<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the year ended December 31, 1998
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 (IRS 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
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(4,174,224 shares) on March 1, 1999 was $8,348,448. 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 1, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
None.
<PAGE> 2
PART I
ITEM 1. BUSINESS.
RECENT DEVELOPMENTS
On February 1, 1999, Data Systems Network Corporation (the
"Company") announced that a definitive merger agreement was signed with Alydaar
Software Corporation doing business as Information Architechs (Nasdaq/NMS:
"ALYD") of Charlotte, North Carolina. Under the terms of the agreement, approved
by the Board of Directors of both companies, Alydaar will exchange 1.6 million
shares of its common stock for all outstanding shares of the Company's stock.
Alydaar is listed on the NASDAQ and had a closing stock price on March 12, 1999
of $8.125 per share.
On February 17, 1999, the Company announced that it had agreed to
a stipulation of settlement of the consolidated securities class action lawsuits
filed in 1998 (See Item 3 - "Legal Proceedings"). The stipulation of settlement
has been filed in federal court in Detroit, Michigan. Although the court gave
preliminary approval for the proposed settlement, it is subject to the courts'
later determination of the settlement's fairness at a hearing currently set for
May 12, 1999. Under the terms of the proposed settlement, and subject to various
conditions, the Company will create a gross settlement fund valued at
approximately two million dollars. The fund will benefit a settlement class of
purchasers who bought the Company's stock during the period from May 16, 1996
through February 24, 1998. The fund will be comprised of $900,000 provided by
the Company's insurer, and, at the defendant's option, either 650,000 shares of
the Company's common stock or an additional $1.1 million. In agreeing to the
proposed settlement, the Company and individual defandants have made no
admission of any wrongdoing. The class action lawsuit stems from the Company's
announcement in the first quarter of 1998, that it had discovered accounting
irregularities which it believed resulted in an overstatement of certain
previously released earnings. The Company's 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 has investigated the matter. As a result of the stipulation
of settlement, the Company has accrued approximately $1.8 million as the
estimate of the liability.
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 state and local governments, Fortune 1000 and middle
market corporations, and institutional users such as hospitals and universities.
2
<PAGE> 3
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.
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. 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 opened over 10 new locations in the eastern,
mid-Atlantic, and southern areas of the United States. During 1998, the Company
consolidated sales offices in various locations and sold its interest in UNS,
effective June 1, 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: 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, Year 2000 remediation, 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.
3
<PAGE> 4
Equipment is generally sold by the Company in conjunction with
its 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 help desk and dispatch services. The
Company generally passes through warranties provided by manufacturers to the
purchaser. The Company offers no warranty separate from manufacturers'
warranties.
MARKETING AND CUSTOMERS
The Company markets its products and services through its internal
sales force. The Company has sales and service personnel in the following
states: Connecticut, Florida, Illinois, Kentucky, Louisiana, Massachusetts,
Michigan, New Jersey, New York, North Carolina, and South Carolina. The Company
has no retail sales outlets and has no intention of entering the retail market.
Marketing efforts are directed at state and local governments,
Fortune 1000 and middle market corporations and institutional users such as
hospitals and universities. Current marketing efforts are generally focused on
customers located in the states in which the Company has offices.
The State of Michigan accounted for approximately 29% of the
Company's revenues in 1998 and 1997. Purchases by agencies of the State of
Michigan were made pursuant to a blanket agreement, which expired in September
1998. The Company continues to provide network services to the State of Michigan
through a third-party master contractor blanket purchase order. Separately, the
State of Michigan extended the Company's maintenance services contract through
March 31, 1999 for Company provided services and through September 30, 1999 for
Company sub-contracted third party maintenance service providers. As with all of
the Company's service contracts and purchase orders, there are no assurances
that any contract can be extended further or that, if re-bid, the Company will
be awarded a new agreement under the same terms and conditions.
During 1998, the State of New York accounted for 12% of the
Company's revenues. The Company was awarded a three-year contract, renewable in
one year increments, to provide system peripheral equipment. The first year
expires on May 6, 1999. The Company is also the authorized reseller of Novell
and Bay Systems products and software to the State of New York.
VENDORS
The Company purchases the microcomputers and related products it
sells directly from manufactures and indirectly through distributors such as
Inacom Corporation and Ingram Micro Corporation. In general, the Company must be
authorized by a vendor in order to sell its products, whether the products are
purchased from distributors or directly from manufacturers. The Company is an
authorized reseller for microcomputers, workstations, and related products of
over
4
<PAGE> 5
50 manufacturers. Sales by the Company of products manufactured by Compaq,
Hewlett-Packard, Sun Microsystems, Bay Networks, Dell, and IBM accounted for
between 40% and 50% of revenues during each of the last three fiscal years.
However, sales of commodity products, such as IBM and Dell, have substantially
declined over this period. 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 agreement with Ingram Micro,
through which it made 9.7% of its product purchases in 1998, provides
competitive pricing, inventory and asset management terms and conditions. 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 however, 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.
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.
Many competitors are larger than the Company and have significantly
greater financial, marketing and human resources, and geographic coverage. The
Company believes that it can compete 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.
5
<PAGE> 6
EMPLOYEES
As of December 31, 1998, the Company employed 204 persons, 41 of
who were sales personnel, 129 of who 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.
ITEM 2. PROPERTIES.
The Company's corporate headquarters are located in Farmington
Hills, Michigan, in a leased facility consisting of approximately 12,555 square
feet of office space rented under a lease expiring in November 2002. The Company
also leases two technical facilities. One is located in Farmington Hills,
Michigan in a facility with approximately 7,000 square feet rented under a lease
expiring in March 2003. The other is located in Raleigh, North Carolina in a
facility with approximately 27,300 square feet rented under a lease expiring
October 2001. The Company is evaluating the Raleigh facility and is in the
process of sub-leasing approximately half of the space. The Company also has two
telephone "help desk" centers. The Grand Rapids, Michigan facility is
approximately 7,518 square feet and is rented under a lease expiring in April
1999. The second facility, located in Baton Rouge, Louisiana, which is part of
the State of Louisiana maintenance contract, is located in a facility with 8,200
square feet rented under a lease expiring in November 1999.
The Company also leases direct sales offices totaling approximately
26,000 square feet under leases with terms of one to five years, in 11 locations
in the United States. The Company believes that its existing facilities and
offices and additional space available to it are adequate to meet its
requirements for its present and reasonably foreseeable needs.
ITEM 3. LEGAL PROCEEDINGS.
Class Action Litigation
As initially reported in the Company's 1997 annual report on Form 10-K,
and subsequently updated by the Company's quarterly reports on Form 10-Q, as
amended, on or about February 26, 1998, plaintiff Tony DiFatta filed civil
action, Case No. 98CV70854 DT (the "DiFatta Complaint"), in the United States
District Court for the Eastern District of Michigan, Southern Division, against
the Company and individual defendants Michael W. Grieves and Philip M. Goy. Mr.
DiFatta sought to represent a class of all purchasers of the Company's stock on
the open market between March 5, 1997 and February 24, 1998, excluding the
individual defendants and any officer, director or control person of the Company
and members of their immediate families. The DiFatta Complaint alleged violation
of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C.
Sections 78j(b) and 78t(a), and SEC Rule l0b-5, through nondisclosure and
misrepresentations of information concerning the Company's financial results and
future prospects.
6
<PAGE> 7
In particular, DiFatta claims that press releases and SEC filings by the Company
were materially false and misleading in that they overstated revenues and
earnings for the year and quarter ended December 31, 1996, and for the quarters
ended March 31, 1997, June 30, 1997 and September 30, 1997 due to accounting
irregularities.
