanced service and network
management offerings. Primarily as a result of this activity, cost of revenues
decreased to 85.8% of total revenues in 1996 from 91.5% of total revenues in
1995. The decline was offset as a result of the restatement of the Company's
1996 financial statements, wherein the cost of revenues for 1996 was increased
by a $2.2 million reduction in inventory due to obsolescence and accounting
errors and a $450,000 reduction in service parts due to obsolescence.
Cost of sales decreased as a percentage of total revenues to 70.1% in
1996 from 87.7% in 1995 and decreased as a percentage of net sales to 86.7% in
1996 from 94.9% in 1995. This decrease was primarily due to the Company's
continued focus on larger project installation sales as well as its 1996
addition of private label computer products and application development. Cost of
service revenue increased to 15.7% of total revenues in 1996 from 3.8% of total
revenues in 1995 due to the significant increase in total service revenues.
Conversely, cost of service revenue increased to 82% of service revenue in 1996
from 51% in 1995. This increase was primarily due to the employment of
significant technical personnel in the fourth quarter in anticipation of greater
service revenue opportunities in 1997.
The Company also incurred research and development expenses of $25,000
in 1996 and $82,000 in 1995 in connection with the development of its network
management service offerings, as well as other infrastructure costs. The Company
believes that the market for its network management services is characterized by
rapid technological advancement. To maintain its competitive position in the
industry, the Company expects to continue to invest significant resources in new
hardware, software and processes, as well as in enhancements to existing
processes including research and development efforts of the Company and UNS,
subject to constraints on working capital.
OPERATING EXPENSES.
Operating expenses increased to 25.3% of total revenues in 1996 from
10.6% of total revenues in 1995. Sales expenses increased to 14.4% of total
revenues in 1996 versus 6.3% of total revenues in 1995. General and
administrative expense was up to 10.9% of total revenues in 1996 from 4.3% of
total revenues in 1995. These increases were due primarily to start-up
expenditures and the temporarily duplicative expenses resulting from the
expansion of the Company's operations through the acquisition of NSG and the
additional eastern region direct sales offices. Additionally, and as a result
of the restatement of the Company's 1996 results, general and administrative
expenses were increased by a $425,000 increase in reserves for uncollected
notes receivable.
OTHER EXPENSES.
Other expenses decreased $92,000 in 1996 to 0.6% of total revenues,
due primarily to the increase of $86,000 in interest income earned from the
investment of the balance of the proceeds of the 1994 public offering,
and miscellaneous UNS income of $74,000. Also contributing to the decrease was a
$119,000 decrease in interest expense due primarily to the Company's success at
negotiating more advantageous payment terms with its key vendors, and the 1996
reduction in the Company's bank borrowing rate to .25% above prime compared to
the 1995 rate of .75% above prime.
<PAGE> 13
FINANCIAL CONDITION
As of December 31, 1997, cash and investments totaled $6.2
million, an increase of $4.7 million from 1996. Cash used in operating
activities for 1997 was $17.1 million compared to cash used of $4.4 million in
1996. The increase was primarily due to a significant increase in sales on
credit during the last quarter of 1997, which caused an increase in accounts
receivable of $17.5 million in 1997 over 1996. The increase was partially
offset by an $8.0 million increase in accounts payable and a $1.2 million
increase in accrued liabilities. Investing activities consumed $1.4 million
during 1997 compared to $1.9 million in 1996, for major investments in
components and computer equipment.
As of December 31, 1997, the Company financed its business primarily
through funds generated internally through operations, trade credit and
advances under its $12 million revolving line of credit and $8 million
discretionary line of credit with NBD Bank (the "Bank"). The line of credit was
secured by substantially all of the Company's assets, with the exception of
those inventory assets acquired with financing under the IBM credit line, and
was due on demand by the Bank. The term of the revolving line of credit
extended to September 30, 1999, and the discretionary line extended to September
30, 1998. The agreement was renewable annually and could be terminated at any
time by the Company or the Bank. As of December 31, 1997, the line of credit
bore interest at rates between 8.0% and 8.5%. Borrowing under the line of
credit was determined based on a collateral formula. As of December 31, 1997,
the formula permitted borrowings of up to $20.0 million, of which $17.2 million
was outstanding.
The agreement in effect at December 31, 1997, contained certain
financial ratio covenants and other covenants which required the Company's
receivables to be genuine and free of all other encumbrances and required the
Company's inventory to be kept only at certain locations and to be free of all
other encumbrances. Although the Company was not in compliance with certain
covenants in its credit agreement regarding minimum current and leverage ratios
at December 31, 1997, the Bank had waived the Company's non-compliance. On June
15, 1998, the Company was verbally informed by the Bank that it was in default
under its credit agreement. The Company and the Bank have recently signed an
agreement replacing the prior credit agreement with a new credit agreement.
The terms of the new credit agreement provide for a $11 million facility based
on a collatera formula, which includes 80% of qualified trade receivables.
Borrowings under the new credit agreement will bear interest at 2% over the
Bank's prime rate and will expire on September 30, 1998. The Company continues
to explore other financing alternatives and has begun negotiating with another
qualified lender to provide a long term commitment for a line of credit. In
the event that the Company is unable to negotiate a new line of credit or is
otherwise unable to borrow amounts necessary to fund its operations, or if
repayment of its obligations under the current credit agreement is demanded by
the Bank, the Company's financial condition would be materially and adversely
affected. In such event, there can be no assurance that the Company would be
able to obtain alternative working capital financing to continue its operations.
The Company finances certain inventory sales through a secured finance
agreement with IBM Credit Corporation. As of December 31, 1997, the agreement
extended a maximum of $2,000,000 in secured funds to be used exclusively for the
acquisition of inventory for resale, limited to those products manufactured by
Apple, Compaq, Hewlett Packard, IBM and Lexmark. Use of this credit line is at
the Company's option. To secure payment of all debt incurred under this
agreement, IBM Credit Corporation was granted a first security interest in the
Company's inventory financed through this agreement equal to the amount of the
outstanding debt. This agreement allows for thirty (30) days interest-free
borrowings of eligible inventory and a variable discount off of invoice for
eligible product purchases paid for within fifteen days from the date of
invoice. This agreement can be terminated at any time by the Company or the
lender. The terms and conditions of this financing agreement can be changed at
the discretion of IBM Credit Corporation. The outstanding amount at December 31,
1997 and 1996 was approximately $1.5 million and $1.2 million respectively and
has been included in accounts payable.
Under the final settlement of the Company's Plan of Reorganization,
the Company is obligated to pay approximately $114,000 as of December 31, 1997
and has been released from the prior contingent obligation. The amount remains
unchanged from December 31, 1996. A total amount of $200,000 is payable to the
Chairman of the Board and one of the Company's other directors, in three equal
annual installments beginning June 1998 under certain 13% subordinated notes
issued pursuant to the Plan of Reorganization. With the Plan of Reorganization
completed, the Company, at its option, may accelerate the payment of this
obligation. The subordinated notes are accounted for
<PAGE> 14
net of a related $200,000 note receivable from the Chairman. There are no
further payment requirements anticipated as the bankruptcy case has been closed
by final decree as of January 16, 1997.
In February, March and April 1998 civil actions were filed against the Company,
certain officers, and the Board of Directors. The complaints allege violations
of the Securities Exchange Act of 1934 resulting from alleged nondisclosures and
misrepresentations of information concerning the Company's financial results and
future prospects due to accounting irregularities. Management is unable to
assess the potential amount of any liability resulting from such class action
lawsuits, however, management currently believes that the resolution of these
proceedings will not have a material adverse effect on the Company's financial
position or results of operations. It is reasonably possible that future events
and circumstances could alter management's belief, however.
The Company believes that the combination of present cash balances,
future operating cash flows, and working capital provided by the Bank credit
facility or alternate working capital financing secured by the Company will be
adequate to fund the Company's internal growth and current short and long term
cash flow requirements.
YEAR 2000 COMPLIANCE
The Company is in the process of addressing the effect of the Year
2000 problem on its computer systems. The Company is currently engaged in a
project to upgrade its information, technology, and accounting software to
programs that will consistently and properly recognize the Year 2000. Many of
the Company's systems include new hardware and packaged software recently
purchased from vendors who have represented that these systems are already "Year
2000 compliant". The Company is also obtaining assurance from other vendors that
timely updates will be made available to ensure the software they have provided
is Year 2000 compliant.
The Company has initiated formal communications with all of its
significant suppliers and large customers to determine the extent to which the
Company may be vulnerable if those third parties fail to remediate their own
Year 2000 issues. The Company can give no assurance that the systems of other
companies on which the Company's systems rely will be converted on time or that
a failure to convert by another company or a conversion that is incompatible
with the Company's systems would not have a material adverse effect on the
Company.
The Company will utilize both internal and external resources to
reprogram, replace and test its software for Year 2000 compliance, and the
Company expects to complete the project in early 1999. The total cost associated
with the required modification and conversion is not yet known but, based upon
current plans, such cost is not expected to be material to the Company's
consolidated results. Costs associated with Year 2000 modification and
conversion will be expensed as incurred.
<PAGE> 15
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The financial statement schedule required by this item is listed in
response to Item 14 of this Report on Form 10-K and is filed as part of this
report.
INDEX TO FINANCIAL STATEMENTS
Independent Auditors' Report 16
Consolidated Balance Sheets as of December 31, 1997 and 1996 18
Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1996 and 1995 19
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1997, 1996 and 1995 20
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995 21
Notes to Consolidated Financial Statements 22
<PAGE> 16
Independent Auditor's Report
To the Directors and Shareholders
Data Systems Network Corporation
We have audited the accompanying consolidated balance sheets of Data Systems
Network Corporation as of December 31, 1997 and 1996 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
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 the significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
presents fairly, in all material respects, the financial position of Data
Systems Network Corporation at December 31, 1997 and 1996 in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has experienced
significant recurring losses from operations. In addition, as described in
Note 7 to the financial statements, the Company's bank has reduced the limits
of the Company's line of credit. These facts raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans
concerning these matters are also described in Note 17. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
We did not audit, review or compile the 1995 financial statements of Data
Systems Network Corporation and, accordingly, do not express an opinion or any
other form of assurance on them.
Southfield, Michigan
August 20, 1998
/s/ Plante & Moran, LLP
<PAGE> 17
To the Directors and Shareholders
Data Systems Network Corporation
We have audited the accompanying consolidated financial statements of Data
Systems Network Corporation as of December 31, 1997 and 1996 and for each of
the two years in the period ended December 31, 1997; and have issued our report
dated August 20, 1998, which report includes an explanatory paragraph as to the
Company's ability to continue as a going concern; such financial statements and
reports are included elsewhere in this Form 10-K. Our audits also included the
financial statement schedule of Data Systems Network Corporation listed in Item
14(a)(2) for the years ended December 31, 1997 and 1996. This financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion based on our audits. In our opinion,
the financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the 1997 and 1996 information set forth therein. We did not
audit, review or compile the 1995, 1994 or 1993 information included in the
financial statement schedule.
/s/ Plante & Moran, LLP
Southfield, Michigan
August 20, 1998
<PAGE> 18
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
RESTATED
DECEMBER 31, DECEMBER 31, 1996
1997 (NOTE 15)
---------------- -----------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 5,349 $ 1,522,434
Investments 6,203,361
Accounts receivable (net of allowance of $800,000 and $67,609 at December 31,
1997 and December 31, 1996,
respectively) 27,098,823 10,413,031
Notes receivable 197,133 169,164
Inventories 680,673 329,199
Other current assets 537,781 672,238
--------------- -----------------
Total current assets 34,723,120 13,106,066
SERVICE PARTS 320,677 1,021,284
PROPERTY AND EQUIPMENT, net (Note 5) 2,583,437 1,811,923
GOODWILL, net (Note 2) 4,072,207 4,291,312
OTHER ASSETS 1,514,125 1,028,273
--------------- -----------------
TOTAL ASSETS $ 43,213,566 $ 21,258,858
=============== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank line of credit (Note 7) $ 17,296,558 $ 9,225,211
Accounts payable (Notes 4 and 7) 16,220,200 7,540,447
Accrued liabilities (Note 6) 2,288,198 1,082,039
Capitalized lease obligation - current portion (Note 9) 79,988 --
Deferred maintenance revenues 927,154 940,627
--------------- -----------------
Total current liabilities 36,812,098 18,788,324
LONG-TERM DEBT (Note 8) 75,000
CAPITAL LEASE OBLIGATION (Note 9) 157,551
STOCKHOLDERS' EQUITY (Notes 2, 3 and 4):
Preferred stock, authorized 1,000,000 shares, none outstanding Common stock
($.01 par value; authorized 10,000,000
shares; issued and outstanding 4,857,974 and 3,255,000 shares
at December 31, 1997 and December 31,1996, respectively) 48,580 32,550
Additional paid-in capital 17,945,606 9,139,153
Accumulated deficit (11,750,269) (6,776,169)
--------------- -----------------
Total stockholders' equity 6,243,917 2,395,534
--------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 43,213,566 $ 21,258,858
=============== =================
</TABLE>
See accompanying notes to the consolidated financial statements.