On or about March 17, 1998, plaintiff Jeffrey P. Emrich filed civil
action, Case No. 98CV1223 DT (the "Emrich Complaint"), in the United States
District Court for the Eastern District of Michigan, Southern Division, against
the Company and individual defendants Grieves and Goy. On or about April 17,
1998, plaintiff David L. Ronick filed a civil action, Case No. 98-71644 DT
(the"Ronick Complaint") in the same court against the Company and individual
defendants Grieves, Goy, Walter J. Aspatore and Jerry A. Dusa. The Emrich
Complaint and the Ronick Complaint each sought to certify an essentially
identical class of purchasers of the Company's stock as the class proposed in
the DiFatta Complaint, and present essentially identical claims. On or about
June 10, 1998, the DiFatta, Emrich and Ronick actions were consolidated for all
purposes under the caption In Re: Data Systems Network Corporation Securities
Litigation, Case No. 98-70854.
On or about July 10, 1998, plaintiffs in the consolidated action filed
a consolidated complaint in lieu of the previously filed complaints against the
Company and individual defendants Grieves and Goy, seeking to represent a class
of purchasers of the Company's stock between May 15, 1996 and February 24, 1998.
On February 17, 1999, the Company announced that it had agreed to a
stipulation of settlement of the consolidated complaint. The stipulation of
settlement has been filed in federal court in Detroit, Michigan. Although the
court gave preliminary approval for the proposed settlement, it is subject to
the court's later determination of the settlement's fairness at a hearing
currently set for May 12, 1999. Under the terms of the proposed settlement, and
subject to various conditions, the Company will create a gross settlement fund
valued at approximately two million dollars. The fund will benefit a settlement
class of purchasers who bought the Company's stock during the period of May 16,
1996 through February 24, 1998. The fund will be comprised of $900,000 provided
by the Company's insurer, and, at the defendants' option, either 650,000 shares
of the Company's common stock or an additional $1.1 million. In agreeing to the
proposed settlement, the Company and individual defendants made no admission of
any wrongdoing. As a result of the stipulation of settlement, the Company has
accrued approximately $1.8 million as the estimate of the liability.
Securities and Exchange Commission Investigation
On or about October 29, 1998, the Securities and Exchange Commission
("SEC") informed the Company that it is conducting a formal private
investigation of the accounting irregularities experienced by the Company in the
fiscal years 1996 and 1997. This inquiry is ongoing, and the Company is
cooperating with the SEC and providing information as requested.
7
<PAGE> 8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the
fourth quarter ending December 31, 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
As of December 31, 1998 the Company's Common Stock was traded on the
Over-the-Counter Bulletin Board ("OTCBB") under the symbol "DSYS." During the
year, the Company was also listed on the Nasdaq SmallCap Market (symbol "DSYS")
and on the Pacific Stock Exchange ("PSE") under the symbol "DSY." Due to late
SEC filings and other related issues experienced during the first two quarters
of 1998, the Company was de-listed from Nasdaq and the PSE. The high and low
sales prices for the Common Stock on the Nasdaq SmallCap Market and the OTC
Bulletin Boards during the period from January 1, 1997, through the end of 1998
are set forth in the following table.
<TABLE>
<CAPTION>
1997 High Low
- ----------- ------ -----
<S> <C> <C>
1st Quarter $10.25 $7.00
2nd Quarter $14.00 $6.88
3rd Quarter $16.88 $9.38
4th Quarter $15.25 $8.75
</TABLE>
<TABLE>
<CAPTION>
1998 High Low
- ----------- ------ -----
<S> <C> <C>
1st Quarter $14.75 $5.50
2nd Quarter $ 7.25 $0.50
3rd Quarter $ 3.88 $0.25
4th Quarter $ 2.41 $0.75
</TABLE>
As of March 22, 1999 the approximate number of record holders
and beneficial owners of the Company's Common Stock was 2,500, 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 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. The Company's primary lender, Foothill
Capital Corporation, must also approve any dividend distribution.
8
<PAGE> 9
ITEM 6. SELECTED FINANCIAL DATA
The following is a summary of selected financial data of the
Company as of, and for each of the five years ended December 31, 1998. The
historical financial data has been derived from the Company's audited
consolidated financial statements for all years presented except for 1995, which
remains unaudited. The selected financial data as of and for the years ended
December 31, 1995 and 1994 are derived from audited consolidated financial
statements of the Company which are not included in this report. The data
presented below should be read in conjunction with the financial statements and
notes thereto. It should also be read in conjunction with "Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations."
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
(in thousands except per share data)
(Restated) (Restated) (Unaudited)
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Total revenues ............................ $ 85,323 $ 85,997 $ 32,577 $ 30,506 $ 22,870
Cost of revenues (1) .............. 71,238 73,516 27,616 27,933 19,572
-------- -------- -------- -------- --------
Gross Profit .............................. 14,085 12,481 4,961 2,573 3,298
Operating expenses ................ 15,673 16,149 8,211 3,228 2,725
Other expenses .................... 2,111 749 185 280 864
-------- -------- -------- -------- --------
Loss before extraordinary item
and discontinued operations ............. (3,699) (4,417) (3,435) (935) (291)
Extraordinary item (2) .................... -- -- 75 322 --
-------- -------- -------- -------- --------
Loss before discontinued operations ....... (3,699) (4,417) (3,360) (613) (291)
Discontinued Operations (3)
Loss from Operations of UNS ....... (1,686) (557) (481) -- --
Gain on Disposal of UNS ........... 706 -- -- -- --
-------- -------- -------- -------- --------
Net Loss .................................. $ (4,679) $ (4,974) $ (3,841) $ (613) $ (291)
======== ======== ======== ======== ========
Net loss per common share-basic and
diluted ................................. $ (0.96) $ (1.15) $ (1.41) $ (0.24) $ (0.22)
======== ======== ======== ======== ========
Weighted average common shares
Shares outstanding (4) ............ 4,859 4,324 2,719 2,560 1,328
======== ======== ======== ======== ========
</TABLE>
Balance Sheet Data:
<TABLE>
<CAPTION>
(in thousands except per share data)
(Restated) (Restated) (Unaudited)
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Total assets ........................... $ 22,466 $ 45,082 $ 20,565 $ 11,938 $ 11,175
Working capital (deficiency) ........... (5,156) (2,371) (6,073) 2,040 3,043
Current liabilities .................... 20,896 36,659 18,504 8,361 6,359
Liabilities from Discontinued
Operations ........................... -- 2,021 1,945 -- --
Long term debt ......................... -- -- 75 100 234
Stockholder's equity ................... 1,571 6,244 2,396 3,477 4,581
</TABLE>
(1) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" 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 K 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 D of Notes to Consolidated Financial Statements" for a
discussion of discontinued operations.
(4) Amounts in 1994, 1995, and 1996 do not include 300,000 issued and
outstanding shares of the Company's common stock which were placed in
escrow at the closing of the Company's initial public offering and
released from escrow in 1997.
9
<PAGE> 10
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, 1998 and should be read in conjunction
with the Company's financial statements and notes thereto.
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 risks may
include the continuation of current 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 its current credit facility or
the Company's ability to secure alternative working capital financing, the
relative uncertainties in the market direction of emerging technologies, the
potential loss of key personnel, the Company's ability to retain its commercial
and governmental contracts, the potential lack of market acceptance of the
Company's products and services, and the approval of Alydaar regarding certain
operating conditions as detailed in the Plan of Merger.
RESULTS OF OPERATIONS
A significant part of a competitive strategy adopted by the Company in
1997 was to focus the Company's resources in two areas: accelerating the
Company's growth rate, and expanding its network management support services
offerings.
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:
YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>
Revenues: 1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Product revenue 74.5% 78.9% 82.2%
Service revenue 25.5% 21.1% 17.8%
------ ------ ------
Total revenues 100.0% 100.0% 100.0%
Cost of Revenues:
Cost of products 61.2% 68.9% 71.1%
Cost of services 22.3% 16.6% 13.7%
------ ------ ------
Total cost of revenues 83.5% 85.5% 84.8%
Gross Profit 16.5% 14.5% 15.2%
Operating expense 18.4% 18.8% 25.2%
Other income(expense) (2.5%) (0.9%) (0.6%)
------ ------ ------
Loss before extraordinary item
and discontinued operations (4.4%) (5.2%) (10.6%)
Extraordinary item -- -- 0.2%
------ ------ ------
Loss before discontinued operations (4.4%) (5.2%) (10.4%)
Discontinued Operations:
Loss from operations of UNS (2.0%) (0.6%) (1.4%)
Gain on disposal of UNS 0.8% -- --
------ ------ ------
Net Loss (5.6%) (5.8%) (11.8%)
====== ====== ======
</TABLE>
10
<PAGE> 11
YEAR ENDED DECEMBER 31, 1998
COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES.
The Company's total revenues declined slightly to $85.3 million in
1998, compared to $86.0 million in 1997. The decline (0.8%) is the net effect of
the termination of a specific product sales contract offset by the Company's
organic growth in service sales and in the eastern region of the United States.
The Company's product sales component of the business declined from
$67.8 million in 1998 to $63.5 million in 1997 due primarily to the completion
and expiration on September 30, 1998, of the Company's master contractor
purchase order with the State of Michigan. Product sales to the State were made
under that agreement. The State continues to buy network services and service
maintenance contracts from the Company. Of the $4.3 million decline in product
sales, approximately $3.8 can be attributed to the completion of the State of
Michigan agreement. The remainder of the decline in product sales is due to
management's continued focus on new account penetration through the offering of
advanced services, including network management services. The Company's shift in
emphasis to service sales from product sales is due to the expectation of high
margins generally associated with sales of technical services.
Service revenues increased 20.1% to $21.8 million in 1998 from $18.1
million in 1997. Service sales accounted for 25.5% of total revenue in 1998
versus 21.1% in 1997. This increase is primarily due to the allocation of
additional resources to further develop the Company's capabilities to deliver
advanced services.
COST OF REVENUES.
The decline in cost of revenues in 1998 is consistent with the
reduction in product sales due to the termination of the Sate of Michigan master
contractor purchase order and the shift to service revenue. 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 advanced service and network management
offerings. Primarily as a result of this activity, cost of revenues decreased to
83.5% of total revenues in 1998 from 85.5% of total revenues in 1997.
Cost of product revenue decreased as a percentage of total revenues to
61.2% in 1998 from 68.9% in 1997. Certain software purchases in support of
maintenance contracts were reclassified as cost of services versus cost of
products. This change, along with the decline in product revenue, accounts for
the reduction in the cost of product revenue. Product revenue gross margins
increased to 17.8% in 1998 versus 12.7% in 1997. The Company has been more
selective in pricing large projects and believes that the increase in product
gross margin is reflective of the strategic shift away from low margin sales.
Cost of service revenue increased to 22.3% of total revenues in 1998
from 16.6% of total revenues in 1997 due to the significant increase in total
service revenues and reclassification of
11
<PAGE> 12
software costs that are more closely related to service revenue. Additionally,
as a result of the Company's decision to move towards a higher mix of service
sales, the Company increased its technical personnel to assist the sales effort
with specialized internal resources. By providing in-house technical resources
to support revenue growth, the Company increased expenditures in third party
consultants and technicians to support existing contracts.
Overall, gross profit margins increased $1.6 million or 12.9%
over 1997. Gross margin in 1998 was 16.5% versus 14.5% in 1997. To maintain its
strategic direction, emphasizing a shift towards higher margin service sales,
the Company expects to continue to invest resources in technical personnel,
hardware, software and processes, subject to working capital constraints.
OPERATING EXPENSES.
Operating expenses decreased to 18.4% of total revenues in 1998
from 18.8% of total revenues in 1997. Sales expenses decreased to 11.2% of total
revenues in 1998 versus 12.0% of total revenues in 1997. General and
administrative expense increased to 7.2% of total revenues in 1998 from 6.8% of
total revenues in 1997. Overall, operating expenses declined due to cost
controls and overhead reductions put in place during 1998. Specifically, sales
offices in Atlanta, GA, Charlotte, NC, Greensboro, NC, Pittsburgh, PA and
Dallas, TX were closed or consolidated into other more strategically located
offices. Administrative and other overhead reductions were completely offset by
the additional expenditures necessary to address legal and auditing issues. The
non-recurring legal, auditing, and professional fees exceeded just over $1.0
million during 1998. These expenses related to the extraordinary efforts
required to complete the Company's year-end 1997 and 1996 reporting, the class
action lawsuits, and bank audit and examination expenses. All totaled, these
matters account for 1.2% of total revenue.
OTHER EXPENSES.
Other expense increased in 1998 due primarily to the recognition
of $1.8 million of liability associated with the proposed stipulation of
settlement of the Company's shareholder class action lawsuit. The Company
established an accrual for the estimated fair market value of the shares of the
Company's common stock that will be contributed into the gross settlement fund,
See "Item 3 - Legal Proceedings." Other expenses, net of the shareholder lawsuit
accrual, declined to $.3 million from $.8 million in 1997. The decrease was due
to a $.8 million decrease in interest expense due primarily to the Company's
success at negotiating more advantageous payment terms with its key vendors and
overall reductions in the Company's bank borrowings.
DISCONTINUED OPERATIONS.
Pursuant to the terms of the original 1996 purchase agreement
by which the Company acquired Unified Network Services Inc. ("UNS"), the
minority shareholders of UNS elected to exercise a contract right to initiate
re-purchase of the the stock of UNS owned by the Company. The Company's Board of
Directors accepted the proposal and adopted a plan to discontinue operations.
Effective June 1, 1998, the Company sold its 70% interest in the UNS subsidiary
for cash and notes and discontinued operations in its large account network
management
12
<PAGE> 13
business. The terms of the sale included $7,000 in cash and a note for
$3,000,000, secured by the stock of UNS. The buyers also assumed the existing
liabilities of UNS. The Company is deferring the recognition of a gain on sale
related to the note until payments on the note begin in 1999. The gain upon
disposal of the discontinued segment was $705,742 which is net of an allowance
of $3,000,000 due to the uncertainty of the buyers ability to pay the note. The
gain is also net of additional allowances of $614,000 and $375,000, due to the
uncertainty of the buyers ability to pay back advances made by the Company for
working capital and payment of certain assumed liabilities.
The Company has restated its prior financial statements to present the
operating results of the UNS segment as a discontinued operation. The
divestiture results in substantial cost savings without significant loss of
customer relationships or the ability to deliver specialized technical services
in any related area.
13
<PAGE> 14
YEAR ENDED DECEMBER 31, 1997
COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES.
The Company's total revenues rose by 164.0% to $86.0 million in
1997, compared to $32.6 million in 1996. This was 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 that directly contributed approximately 29% of 1997 total
revenues.
The Company's product sales component of the business grew
153.3%, or $41.1 million, to $67.9 million in 1997. Service revenue grew 213.3%
as management continued to focus on new account penetration through the offering
of advanced services in conjunction with product sales. The Company was able to
secure certain product sales by leveraging its strategic vendor alliances and
partnering with these vendors in manufacturer direct sales efforts. Product
sales leveled out on a year to year basis as the Company continued its strategic
shift towards increasing the higher margin service revenue. As a result of the
Company's comprehensive accounting review and year-end audit, a number of
adjustments were made which negatively affected the results for 1997 and 1996.