<PAGE> 19
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
1997 1996 1995
RESTATED (UNAUDITED)
(NOTE 15)
------------- ------------- -------------
<S> <C> <C> <C>
REVENUES:
Net sales $ 68,867,422 $ 27,136,268 $ 28,209,390
Service revenue 19,143,027 6,413,326 2,297,170
------------ ------------ ------------
Total revenues 88,010,449 33,549,594 30,506,560
COST OF REVENUES:
Cost of sales 59,881,745 23,515,177 26,760,288
Cost of service revenue 15,563,062 5,276,541 1,172,490
------------ ------------ ------------
Total cost of revenues 75,444,807 28,791,718 27,932,778
GROSS PROFIT 12,565,642 4,757,876 2,573,782
OPERATING EXPENSES:
Selling expenses 10,992,600 4,838,003 1,922,517
General and administrative expenses 5,795,220 3,651,323 1,306,020
------------ ------------ ------------
Total operating expenses 16,787,820 8,489,326 3,228,537
LOSS FROM OPERATIONS (4,222,178) (3,731,450) (654,755)
OTHER INCOME (EXPENSE):
Interest expense (1,616,723) (580,304) (461,572)
Interest income 373,163 267,886 181,635
Other income 491,638 124,301
------------ ------------ ------------
Other expense - net (751,922) (188,117) (279,937)
LOSS BEFORE INCOME TAXES
MINORITY INTEREST AND EXTRAORDINARY ITEM (4,974,100) (3,919,567) (934,692)
INCOME TAXES (Note 10 )
MINORITY INTEREST IN SUBSIDIARY 3,000
------------ ------------ ------------
LOSS BEFORE EXTRAORDINARY ITEMS (4,974,100) (3,916,567) (934,692)
EXTRAORDINARY ITEMS:
Gain recognized upon
extinguishment of debt 75,494 321,962
------------ ------------ ------------
NET LOSS $ (4,974,100) $ (3,841,073) $ (612,730)
============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Basic Basic Basic
------------ ------------ ------------
<S> <C> <C> <C>
LOSS PER COMMON SHARE
LOSS BEFORE EXTRAORDINARY ITEM $ (1.15) $ (1.44) $ (0.37)
EXTRAORDINARY ITEM 0.03 0.13
============ ============ ============
NET LOSS $ (1.15) $ (1.41) $ (0.24)
============ ============ ============
WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING 4,324,229 2,719,091 2,560,281
============ ============ ============
</TABLE>
See accompanying notes to the consolidated financial statements
<PAGE> 20
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 1997, 1996 AND 1995
PREFERRED COMMON ADDITIONAL PAID-IN (ACCUMULATED
STOCK STOCK CAPITAL DEFICIT) TOTAL
<S> <C> <C> <C> <C> <C>
BALANCES, DECEMBER 31, 1994 None $ 27,150 $ 6,876,284 $ (2,322,366) $ 4,581,068
Additional common stock offering costs (169,275) (169,275)
Acquistion of warrants for 109,719 shares -
of common stock (Note 12) (321,962) (321,962)
Net loss (612,730) (612,730)
--------- -------- ----------------- ------------ -----------
BALANCES, DECEMBER 31, 1995 (UNAUDITED) None $ 27,150 $ 6,385,047 $ (2,935,096) $ 3,477,101
Acquistion of warrants for 10,413 shares
of common stock (Note 12) (75,494) (75,494)
Issuance of common stock in connection
with acquisition (Note 2) 5,400 2,829,600 2,835,000
Net loss - Restated (Note 15) (3,841,073) (3,841,073)
--------- -------- ----------------- ------------ -----------
BALANCES, DECEMBER 31, 1996 None 32,550 9,139,153 (6,776,169) 2,395,534
Exercise of stock options and warrant redemptions (net) 16,030 8,806,453 8,822,483
Net loss (4,974,100) (4,974,100)
--------- -------- ----------------- ------------ -----------
BALANCES, DECEMBER 31, 1997 None $ 48,580 $ 17,945,606 $(11,750,269) $ 6,243,917
========= ======== ================= ============ ===========
</TABLE>
See accompanying notes to the consolidated financial statements.
<PAGE> 21
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
1997 1996 1995
RESTATED (UNAUDITED)
(NOTE 15)
-------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,974,100) $ (3,841,073) $ (612,730)
Adjustments to reconcile net (loss)
to net cash used in operating activities:
Depreciation and amortization 881,970 365,227 381,910
Extraordinary gain (75,494) (321,962)
Provision for doubtful receivables 732,391 27,642 (24,195)
Provision for inventory obsolescence 195,767 701,976
Changes in assets and liabilities that provided (used) cash,
net of effects of acquisition:
Investments (6,203,361)
Accounts receivable (17,418,183) (5,106,514) (1,222,831)
Notes receivable (27,969) 73,371 (692,387)
Inventories (351,474) 467,956 441,638
Other current assets 134,457 338,510 (227,073)
Service parts 700,607 760,549 (27,321)
Other assets (485,852) (859,241) (24,215)
Accounts payable 8,679,753 3,564,518 1,664,934
Accrued liabilities 1,206,159 (141,927) (138,474)
Deferred maintenance revenues (13,473) (146,088) 51,245
-------------- ------------- -------------
Net cash used in operating activities (17,139,075) (4,376,797) (49,485)
-------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES :
Acquisition of property and equipment, net (1,434,379) (771,411) (95,899)
Purchase of UNS common stock (7,000)
Payments for NSG net assets including transaction costs (1,133,035)
-------------- ------------- -------------
Net cash used in investing activities (1,434,379) (1,911,446) (95,899)
-------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net current borrowings under bank line of credit 8,071,347 4,664,133 977,335
Net proceeds from capital lease obligation financing 237,539 -- --
Payment of principal on long-term debt (75,000) (25,000) (687,170)
Proceeds from issuance of common stock (net of offering costs) 8,822,483 (169,275)
-------------- ------------- -------------
Net cash provided by financing activities 17,056,369 4,639,133 120,890
-------------- ------------- -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,517,085) (1,649,110) (24,494)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,522,434 3,171,544 3,196,038
-------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,349 $ 1,522,434 $ 3,171,544
============== ============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS:
Cash paid during the period for:
Interest $ 1,454,922 $ 559,438 $ 468,535
============== ============= =============
Income taxes $ 60,000 None $ 40,000
============== ============= =============
</TABLE>
See accompanying notes to the consolidated financial statements.