These adjustments included a general reserve against total 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 $12.4 million, to $18. 2 million in
1997 and accounted for 21.1% of total revenues, compared to 17.8% in 1996. This
increase was 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 product sales decreased as a percentage of total revenues
to 68.9% in 1997 compared to 71.1% 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 product 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 total cost of sales as a percentage of total
sales revenue for 1997 was 85.5% compared to 84.8% in 1996.
Cost of service revenues increased to 16.6% of total revenues in
1997 from 13.7% of total revenues in 1996, as management's focus on the offering
of advanced services in conjunction with product sales continued. Cost of
services as a percentage of service revenue increased slightly to 78.7% in 1997
from 77.0% in 1996. This increase was primarily due to the employment of
in-house technical resources in 1997 in anticipation of greater service revenue
opportunities and the
14
<PAGE> 15
Company's increased use of the broader base of in-house technical talent to
enhance the sales effort during the year. Essentially, the Company began to
benefit in 1997 from investments the Company made in 1996 in NSG and additional
technical personnel.
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 hardware, software and processes, as well as in enhancements to
existing processes, including research and development efforts by the
Company, subject to constraints on working capital.
OPERATING EXPENSES.
Operating expenses decreased to 18.8% of total revenues in 1997
from 25.2% of total revenues in 1996 and sales expenses decreased to 12.0% of
total revenues in 1997 versus 14.1% 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 6.8% of total
revenues in 1997 compared to 11.2% of total revenues in 1996. The 1996 results
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 receivable 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 $.6 million in 1997 over 1996 to 0.9% of
total revenues, due primarily to the increase in interest expense which resulted
from increased utilization of the Company's bank line of credit. Interest
expense, net of interest income from cash invested, was $1.2 million and was
partially offset by other income of $.5 million, which is primarily due to
vendor rebate programs.
15
<PAGE> 16
FINANCIAL CONDITION
As of December 31, 1998, cash and investments totaled $2.7 million, a
decrease of $3.5 million from 1997. Cash provided from operating activities for
1998 was $17.2 million compared to cash used of $16.9 million in 1997. The cash
provided by operating activities was primarily due to a significant decrease in
accounts receivable of $15.0 million. Collections on a major contract in the
first quarter of 1998 accounted for $6.8 million of the change. The Company has
also reduced past due accounts significantly. A decrease in account payable of
$6.5 million was offset by a reduction in investments of $6.2 million. The
Company, in accordance with its bank financing agreement, applies all available
cash to its outstanding line of credit balance. The impact of discontinued
operations of $2.0 million was offset by the change in accrued liabilities,
primarily due to the accrual for the shareholder lawsuit of $1.8 million. All
available cash, $14.3 million, was used in financing activities. Per the
Company's credit agreement with NBD Bank, which expired in September 1998, and
its current line of credit agreement with Foothill Capital Corporation, all
funds are applied to the outstanding loan balance. Daily working capital
requirements are managed through daily borrowings.
As of September 30, 1998, the Company had a credit agreement ("NBD
Agreement") with NBD Bank ("NBD"). The Agreement provided for a discretionary
line of credit not to exceed $11 million. Borrowing limits under the credit
facility were determined based on a collateral formula, which included 80% of
qualified trade receivables. Borrowings under the credit agreement bore interest
at 2% over NBD's prime rate and had a term extending to September 30, 1998.
Previously, the Company had a credit agreement that 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. Each
was collateralized by an interest in the Company's entire accounts receivable,
inventory (other than equipment financed through IBM Credit) and equipment.
On September 30, 1998 the Company and Foothill Capital Corporation
("Foothill") entered into a new credit facility ("Foothill Agreement"),
replacing in its entirety, the NBD Agreement. The Foothill Agreement provides
for an initial revolving line of credit not to exceed $15 million. The Company
may, at its option and subject to certain collateral requirements, increase the
line to $20 million during the term of the Foothill Agreement. Borrowing limits
under the Foothill Agreement are determined based on a collateral formula, which
includes 85% of qualified trade receivables. Borrowings under the Foothill
Agreement bear interest at 1% over Norwest Bank's prime rate and have a term
extending to September 30, 2001. All monies owed by the Company to NBD were paid
on October 1, 1998. As of December 31, 1998, the line of credit under the
Foothill Agreement bore interest at rates between 8.0% and 8.5%. As of December
31, 1998, the line of credit collateral formula permitted borrowings of up to
$6.3 million, of which $3.2 million was outstanding
The agreement in effect at December 31, 1998, contains certain
financial covenants related to earnings before interest, taxes, depreciation and
amortization ("EBITDA"), net worth and capital expenditures. There are other
covenants that require the Company's receivables to be genuine and free of all
other encumbrances and require the Company's inventory to be kept only at
certain locations and to be free of all other encumbrances. At December 31,
1998, due primarily to the
16
<PAGE> 17
accrual related to the stipulation of settlement in the Company's shareholder
lawsuit (See Item 3 - "Legal Proceedings"), the Company was not in compliance
with the EBITDA and net worth covenants. However, the Company has received the
necessary waivers from Foothill Capital Corporation and the Company's access and
use of the line of credit was not effected. In the event that the Company would
be unable to borrow amounts necessary to fund its operations, or if repayment of
its obligations under the current credit agreement were demanded by Foothill,
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 has also entered into a finance agreement with IBM Credit
Corporation. As of September 30, 1998, the agreement extended a maximum of
$2,000,000 to be used exclusively for the acquisition of inventory for resale.
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-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 changed at the discretion of IBM
Credit Corporation. The amount outstanding at December 31, 1998 and 1997 is
approximately $1.4 million and $1.5 million, respectively, and has been included
in accounts payable.
The Company's working capital deficiency as of December 31, 1998 was
$5.2 million. Significant non-cash accruals (See "Note P" of the Notes to the
Consolidated Financial Statements) have negatively impacted the deficiency. The
Company believes that the combination of present cash balances, future operating
cash flows, and working capital provided by the Foothill Agreement 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.
Upon completion of its merger with Alydaar Software Corporation (See
Note Q of the Notes to the Consolidated Financial Statements), the Company
believes that additional financing resources will be available and certain
synergies relating to business opportunities will be realized to help return the
Company to profitability. However, the Agreement and Plan of Merger requires the
Company to conduct business in the usual and ordinary course but under certain
restrictions and limitations. These restrictions and limitations, in the
aggregate, could have a material effect on the Company's ability to quickly
respond to changes in its business.
YEAR 2000 COMPLIANCE
The Year 2000 ("Y2K") issue is the result of computer programs using
a two-digit format, as opposed to four digits, to indicate the year. Such
computer systems will be unable to interpret dates beyond the year 1999, which
could cause a system failure or other computer errors, leading to disruptions in
operations. In 1997, the Company developed a three-phase program for Y2K
information systems compliance. Phase I was to identify those systems with which
the Company
17
<PAGE> 18
has exposure to Y2K issues. Phase I was completed in 1998. Phase II is the
development and implementation of action plans to be Y2K compliant in all areas
by mid 1999. Phase III, to be completed by the end of the third quarter of 1999,
is the final testing of each major area of exposure to ensure compliance. The
Company has identified three major areas determined to be critical for
successful Y2K compliance: (1) financial and informational system applications,
(2) customer relationships and equipment applications and (3) third-party
consultant and vendor relationships.