<PAGE> 22
DATA SYSTEMS NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION The accompanying consolidated financial statements include the
accounts of Data Systems Network Corporation and its 70% - owned subsidiary,
Unified Network Services, Inc. ("UNS") and the operation of the Network Systems
Group ("NSG") from their respective dates of purchase (Note 2). The principal
activities of Data Systems Network Corporation (the "Company") involve the sales
of microcomputer and network hardware and software and the performance of
maintenance and advance services, such as network management, imaging and
systems consulting, to major corporate and state and local government customers
in the United States. The Company's corporate headquarters are in Michigan.
Additionally, there are two technical centers, one in Michigan and one in North
Carolina, and 20 direct sales offices located throughout the United States.
RECOVERABILITY OF LONG-LIVED ASSETS The Company reviews the recoverability of
its assets on a periodic basis in order to identify business conditions that may
indicate a possible impairment. The assessment for potential impairment is based
primarily on the Company's ability to recover the unamortized balance of its
long-lived assets from expected future cash flows on an undiscounted basis.
LEASES, which meet certain criteria evidencing substantive ownership by the
Company, are capitalized and the related capital lease obligations are included
in current and long-term liabilities. Amortization and interest are charged to
expense, with rent payments being treated as payments of the capital lease
obligation. All other leases are accounted for as operating leases, with rent
payments being charged to expense as incurred.
STOCK OPTIONS The Company has a stock option plan (Note 12). Options granted to
employees are accounted for using the intrinsic value method, under which
compensation expense is recorded at the amount by which the market price of the
underlying stock at the grant date exceeds the exercise price of an option.
Under the Company's plan the exercise price on all options granted equals or
exceeds the fair value of the stock at the grant date. Accordingly, no
compensation cost is recorded as a result of stock option awards under the plan.
INVESTMENTS The Company's management determines the appropriate classification
of securities at the time of purchase and re-evaluates such designation as of
each balance sheet date. The investments are primarily Industrial Revenue Bond
securities that are classified as trading securities. The securities are
reported at fair value with unrealized gains and losses, net of tax, reported in
the income statement. Unrealized losses, net of tax, at December 31, 1997 were
approximately $6,000. All of the investments were sold subsequent to December
31, 1997.
CASH AND CASH EQUIVALENTS For the purposes of cash flows, the Company considers
all highly liquid investments with maturities of three months or less when
purchased as cash equivalents.
INVENTORIES, consisting entirely of goods for resale, are stated at the lower of
cost or market with cost determined on the weighted average method.
SERVICE PARTS are stated at the lower of cost or market and represent equipment
spares utilized for service contracts.
PROPERTY AND EQUIPMENT are stated at cost. Depreciation and amortization are
computed using straight-line methods over the estimated useful lives of the
respective assets ranging from five to seven years.
GOODWILL which represents the excess of purchase price over fair value of net
assets acquired is being amortized on a straight-line basis over twenty years,
which is the estimated future period to be benefitted. Goodwill will be
periodically reviewed for impairment based on an assessment of future operations
to ensure that they are appropriately valued. Accumulated amortization was
$309,879 and $97,774 at December 31, 1997 and 1996, respectively.
<PAGE> 23
INCOME TAXES are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled.
RESEARCH AND DEVELOPMENT costs are expensed as incurred.
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 reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Management has made significant estimates with respect to the
collection of receivables, obsolescence of inventory and the possible outcome
of outstanding litigation. Actual results could differ from those estimates,
making it reasonably possible that a change in these estimates could occur in
the near term.
FINANCIAL INSTRUMENTS consist primarily of cash and cash equivalents, bank line
of credit, long-term debt, accounts receivable and accounts payable. As of
December 31, 1997 and 1996, the fair value of these financial instruments
approximates the carrying amount.
REVENUE RECOGNITION for consulting, network installation services, time and
materials services, and training is recognized when the services are rendered.
Revenue from the sale of merchandise is recognized when shipped. Revenue from
the sales of after-installation service maintenance contracts is recognized on a
straight-line basis over the lives of the respective contracts.
PRODUCT RETURNS AND SERVICE ADJUSTMENTS are estimated based upon historical
data. Actual credits are recorded against the established reserve in the month
they are authorized and accepted. The Company's customers have no contractual
rights to return products. The Company determines whether to accept product
returns on a case by case basis and will generally accept product returns only
upon payment of a restocking fee and/or if the products may be returned to the
manufacturer. The Company offers no warranty separate from the product
manufacturers' warranties. As of December 31, 1997 the Company had recorded a
reserve of $500,000 for potential product returns and service adjustments.
EARNINGS (LOSS) PER COMMON SHARE In February 1997, the Financial Accounting
Standards Board issued Statement No. 128, "Earnings per Share" ("SFAS 128").
SFAS 128 specifies the computation and presentation and disclosure requirements
for earnings per share ("EPS") of entities with publicly held common stock or
potential common stock. SFAS 128 defines two EPS calculations, basic and
diluted. The objective of basic EPS is to measure the performance of an
entity over the reporting period by dividing income available to common stock
by the weighted average of shares outstanding. The objective of diluted EPS is
consistent with that of basic EPS while giving effect to all dilutive potential
common shares that were outstanding. All potential common shares were excluded
from the computations of diluted earnings per share for the years ended
December 31, 1997, 1996 and 1995 because the effect would have been
anti-dilutive.
RECENT ACCOUNTING PRONOUNCEMENTS - In June 1997, the FASB issued SFAS No. 130,
Reporting Comprehensive Income, and SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information. SFAS No. 130 establishes standards for
reporting and displaying of comprehensive income and its components. SFAS No.
131 establishes standards for the way that public business enterprises report
information about operating segments and related information in interim and
annual financial statements. SFAS No. 130 and 131 are effective for fiscal years
beginning after December 15, 1997. These two statements did not have any effect
on the Company's 1997 financial statements; however, management is evaluating
what, if any additional disclosures may be required when these two statements
are implemented.
<PAGE> 24
2. ACQUISITIONS
On February 22, 1996, the Company purchased 70% (7,000 shares) of UNS for
$7,000, and acquired certain liabilities in a transaction accounted for as a
purchase. The purchase price was allocated to the assets acquired and
liabilities assumed based upon their estimated fair market value. The excess of
the purchase price over the estimated fair market value of the net assets
acquired amounted to $999,078, which is being accounted for as goodwill and is
being amortized over 20 years using a straight-line method. (See Note 16
regarding the sale of the Company's interest in UNS during 1998).
Effective September 3, 1996, the Company purchased the assets and operations of
The Network Services Group of SofTech, Inc. ("SofTech"), and assumed certain
liabilities from SofTech. The acquisition has been accounted for as a purchase.
In exchange for certain assets and liabilities, SofTech received cash in the
amount of $890,000 and 540,000 shares of the Company's common stock valued at
approximately $2,835,000. The purchase price was allocated to the net assets
acquired based upon their estimated fair market values. The excess of the
purchase price over the estimated fair market value of the net assets acquired
amounted to $3,390,008, which is being accounted for as goodwill and is being
amortized over 20 years using a straight-line method.
Operating results of these acquired operations are included in the consolidated
financial statements from their respective dates of purchase.
3. REDEMPTION OF WARRANTS
During February 1997, the Company called all of its outstanding Redeemable
Common Stock Purchase Warrants ("Purchase Warrants") for redemption as of March
10, 1997 pursuant to the Warrant Agreement, dated October 28, 1994, setting
forth the terms of the Purchase Warrants. Approximately 99% of the Warrants were
exercised on or prior to the date of redemption at a price of $6.25 per Warrant,
resulting in net proceeds to the Company of approximately $7,300,000. In
connection with the receipt of consent to the redemption, the Company agreed to
file a registration statement with the Securities and Exchange Commission with
respect to 60,000 units, issued to the underwriters' representatives in the
Company's initial public offering, consisting of two common shares and two
warrants to purchase an additional two common shares which may be purchased upon
exercise of a warrant. The exercise price of these warrants was reduced from
$16.50 to $12.50 per unit and the exercise price of the purchase warrants was
reduced from $10.3125 to $6.25 per unit. The registration was completed in July
1997 and during the third quarter of 1997, all related warrants were exercised,
resulting in net proceeds to the Company of approximately $1,400,000.
4. PLAN OF REORGANIZATION
On August 30, 1991, the Company filed a petition for relief under Chapter 11 of
the federal bankruptcy laws in the United States Bankruptcy Court for the
Eastern District of Michigan (the "Bankruptcy Court").
On May 22, 1992, the Company's Third Amended Plan of Reorganization (the "Plan
of Reorganization") was confirmed by the Bankruptcy Court. The Plan of
Reorganization became effective after the close of business on June 30, 1992 and
the final decree which ordered the case closed was issued January 16, 1997. As
of December 31, 1997 and 1996 approximately $114,000 is recorded in accounts
payable, representing the final balance of all unpaid claims.
<PAGE> 25
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Computer equipment and software $3,147,140 $2,085,385
Furniture and fixtures 753,951 427,210
Leasehold improvements 212,450 166,567
---------- ----------
Total 4,113,541 2,679,162
Less accumulated depreciation 1,530,104 867,239
---------- ----------
Property and equipment - net $2,583,437 $1,811,923
========== ==========
</TABLE>
6. ACCRUED LIABILITIES
Accrued liabilities consist of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Compensation, benefits and taxes $1,348,897 $ 252,859
Customer advances 11,500 108,019
State sales and other taxes 414,742 209,488
Interest 161,801 55,416
Other 351,258 456,257
---------- ----------
Total $2,288,198 $1,082,039
---------- ==========
</TABLE>
7. LINES OF CREDIT
As of December 31, 1997, the Company had a credit agreement ("Agreement") with
NBD Bank ("NBD"). The Agreement provided for a revolving line of credit not to
exceed $12 million, a discretionary line of credit not to exceed $8 million and
a discretionary lease line not to exceed $500,000, collateralized by an interest
in all of the Company's accounts receivable, inventory (other than equipment
financed through IBM Credit) and equipment. Borrowing limits under the revolving
and discretionary lines were determined based on a collateral formula. The
revolving line of credit was to expire September 30, 1999 and the discretionary
line was to expire September 30, 1998. The Agreement also contained certain
covenants including minimum current ratio and leverage ratios. The Company was
not in compliance with the covenants as of December 31, 1997 but has obtained a
waiver from NBD. The Company and NBD have recently signed an agreement
replacing the Agreement. The terms of the new credit agreement provide for a $11
million facility based on a collateral formula, which includes 80% of qualified
trade receivables. Borrowings under the new credit agreement would bear interest
at 2% over NBD prime and would have a term extending to September 30, 1998.
The Company has also entered into a finance agreement with IBM Credit
Corporation. As of December 31, 1997, the agreement extended a maximum of
$2,000,000 to be used exclusively for the acquisition of inventory for resale,
limited to those products manufactured by Apple, Compaq, Hewlett Packard, IBM
and Lexmark. Use of this credit line is at the Company's option. As collateral
for payment of all debt incurred under this agreement, IBM Credit Corporation
was granted a first security interest in the Company's inventory equal to the
amount of the outstanding debt. This agreement allows for thirty (30) day
interest free financing of eligible inventory and a variable discount off of
invoice for eligible product purchases paid for within fifteen days from the
date of invoice. The Company or the lender can terminate this agreement at any
time. The terms and conditions of this financing agreement can be
<PAGE> 26
changed at the discretion of IBM Credit Corporation. The amount outstanding at
December 31, 1997 and 1996 is approximately $1.5 million and $1.2 million
respectively and has been included in accounts payable.