The Company, in accordance with Phase I of the program, conducted an
internal review and inventory of all systems (including information technology
and non-information technology systems), and contacted all critical suppliers to
determine major areas of exposure to Y2K issues. In the financial and
information system area, a number of applications were identified as Y2K
compliant due to their recent implementation. The Company's core financial and
reporting systems are not Y2K compliant but were already scheduled for
replacement by early 1999. In the customer and equipment area, the Company is in
the process of identifying areas of exposure. As a result of its Phase I
assessment of its non-information technology systems, the Company does not
believe it will incur significant costs remediating those systems for Y2K
compliance. In the third-party consultant and vendor area, most of the parties
contacted by the Company state that they expect to be Y2K compliant by 2000.
Additionally, the Company has included Y2K requirements on all purchase orders
issued to vendors and has included a Y2K disclaimer on all customer invoices.
The Company believes it will cost approximately $200,000 to replace its
core financial and reporting systems and has identified the potential for 1,000
man hours of work to bring the remaining systems network, and financial and
informational system applications into Y2K compliance at an estimated cost of
$100,000. Because of the Company's expertise in this area, internal personnel
will undertake the majority of the work. Approximately one-half of the
compliance costs were incurred in 1998 and the Company expects the remainder to
be incurred in 1999. The Company does not expect to incur significant costs in
connection with the customer and equipment area and the third party consultants
and vendor area.
The Company believes that its most reasonably likely worst case Y2K
scenario is that certain vendors fail to supply the Company with products that
are Y2K compliant, which are then sold to the Company's customers. And that,
certain vendors will be unable to provide the Company with needed products or
services due to the failure of the vendor to be Y2K compliant. In such cases,
the Company plans to use its expertise in this area to work with its customers
to provide Y2K remediation and seek out alternative Y2K compliant vendors. It is
uncertain how the Company might be effected by the occurrence of its most
reasonable likely worst case scenario. However, in the event of such an
occurrence, the Company's revenue, net income or financial condition could be
materially adversely effected. The Company is continuing to review contingency
plans to evaluate Y2K business interruption scenarios, but has not established a
timetable for completion of a formal plan.
18
<PAGE> 19
ITEM 7a QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
In the normal course of business, the financial position of the Company
is routinely subjected to a variety of risks. In addition to the market risk
associated with interest on outstanding debt, other examples of risk include
collectibility of accounts receivable and recoverability of residual values of
assets placed in service.
The Company's debt contains an element of market risk due to possible
changes in interest rates. The Company regularly assesses these risks and has
established collection policies and business practices to minimize the adverse
effects of these and other potential exposures. The Company does not currently
anticipate any material losses in these areas, due primarily to the lack of
significant fluctuation in the prime lending rate on which the Company's
interest expenses are determined. The financial instruments included in the debt
of the Company consist of all of the Company's cash and cash equivalents, bank
financing, bank credit facilities and lines of credit, vendor credit lines,
leases, and, if applicable, marketable securities, and any short and long-term
investments.
The Company assesses the risk of loss due to the impact of changes in
interest rates on market sensitive instruments. Interest rates effecting the
Company's debt are market based and will fluctuate as a result. The Company
prepares forecasts and cost of funds analysis on significant purchases to
anticipate the effect of market interest rate changes.
The Company's earnings are affected by changes in short-term interest
rates as a result of its use of bank (line of credit) financing for working
capital. If market interest rates based on the prime lending rate average 2%
more in 1999 than they did during 1998, the Company's interest expense, after
considering the effects of interest income, would increase, and income before
taxes would decrease by approximately $.2 million assuming comparable average
borrowings. Comparatively, if market interest rates based on the prime lending
rate averaged 2% more in 1998 than they did in 1997, the Company's interest
expense, after considering the effects of any interest income, would have
increased, and income before taxes would have decreased, by $.2 million assuming
comparable average borrowings. These amounts are determined by considering the
impact of the hypothetical change in the interest rates on the Company's
borrowing cost and short-term investment balances, if any. These analyses do not
consider the effects of the reduced level of overall economic activity that
could exist in such an environment. Further, in the event of a change of such
magnitude, management would likely take actions to further mitigate its exposure
to the change. However, due to the uncertainty of the specific actions that
would be taken and their possible effects, the sensitivity analysis assumes no
changes in the Company's financial structure.
19
<PAGE> 20
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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
Report of Independent Certified Public Accountants 21
Independent Auditor's Report 22
Consolidated Balance Sheets as of December 31. 1998 and 1997 23
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997 and 1996 24
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1998, 1997 and 1996 25
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 26
Notes to Consolidated Financial Statements for the Years
Ended December 31, 1998, 1997, and 1996 27
20
<PAGE> 21
Report of Independent Certified Public Accountants
Board of Directors
Data Systems Network Corporation
We have audited the consolidated balance sheet of Data Systems Network
Corporation (a Michigan Corporation) and subsidiary as of December 31, 1998,
and the related consolidated statements of operations, stockholders' equity,
and cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, based on our audit, the financial statements referred to above
present fairly, in all material respects, the financial position of Data
Systems Network Corporation and subsidiary as of December 31, 1998, and the
results of its operations and its cash flows for the year then ended, in
conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note B to the
financial statements, the Company has suffered recurring losses from operations,
has a deficit in working capital. These matters, among others, as discussed in
Note B to the financial statements, raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note B. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
We have also audited Schedule II of Data Systems Network Corporation and
subsidiary as of and for the year ended December 31, 1998. In our opinion this
schedule presents fairly in all material respects, the information required to
be set forth therein.
Grant Thronton LLP
Southfield, Michigan
March 8, 1999
21
<PAGE> 22
INDEPENDENT AUDITORS REPORT
To the Directors and Shareholders
Data Systems Network Corporation
We have audited the accompanying consolidated balance sheet of Data Systems
Network Corporation as of December 31, 1997 and the related consolidated
statements of operations, stockholders' equity, and cash flows for the years
ended December 31, 1997 and 1996. 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 the results of its
operations and its cash flows for the years ended 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, which raises substantial doubt
about the Company's ability to continue as a going concern. Management's plans
concerning these matters are also described in Note B. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
PLANTE & MORAN, LLP
Southfield, Michigan
August 20, 1998
22
<PAGE> 23
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
December 31, 1997
1998 (Restated)
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,695,863 $ 4,463
Investments -- 6,203,361
Accounts receivable (net of allowance of $561,600 and $800,000
at December 31, 1998 and December 31, 1997 respectively) 11,339,484 26,343,980
Notes receivable 60,000 197,133
Inventories 1,296,145 1,001,350
Other current assets 347,983 537,780
------------ ------------
Total current assets 15,739,475 34,288,067
PROPERTY AND EQUIPMENT, net 2,522,978 2,369,744
GOODWILL, (net of amortization of $309,879 and $388,438 at
December 31, 1998 and 1997 respectively) 3,001,570 4,072,207
OTHER ASSETS 1,202,298 4,351,966
TOTAL ASSETS 22,466,321 45,081,984
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank line of credit 3,231,287 17,296,558
Accounts payable 9,640,159 16,154,232
Accrued liabilities 2,390,906 2,201,513
Shareholder Settlement Liability 1,768,000 --
Obligations Under Capital Leases - current portion -- 79,988
Deferred maintenance revenues 3,865,320 927,154
------------ ------------
Total current liabilities 20,895,672 36,659,445
OBLIGATIONS UNDER CAPITAL LEASES -- 157,551
COMMITMENTS and CONTINGENCIES (Notes I & P) -- --
NET LIABILITIES OF DISCONTINUED OPERATIONS -- 2,021,070
STOCKHOLDERS' EQUITY
Preferred stock, authorized 1,000,000 shares, none outstanding -- --
Common stock ($.01 par value; authorized 10,000,000
shares; issued and outstanding 4,859,224 and 4,857,974 shares
at December 31, 1998 and December 31,1997, respectively) 48,592 48,580
Additional paid-in capital 17,951,219 17,945,606
Accumulated deficit (16,429,162) (11,750,269)
------------ ------------
Total stockholders' equity 1,570,649 6,243,917
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 22,466,321 $ 45,081,984
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements
23
<PAGE> 24
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31,
<TABLE>
<CAPTION>
1997 1996
1998 (Restated) (Restated)
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES:
Product revenue $ 63,530,818 $ 67,845,466 $ 26,782,693
Service revenue 21,792,682 18,151,674 5,794,563
------------ ------------ ------------
Total revenues 85,323,500 85,997,140 32,577,256
COST OF REVENUES:
Cost of products 52,213,508 59,227,854 23,151,534
Cost of services 19,024,585 14,287,978 4,464,455
------------ ------------ ------------
Total cost of revenues 71,238,093 73,515,832 27,615,989
GROSS PROFIT 14,085,407 12,481,308 4,961,268
OPERATING EXPENSES:
Selling expenses 9,556,336 10,334,103 4,578,613
General and administrative expenses 6,116,171 5,814,607 3,632,580
------------ ------------ ------------
Total operating expenses 15,672,508 16,148,710 8,211,193
LOSS FROM OPERATIONS (1,587,100) (3,667,402) (3,249,926)
OTHER INCOME (EXPENSE):
Interest expense (802,329) (1,612,583) (580,304)
Interest income 109,592 371,716 267,886
Shareholder settlement (1,768,000) -- --
Other income 349,254 491,638 127,301
------------ ------------ ------------
(2,111,482) (749,229) (185,117)
Loss before extraordinary item and
discontinued operations (3,698,582) (4,416,631) (3,435,043)
EXTRAORDINARY ITEM
Gain recognized upon extinguishment of debt -- -- 75,494
------------ ------------ ------------
Loss before discontinued operations (3,698,582) (4,416,631) (3,359,549)
DISCONTINUED OPERATIONS
Loss from operations of Unified Network Services (1,686,054) (557,469) (481,524)
Gain on Disposal of Unified Network Services 705,742 -- --
------------ ------------ ------------
(980,311) (557,469) (481,524)
------------ ------------ ------------
NET LOSS $ (4,678,893) $ (4,974,100) $ (3,841,073)
============ ============ ============
Loss per common share - basic and diluted
Continuing operations $ (0.76) $ (1.02) $ (1.26)
Discontinued operations (0.20) (0.13) (0.18)
Extraordinary item -- -- 0.03
------------ ------------ ------------
Net loss per common share $ (0.96) $ (1.15) $ (1.41)
============ ============ ============
Weighted average shares outstanding 4,859,224 4,324,229 2,719,091
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
24
<PAGE> 25
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON ADDITIONAL PAID-IN (ACCUMULATED
STOCK CAPITAL DEFICIT) TOTAL
-------- ------------------ ------------- ------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995 $ 27,150 $ 6,385,047 $ (2,935,096) $ 3,477,101
Exercise of warrants for 10,413 shares of common
stock -- (75,494) -- (75,494)
Issuance of common stock in connection with
acquisition 5,400 2,829,600 -- 2,835,000
Net loss -- -- (3,841,073) (3,841,073)
-------- ------------ ------------ ------------
Balance at December 31, 1996 32,550 9,139,153 (6,776,169) 2,395,534
Exercise of stock options and warrant
redemptions 16,030 8,806,453 -- 8,822,483
Net loss -- -- (4,974,100) (4,974,100)
-------- ------------ ------------ ------------
Balance at December 31, 1997 48,580 17,945,606 (11,750,269) 6,243,917
Exercise of stock options 12 5,613 -- 5,625
Net loss -- -- (4,678,893) (4,678,893)
-------- ------------ ------------ ------------
Balance at December 31, 1998 $ 48,592 $ 17,951,219 $(16,429,162) $ 1,570,649
======== ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
25
<PAGE> 26
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1997 1996
1998 (Restated) (Restated)
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,678,893) $ (4,974,100) $ (3,841,073)
Adjustments to reconcile net loss to net cash provided by
operating activities
Depreciation and amortization 1,145,088 883,084 365,227
Extraordinary gain -- -- (75,494)
Provision for doubtful receivables -- 732,391 27,642
Provision for inventory obsolescence -- -- 195,767
Settlement of shareholder lawsuit 1,768,000 -- --
Changes in assets and liabilities that provided (used)
cash net of effects of discontinued operations:
Decrease(Increase) in investments 6,203,361 (6,203,361) --
Decrease(Increase) in accounts receivable 15,004,496 (17,142,838) (4,627,016)
(Increase)Decrease in notes receivable 137,133 (97,043) 142,446
(Increase)Decrease in inventories (294,795) 244,812 1,332,826
Decrease in other current assets 189,797 223,524 359,472
(Increase)Decrease in other assets 3,149,668 (667,355) 502,719
(Decrease)Increase in accounts payable (6,514,071) 8,798,041 3,380,262
Increase(Decrease) in accounts payable 199,678 1,346,598 (241,542)
Increase(Decrease) in deferred maintenance 2,938,166 (13,473) (146,088)
Decrease in net liabilities
of discontinued operations (2,021,070) (75,944) (1,945,126)
------------ ------------ ------------
Net cash provided by (used in) operations 17,226,557 (16,945,664) (4,569,978)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment, net (1,104,304) (1,627,789) (579,117)
Purchase of UNS common stock -- -- (7,000)
Payments for NSG net assets including transaction costs -- -- (1,133,035)
Reduction of intangible asset 866,335 -- --
Redemption of warrants and exercise of stock options, net 5,624 -- --
------------ ------------ ------------
Net cash used in investing activities (232,345) (1,627,789) (1,719,152)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net current borrowings (repayment) under bank line of credit (14,065,272) 8,071,347 4,664,133
Payment of principal on long-term debt -- (75,000) (25,000)
Proceeds from issuance of common stock (net of offering costs) -- 8,822,483 --
Net proceeds (repayment) from capital lease obligation financing (237,539) 237,539 --
------------ ------------ ------------
Net cash provided by (used in) financing activities (14,302,811) 17,056,369 4,639,133
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,691,400 (1,517,084) (1,649,997)
CASH AND CASH EQUIVALENTS AT JANUARY 1 4,463 1,521,547 3,171,544
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT DECEMBER 31 $ 2,695,863 $ 4,463 $ 1,521,547
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS
Cash paid during the period for:
Interest $ 965,000 $ 1,455,000 $ 559,000
============ ============ ============
Income taxes $ -- $ 60,000 $ --
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
26
<PAGE> 27
DATA SYSTEMS NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
NOTE A - NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
The Company's principal activities involve 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 has
two technical helpdesk centers, one in Michigan and one in Louisiana, and 12
direct sales offices located throughout the midwest and eastern United States.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiary, Unified Network Service, Inc (UNS). The operations of UNS were
sold during 1998 and they are shown as discontinued operations (See Note D).
Cash Equivalents
For purposes of the statement of cash flows, the Company considers all highly
liquid debt instruments purchased with a maturity of three months or less to be
cash equivalents.
Restricted Cash
At December 31, 1998, cash of $1,859,000 was restricted in connection with
maintenance agreements. It will become unrestricted as revenue is recognized
according to the terms of the agreements.