8. LONG-TERM DEBT
Long-term debt consists of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
13% subordinated notes payable to the Company's majority stockholders in a
principal amount of $200,000 and $275,000 at December 31, 1997 and 1996,
respectively due in 2000. If the appropriate conditions are met, the holders may
require the Company to redeem the notes in three equal annual installments
including interest beginning July 1, 1998 through July 1, 2000. Offset against
this amount is a promissory note of $200,000 receivable from the Company's Chairman and
Chief Executive Officer which was given in consideration of the subordinated notes None $75,000
==== =======
</TABLE>
9. LEASES
Future minimum lease payments for assets under capital leases at December 31,
1997 are as follows:
<TABLE>
<S> <C>
1998 $ 102,563
1999 102,563
2000 44,838
2001 23,838
2002 22,986
----------
Total minimum obligations $ 296,788
Less interest 59,249
----------
Present value of minimum obligations $ 237,539
Less current portion 79,988
----------
Long term portion $ 157,551
==========
</TABLE>
Included in property and equipment is approximately $306,000 relating to assets
under capital leases less $58,000 in accumulated depreciation.
The Company has entered into several noncancelable operating leases for office
space, computer equipment, and certain furniture and fixtures that expire at
various dates through 2002. Approximate future minimum annual rentals under
noncancelable operating leases as of December 31, 1997 are as follows:
<TABLE>
<S> <C>
1998 $1,257,500
1999 861,300
2000 751,900
2001 732,700
2002 273,800
----------
$3,877,200
==========
</TABLE>
Total rent expense for the years ended December 31, 1997, 1996, and 1995
(unaudited) was approximately $1,130,000, $595,000 and $257,000, respectively.
<PAGE> 27
10. INCOME TAXES
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and liabilities at December 31, 1997 and 1996 are
presented below:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Current deferred tax assets (liabilities):
Capitalized inventory costs $19,000 $19,000
Allowance for obsolete inventories 399,000
Prepaid costs (54,000)
Other (69,000) (69,000)
Deferred maintenance revenues 2,000
Accrued liabilities 93,000 18,000
Allowance for doubtful accounts 437,000 23,000
-------------- ---------------
Total current deferred taxes 480,000 338,000
-------------- ---------------
Noncurrent deferred tax assets:
Net operating loss carryforwards 3,205,000 1,515,000
Depreciation and amortization 112,000 161,000
-------------- ---------------
Total noncurrent deferred taxes 3,317,000 1,676,000
-------------- ---------------
Total deferred taxes 3,797,000 2,014,000
Less valuation allowance (3,797,000) (2,014,000)
-------------- ---------------
Total deferred taxes, net None None
============== ===============
</TABLE>
The reconciliation of the tax expense at the statutory rates to the reported
tax expense is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
(UNAUDITED)
------------ --------------------------------
<S> <C> <C> <C>
Federal income taxes (benefit) at statutory rates $ (1,691,000) $(1,289,000) $(208,000)
Nondeductible expense 52,000 11,000
14,000
Extraordinary gain (26,000) (109,000)
Other (144,000) 28,000 35,000
Increase in deferred tax asset valuation allowance 1,783,000 1,273,000 271,000
------------ --------------------------------
Income tax(benefit) reported None None None
============ ================================
</TABLE>
A reconciliation of the current tax expense is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
(UNAUDITED)
------------ ---------------------------------
<S> <C> <C> <C>
Deferred tax expense (benefit) $(1,783,000) $(1,273,000) $(271,000)
Increase in deferred tax asset
valuation allowance 1,783,000 1,273,000 271,000
------------ ---------------------------------
Total tax expense (benefit) None None None
============ =================================
</TABLE>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences
<PAGE> 28
become deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income and tax planning strategies in
making this assessment.
11. MAJOR CUSTOMERS
The Company had one customer, the State of Michigan, which accounted for
approximately 30% and 24% of revenue in 1997 and 1996, respectively.
12. STOCK OPTION PLAN
In April 1994 the Company adopted the 1994 Stock Option Plan ("Plan"). A total
of 200,000 shares were reserved for issuance under the Plan. The options vest
over a two-year period at the rate of 50% per year, beginning on the first
anniversary of the grant date. In October 1994, the Company granted options, in
connection with its initial public offering, for 58,016 shares exercisable at a
price of $4.75 per share, which was the fair market value at the date of grant.
In 1997,1996 and 1995, the Company granted options for 3,000 shares exercisable
at a price of $9.83, $4.00 and $3.00 per share, respectively, which was the fair
market value at the grant date, to the Directors of the Company. Such options
vest one year from the date of grant.
In April 1997, the Company amended the Plan to increase the reserved shares to
600,000. The vesting period in the Company's form option grant agreement was
also changed to 50% on the second anniversary of the grant date and 25% on
each of the third and fourth anniversaries of the grant date. The Company's
Compensation Committee retains the ability to change the vesting schedule at
any time. The per share weighted-average fair value of stock options granted
during 1997, 1996 and 1995 was $7.08, $2.59 and $2.07, respectively, on the
date of grant using the Black Scholes option-pricing model with the following
weighted average assumptions: expected dividend yield 0.0%, risk-free interest
rate of 6.5% in 1997 and 6.9% in 1996 and 1995, expected volatility of the
stock over the expected life 70% in 1997 and 30% in 1996 and 1995, and expected
life ranging from 7 to 10 years.
The Company applies intrinsic value accounting for its Plan and, accordingly, no
compensation cost has been recognized for its stock options in the financial
statements. Had the Company determined compensation cost based on the fair value
at the grant date for its stock options under SFAS No. 123, the Company's net
loss and loss per share would have been increased to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
1997 1996 1995
(UNAUDITED)
---- ---- ---------
<S> <C> <C> <C>
Net loss As reported $4,974 $3,841 $613
(in thousands)
Pro forma $5,418 $3,930 $616
Loss per share (Basic) As reported $1.15 $1.41 $0.24
Pro forma $1.25 $1.45 $0.24
</TABLE>
The pro forma information above only includes stock options granted in the years
ended December 31,1997, 1996 and 1995. Compensation expense under the fair value
based method of accounting will increase over the next few years as granted
stock options vest and additional stock option grants are considered.
<PAGE> 29
The following table illustrates the outstanding stock options and related
average exercise prices during each of the last three years.