Investments
Management determines the appropriate classification of securities at the time
of purchase and re-evaluates such designation as of each balance sheet date. In
1997 the investments are primarily industrial revenue bonds. The securities are
reported at fair value with unrealized gains and losses, net of tax, reported in
the statement of operations. All of the securities were sold in 1998.
Inventories
Inventories are stated at the lower of cost or market as determined by the
weighted average method. Inventories consist of goods for resale and service
parts which represent equipment spares utilized for service contracts.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are
computed principally using the straight-line method based upon estimated useful
lives ranging from 5 to 7 years. Amortization of leasehold improvements is
provided over the terms of the various leases.
Goodwill and Long-Lived Assets
The cost in excess of net assets acquired (goodwill) is amortized using the
straight-line method over twenty years which is the estimate of future periods
to be benefited. The Company performs a review for impairment when events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Undiscounted estimated future cash flows of an asset are
compared with its carrying value, if the cash flows are less than the carrying
value, an impairment loss is recognized.
27
<PAGE> 28
Income Taxes
Income taxes are accounted for by using an asset and liability approach.
Deferred tax assets and liabilities are recognized for the expected future tax
consequences of temporary differences between the financial basis and tax basis
of assets and liabilities. 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.
Revenue recognition
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 the customer receives
the product. 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
Product returns and service adjustments are estimated based upon historical
data. 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.
Loss Per 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 computation of diluted earnings
per share because the effect would have been anti-dilutive.
Use of Estimates
The preparation of financial statements in accordance 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.
Actual results could differ from those estimates.
Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments consist primarily of
cash and cash equivalents, bank lines of credit, accounts receivables, accounts
payable and short-term and long-term debt approximate their fair values.
Financial Statement Presentation
Certain amounts in the 1997 and 1996 financial statements have been reclassified
to conform to the 1998 presentation.
New 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
28
<PAGE> 29
annual financial statements. SFAS No. 130 and 131 are effective for fiscal years
beginning after December 15, 1997. These statements did not have an effect on
the Company's 1998 financial statements.
NOTE B - GOING CONCERN
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, during the years ended December 31, 1998, 1997 and 1996, the Company
incurred losses of $4,688,893, $4,974,100 and $3,841,073, respectively. These
losses have contributed to the Company's deficit in working capital of
$5,156,197. These factors, among others, raise substantial doubt about the
Company's ability to continue as a going concern. The accompanying financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
The financial statements do not include any adjustment relating to the
recoverability and classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. However, the Company has a long term
commitment for a working capital line of credit with its primary lender as
discussed in Note H. The Company has consolidated operations and reduced
overhead expenses. The Company has sold its UNS subsidiary (See Note D) and
reduced staff size in non-revenue generating areas. Management will attempt to
consolidate its business operations and stabilize strategic business
relationships so the Company can meet its obligations and attain a level of
operations that are profitable.
In addition, upon completion of the merger with Alydaar Software Corporation
(see Note Q) the Company believes that additional financial resources would be
available and certain synergies relating to business opportunities and
operations will be realized to help return the company to profitability.
NOTE C - 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 the 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 D
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.
NOTE D - DISCONTINUED OPERATIONS - SALE OF UNIFIED NETWORK SERVICES INC.
During 1998, the Company decided to sell its 70% interest in its large account
network management services operation, Unified Network Services Inc. Under the
terms of the original 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 interest in UNS for cash and
notes and to classify the business of UNS as a discontinued operation, 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 also assumed the
existing liabilities of UNS. The gain upon disposal of the discontinued
operations is net of allowances of $3,000,000 due to the uncertainty of the
buyer's ability to repay the note and $989,400 in advances made by the Company
for working capital and payment of certain assumed liabilities.
29
<PAGE> 30
As of December 31, 1998 and 1997, assets and liabilities of the discontinued
operations included in the balance sheet are summarized below:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997
1998 (RESTATED)
------ -----------
<S> <C> <C>
Assets
Current assets -- $ 764,813
Property,plant and equipment, net -- $ 213,695
Liabilities
Current liabilities -- $ (152,653)
Other liabilities -- $(2,846,925)
------ -----------
Net assets (liabilities) of discontinued operations $ -- $(2,021,070)
====== ===========
</TABLE>
The results of operations of the discontinued operations for the years ended
December 31, 1998, 1997 and 1996 are summarized below:
<TABLE>
<CAPTION>
For years ended December 31, 1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Revenues $ 278,060 $ 2,013,309 $ 72,338
Loss from discontinued operations $(1,686,054) $ (557,469) $ (481,524)
</TABLE>
NOTE E - PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows at December 31:
<TABLE>
<CAPTION>
1997
1998 (RESTATED)
----------- -----------
<S> <C> <C>
Computer equipment and software $ 3,889,597 $ 3,019,280
Furniture and Fixtures 856,720 712,972
Leasehold improvements 257,831 75,905
----------- -----------
5,004,148 3,808,157
Less accumulated depreciation and amortization (2,481,170) (1,438,413)
----------- -----------
$ 2,522,978 $ 2,369,744
=========== ===========
</TABLE>
Depreciation and amortization expense was approximately $914,000, $574,000 and
$583,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
30
<PAGE> 31
NOTE F - OTHER ASSETS
Other Assets Consist Of The Following At December 31,
<TABLE>
<CAPTION>
1997
1998 (RESTATED)
---------- ----------
<S> <C> <C>
Prepaid expenses $ 406,662 $ 709,405
Advances to Subsidiary -- 2,846,925
Accounts receivable - other 795,636 795,636
---------- ----------
$1,202,298 $4,351,966
========== ==========
</TABLE>
NOTE G - ACCRUED LIABILITIES
Accrued liabilities consist of the following at December 31,
<TABLE>
<CAPTION>
1997
1998 (RESTATED)
---------- ----------
<S> <C> <C>
Compensation benefits and taxes $1,229,821 $1,264,158
Customer advances 140,181 11,500
State sales and other taxes 74,208 414,742
Interest -- 161,801
Other 946,696 349,312
---------- ----------
$2,390,906 $2,201,513
========== ==========
</TABLE>
NOTE H - LINES OF CREDIT
As of September 30, 1998, the Company had a credit agreement ("NBD Agreement")
with NBD Bank ("NBD"). The Agreement provided for a discretionary line of credit
not to exceed $11 million. Borrowing limits under the credit facility were
determined based on a collateral formula, which included 80% of qualified trade
receivables. Borrowings under the credit agreement bore interest at 2% over NBD
prime and had a term extending to September 30, 1998. Previously, the Company
had a credit agreement that 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. Each was collateralized by an
interest in the Company's accounts receivable, inventory (other than equipment
financed through IBM Credit) and equipment.
On September 30, 1998 the Company and Foothill Capital Corporation ("Foothill")
entered into a new credit facility ("Foothill Agreement"), replacing in its
entirety, the NBD Agreement. The Foothill Agreement provides for an initial
revolving line of credit not to exceed $15 million. The available line of credit
at December 31,1998 was $3,231,287. The Company may, at its option and subject
to certain collateral requirements, increase the line to $20 million during the
term of the Foothill Agreement. Borrowing limits under the Foothill Agreement
are determined based on a collateral formula, which includes 85% of qualified
trade receivables. Borrowings under the Foothill Agreement bear interest at 1%
over Norwest Bank prime (7.5 % at December 31, 1998)and have a term extending to
September 30, 2001. All monies owed by the Company to NBD were paid on October
1, 1998.
The Company is required to maintain certain financial ratios. At December 31,
1998 the company was not in compliance with several ratios and obtained a waiver
from Foothill Capital Corporation.