<TABLE>
<CAPTION>
AVERAGE PER
SHARE EXERCISE
SHARES PRICE
------ -----
<S> <C> <C>
BALANCE DECEMBER 31, 1994 58,016 $4.75
ISSUED 12,700 $3.57
EXERCISED
BALANCE DECEMBER 31, 1995 70,716 $4.58
ISSUED 146,437 $4.46
FORFEITED (25,450) $4.11
EXERCISED
BALANCE DECEMBER 31, 1996 191,703 $4.55
ISSUED 215,350 $9.82
FORFEITED (9,062) $6.19
EXERCISED (21,768) $4.57
BALANCE DECEMBER 31, 1997 376,223 $7.54
</TABLE>
The range of exercise prices on outstanding options at December 31, 1997 is as
follows:
<TABLE>
<CAPTION>
PRICE RANGE WEIGHTED AVERAGE AVERAGE REMAINING LIFE
SHARES EXERCISE PRICE (IN YEARS)
-------------- ----------
<S> <C> <C> <C>
$1.63 - $5.00 148,923 $4.18 7.9
$5.01 - $7.50 106,400 $6.86 8.8
$7.51 - $10.00 33,000 $8.91 8.9
$10.01 - $14.38 87,900 $13.43 9.6
-------
TOTAL 376,223
=======
</TABLE>
As of December 31, 1997, 1996 and 1995, the number of options exercisable was
62,461, 56,892 and 31,446, respectively, and weighted average exercise price of
those options was $4.53, $4.75 and $4.58, respectively.
13. FORGIVENESS OF DEBT
During the course of 1995 and 1996, the Company negotiated with certain
creditors to accelerate the payment of unsecured debt in exchange for the
creditors' agreement to forgive a portion of the unsecured debt and contingent
liabilities and to cancel a portion of the fully paid warrants. Under the terms
of the 1992 Plan of Reorganization, the unsecured creditors were granted fully
paid warrants for 170,000 shares of the Company's authorized common stock and
contingent payments of up to a total of $650,000. This contingent liability was
not previously recorded, as the amount could not be reasonably estimated. As a
result of these extensive negotiations, the Company has purchased
<PAGE> 30
approximately 110,000 warrants in 1995 and 10,400 in 1996. In addition, the
Company received the approval of the bankruptcy court to enter into an agreement
whereby all outstanding claims have been settled with aggregate payments of
approximately $114,000 and the contingent payments noted above have been
eliminated. The bankruptcy court issued its final decree on January 16, 1997.
The extraordinary gains of approximately $75,000 and $322,000 in 1996 and 1995,
respectively, represent the purchase of the warrants and the extinguishment of
the related debt.
14. LEGAL PROCEEDINGS
In February, March and April 1998 civil actions were filed against the Company,
certain officers, and the Board of Directors. The complaints allege violations
of the Securities Exchange Act of 1934 resulting from alleged nondisclosures and
misrepresentations of information concerning the Company's financial results and
future prospects due to accounting irregularities. Management is unable to
assess the potential amount of any liability resulting from such class action
lawsuits, however, management currently believes that the resolution of these
proceedings will not have a material adverse effect on the Company's financial
position or results of operations. It is reasonably possible that future events
and circumstances could alter management's belief, however.
15. RESTATEMENT OF PRIOR FINANCIAL STATEMENTS
As announced on February 24, 1998, the Company became aware of certain
accounting errors and irregularities affecting previously issued financial
statements. Contemporaneously, the Company's independent accountants advised the
Company that their unqualified auditor's report on the Company's consolidated
financial statements as of December 31, 1996 and 1995 and for each of the years
ended in that two year period was being withdrawn and should no longer be relied
upon. On March 13, 1998, the Company's independent accountants informed the
Board of Directors that they were resigning.
In connection with their audits for the two most recent fiscal years and through
March 13 there were no disagreements between the Company and the independent
accountants on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements if not
resolved to the satisfaction of the independent accountants would have caused
them to make reference thereto in their report on the financial statements for
such fiscal years.
A special committee of the outside members of the Company's Board of Directors
has investigated the accounting errors and irregularities. All known adjustments
to the prior year financial statements have been reflected in the restated 1996
financial statements presented. The major adjustments to restate the 1996
financial statements are summarized as follows: a $1,100,000 reduction
in accounts receivable due to credit memos issued in 1997 that relate to 1996
sales; a $2,200,000 reduction in inventory due to obsolescence and accounting
errors; a $450,000 reduction in service parts due to obsolescence; and a
$425,000 increase in the reserve for uncollectable notes receivable.
16. SUBSEQUENT EVENTS
During fiscal 1998, the Company decided to sell its 70% interest in its large
account network management services operation, Unified Network Services Inc.
("UNS"). Under the terms of the original 1996 purchase agreement, the minority
shareholders of UNS elected to exercise a contract option to initiate
re-purchase of the UNS subsidiary. The Company's Board of Directors accepted
the proposal. On June 17, 1998, the Company executed an agreement to sell its
70% interest in the UNS subsidiary for cash and notes, and discontinued
operations in its large account network management business effective June 1,
1998. The terms of the sale included $7,000 in cash and a note for
$3,000,000, which is secured by the stock of UNS. The buyers will also assume
the existing liabilities of UNS. The gain upon disposal of the discontinued
segment was $1,605,304 which is net of an allowance of $3,000,000 due to the
uncertainty of the buyers ability to pay the note.
For the years ended December 31, 1997 and 1996, the condensed financial
information for UNS is as follows:
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Revenues $2,013,309 $2,435,070
Expenses 3,562,856 2,916,594
---------- ----------
Net loss $1,549,547 $ 481,524
========== ==========
</TABLE>
17. GOING CONCERN MATTERS
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. As shown in the financial
statements for the years ended December 31, 1997, 1996, and 1995, the Company
incurred losses of $4,974,100, $3,841,073 and $612,730 respectively. The
working capital deficiency as of December 31, 1997 was $2,088,978.
The financial statements do not include any adjustment relating to the
recoverability and classification of recorded asset amounts or the amounts or
the amounts and classification of liabilities that might be necessary should
the Company be unable to continue as a going concern. Management has
successfully negotiated a continuation of its previously authorized line of
credit with its primary lender as discussed in Note 7, although at reduced
credit limits. Management continues to explore other financing alternatives
and has begun negotiating with another qualified lender to provide a long-term
commitment for line of credit financing. Additionally the Company has sold
its unprofitable UNS subsidiary (Note 16) and reduced staff size in
non-revenue generating areas, Management will continue to consolidate its
business operations and stabilize strategic business relationships so the
Company can meet its obligations and attain a level of operations that is
profitable.
<PAGE> 31
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial Statements, Financial Statement Schedules and
Exhibits.
(1) The financial statements required by Item 8 of this report
are listed and included in Item 8 of this report.
(2) The following financial statement schedule of the Company
is submitted herewith.
Schedule II Valuation and Qualifying Accounts
(3) A list of the exhibits required to be filed as part of
this Form 10-K is included under the heading "Exhibit Index" in this Form 10-K
and incorporated herein by reference. Included in such list as Item 10.3 (1994
Stock Option Plan) are the Company's management contracts and compensatory plans
and arrangements which are required to be filed as exhibits to this Form 10-K.
(b) Reports on Form 8-K.
There were no Form 8-K filings in the fourth quarter of 1997. However,
the following filings occurred in the first and second quarters of 1998:
Date Information Reported
February 24, 1998 Items 5 and 7
March 19, 1998 Items 4 and 7
March 31, 1998 Items 4, 5, and 7
May 7, 1998 Items 5 and 7
May 21, 1998 Items 5 and 7
No financial statements were filed with these Reports on Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
DATA SYSTEMS NETWORK CORPORATION
By: /s/ Michael W. Grieves
Michael W. Grieves
Chairman, President and Chief
Executive Officer
Dated September 2, 1998
<PAGE> 32
SCHEDULE II
DATA SYSTEMS NETWORK CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
DATA SYSTEMS NETWORK CORPORATION
YEARS ENDED DECEMBER 31, 1997, 1996, 1995, 1994 AND 1993
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Additions
----------------------------
Balance at Charged to
beginning of costs and Charged to Balance at
period expenses other accounts Deduction end of period
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Description
Year ended Decenber 31, 1997:
Allowances for doubtful receivables 67,609 1,227,223 (494,832) 800,000
Allowance for inventory obsolescence 0 - - 0
Year ended December 31, 1996:
Allowances for doubtful receivables 39,967 91,335 (63,693) 67,609
Allowance for inventory obsolescence 978,446 - (978,446) 0
Year ended December 31, 1995:
Allowances for doubtful receivables 64,162 32,016 (56,211) 39,967
Allowance for inventory obsolescence 276,469 760,888 (58,911) 978,446
Year ended December 31, 1994:
Allowances for doubtful receivables 48,010 26,772 (10,620) 64,162
Allowance for inventory obsolescence 179,567 139,433 (42,531) 276,469
Year ended December 31, 1993:
Allowances for doubtful receivables 113,330 149,281 (214,601) 48,010
Allowances for inventory obsolescence 920,694 (741,127) 179,567
</TABLE>
<PAGE> 33
EXHIBIT INDEX
Exhibit No. Description of Exhibits
2.2 Asset Purchase Agreement, dated September 12, 1996, by and
among the Company, Information Decisions, Inc., System
Constructs, Inc. and SofTech, Inc. Schedules to the Agreement,
listed on pp. iii-iv of the Table of Contents of the
Agreement, were not filed, but will be provided to the
Commission supplementally upon request.(5)
4.5 Form of Warrant issued to former unsecured creditors
pursuant to Third Amended Plan of Reorganization*
10.1 Compaq Computer Corporation Authorized Dealer
Agreement.(1)
10.3(a) Form of non-qualified stock option agreement under 1994 Stock
Option Plan.(3)
10.3(c) 1994 Stock Option Plan, as amended and restated April 1997.(8)
10.3(d) Form of non-qualified stock option agreement under 1994 Stock
Option Plan (April 1997 version).(8)
10.4(b) Restated Business Financing Agreement - NBD Secured Credit
Agreement, dated November 27, 1996.(5)
10.4(c) Amendment to NBD Credit Facility Agreement, dated April 23,
1997.(7)
10.4(d) NBD Bank Credit Agreement, dated September 30, 1997.(9)
10.8 Subordinated Promissory Notes issued to Michael Grieves and
Richard Burkhart, dated May 22, 1992.(1)
10.9 Promissory Note, dated June 30, 1992, from Michael Grieves.(1)
10.14 Shareholder Agreement, dated February 22, 1996, among the
Company and Unified Network Services.(4)
10.15 Stock Purchase Agreement, dated February 22, 1996, among the
Company and Unified Network Services.(4)
10.16 Registration Rights Agreement, dated September 12, 1996,
entered into by the Company and SofTech, Inc.(5)
10.17 Financial Consulting Agreement between the Company and H.J.
Meyers & Co., Inc. and Amendment of Representative's Warrant,
dated as of December 22, 1996.(6)
10.18 Warrant Redemption Agreement, dated January 21, 1997, between
the Company and H.J. Meyers & Co., Inc.(6)
10.19 Letter Agreement between First Colonial Securities Group, Inc.
and the Company, dated as of January 29, 1997.(6)
23.1 Consent of Plante & Moran LLP**
24.1 Power of Attorney of Walter J. Aspatore*
24.2 Power of Attorney of Richard P. Burkhart*
24.3 Power of Attorney of Jerry A. Dusa*
27 Financial Data Schedule*
- --------------------------------------------
* Previously filed with the Company's Annual Report on Form 10-K for the year
ended December 31, 1997, as amended, and incorporated by reference herein.
** Filed herewith.
(1) Incorporated by reference from the Company's Registration Statement on
Form S-1, No. 33-81350, as amended.
(2) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1994.
(3) Incorporated by reference from the Company's Annual Report on Form 10-K
for the year ended December 31, 1995.
(4) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the period ended March 31, 1996.
(5) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1996.
(6) Incorporated by reference from the Company's Annual Report on Form 10-K
for the year ended December 31, 1996.
(7) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the period ended March 31, 1997.
(8) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the period ended June 30, 1997.
(9) Incorporated by reference from the Company's Quarterly Report on Form
10-Q for the period ended September 30, 1997.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report on Form
10-K of Data Systems Network Corporation for the years ended December 31,
1997 and 1996 , of our report on the consolidated financial statements dated
August 20, 1998.
PLANTE & MORAN, LLP
Southfield, Michigan
August 31, 1998