The Company has also entered into a finance agreement with IBM Credit
Corporation. The agreement extended a maximum of $2,000,000 to be used
exclusively for the acquisition of inventory for resale. 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-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
31
<PAGE> 32
changed at the discretion of IBM Credit Corporation. The amount outstanding at
December 31, 1998 and 1997 is approximately $1,400,000 and $1,500,000,
respectively, and has been included in accounts payable.
NOTE I - LEASE COMMITMENTS
The Company has entered into several non-cancelable operating leases for office
space, computer equipment, and certain furniture and fixtures that expire at
various dates through 2003. The approximate future minimum annual rentals under
non-cancelable operating leases are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
- ------------------------
<S> <C>
1999 $1,103,973
2000 877,135
2001 790,671
2002 298,760
2003 77,320
-----------
Total minimum lease obligations $3,147,859
===========
</TABLE>
All leases previously recorded as capital leases were paid off as of October 1,
1998 in accordance with the terms of the Foothill Agreement.
Total rent expense for the years ended December 31, 1998, 1997, and 1996 was
approximately $1,558,000, $1,130,000 and $595,000, respectively.
NOTE J - INCOME TAXES
Deferred tax assets and liabilities at December 31, consist of the following:
<TABLE>
<CAPTION>
1997
1998 (RESTATED)
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 3,336,000 $ 3,205,000
Deferred maintenance revenue 17,000 --
Allowance for doubtful accounts 273,000 437,000
Shareholder lawsuit settlement 601,000 --
Inventory -- 19,000
Depreciation -- 112,000
Accrued vacation 102,000 93,000
----------- -----------
4,329,000 3,866,000
Deferred tax liabilities
Depreciation (138,000) --
Amortization (114,000) --
Other -- (69,000)
----------- -----------
(252,000) (69,000)
Less valuation allowance (4,077,000) (3,797,000)
----------- -----------
$ -- $ --
=========== ===========
</TABLE>
32
<PAGE> 33
The net operating loss carryforwards expire in 2007 - 2018.
The income tax provision reconciled to the tax computed at the statutory federal
rate for continuing operations was as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1997 1996
1998 (RESTATED) (RESTATED)
----------- ----------- -----------
<S> <C> <C> <C>
Tax (benefit) at statutory rates applied to income before
federal income tax from continuing operations $(1,260,000) $(1,502,000) $(1,142,000)
Effect of nondeductible items 41,000 52,000 14,000
Extraordinary gain -- -- (26,000)
Other -- (144,000) 28,000
Change in treatment on income tax return 939,000 -- --
Valuation allowance 280,000 1,594,000 1,126,000
----------- ----------- -----------
$ -- $ -- $ --
=========== =========== ===========
</TABLE>
NOTE K - FORGIVENESS OF DEBT
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. 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.
This contingent liability was not previously recorded, as the amount could not
be reasonably estimated. As a result of extensive negotiations, the Company
purchased 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 due of approximately $114,000 and the contingent payments
noted above have been eliminated. The bankruptcy court issued its final decree
on January 16, 1997.
There was an extraordinary gain of approximately $75,000 in 1996, which
represents the purchase of the warrants and the extinguishment of the related
debt.
NOTE L - 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.
33
<PAGE> 34
NOTE M - STOCK OPTION PLANS
In April 1994 the Company adopted the 1994 Stock Option Plan ("the 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 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.
In 1998 the Company granted options for 40,000 shares to a Director of the
Company exercisable at a price of $.88 per share which approximated the fair
market value at the date of grant. Such options vest 50% on the second
anniversary date, and the 25% vest each of the next two years. In 1997 and 1996,
the Company granted options for 3,000 shares exercisable at a price of $9.83
and $3.00 per share, respectively, which was the fair market value at the date
of grant, to Directors of the Company. Such options vest one year from the grant
date.
The per share weighted-average fair value of stock options granted during 1998,
1997 and 1996 was $3.86, $9.83 and $4.00 per share, respectively.
<TABLE>
<CAPTION>
SHARES AVERAGE PER
UNDER SHARE EXERCISE
OPTIONS PRICE
-------- --------------
<S> <C> <C>
Balance at December 31, 1995 70,716 $ 4.58
Issued 146,437 $ 4.46
Forfeited (25,450) $ 4.11
Exercised -- --
--------
Balance at December 31, 1996 191,703 $ 4.55
Issued 215,350 $ 9.82
Forfeited (9,062) $ 6.19
Exercised (21,768) $ 4.57
--------
Balance at December 31, 1997 376,223 $ 7.54
Issued 138,750 $ 3.86
Forfeited (137,900) $10.10
Exercised (1,250) $ 4.50
--------
Balance at December 31, 1998 375,823 $ 5.15
========
</TABLE>
The range of exercise prices on outstanding options at December 31, 1998 is as
follows:
<TABLE>
<CAPTION>
Weighted Average
AVERAGE REMAINING
PRICE RANGE SHARES EXERCISE PRICE LIFE
<S> <C> <C> <C>
.88 - 2.50 108,125 $ 1.10 9.4
2.51 - 5.00 123,548 4.18 7.1
5.01 - 7.50 80,900 6.86 8.2
7.51 - 10.00 18,550 8.99 8.2
10.01 - 13.75 44,750 12.91 8.8
-------
375,823
=======
</TABLE>
As of December 31, 1998, 1997 and 1996 the number of options exercisable was
193,123, 62,641 and 56,892, respectively and the weighted average exercise price
of those options was $5.29, $4.53 and $4.75, respectively.
The Financial Accounting Standard Board has issued Statement No. 123,
"Accounting for Stock Based Compensation" ("SFAS No. 123"). The Statement
established a fair value method of accounting for employee
34
<PAGE> 35
stock options and similar equity instruments such as warrants, and encourages
all companies to adopt that method of accounting for all of their stock
compensation plans. However, the statement allows companies to continue
measuring compensation for such plans using accounting guidance in place prior
to SFAS No. 123. Companies that elect to remain with the former method of
accounting must make pro-forma disclosures of net earnings and earnings per
share as if the fair value method provided for in SFAS No. 123 had been adopted.
The fair value of each grant is estimated on the date of grant using the
Black-Scholes option - pricing model with the following weighted average
assumptions for grants: dividend yield of 0%, expected volatility of 157.6%,
70%, and 30% in 1998, 1997 and 1996 respectively, risk-free interest rate of
5.8%, 6.5% and 6.9% in 1998, 1997 and 1996 respectively, and expected life
ranging from seven to ten years.
The Company has not adopted the fair value accounting provisions of SFAS No.
123. Accordingly, SFAS No. 123 has no impact on the Company's financial position
or results of operations.
The Company accounts for the stock option plan under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." No compensation costs have been
recognized. Had compensation cost for the plan been determined based on the fair
value of the options at the grant dates consistent with the method of SFAS No.
123, the Company's net loss and loss per share would have been as follows (in
thousands, except for per share data):
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Net Loss as reported $ 4,678 $ 4,974 $ 3,841
Proforma 4,985 5,418 3,930
Loss per share as reported $ (.96) $ (1.15) $ (1.41)
Proforma (1.03) (1.25) (1.45)
</TABLE>
NOTE N - EMPLOYEE BENEFIT PLANS
The Company maintains a defined contribution 401(k) plan that covers
substantially all employees. Contributions to the Plan may be made by the
Company (which are discretionary) or by plan participants through elective
salary reductions. No contributions were made to the plan by the Company during
the years ended December 31, 1998, 1997, and 1996.
NOTE O - MAJOR CUSTOMERS
The Company had one customer, the State of Michigan, which accounted for
approximately 29% of revenue in each of 1998 and 1997. Additionally, during
1998, the State of New York represented 12%.
NOTE P - COMMITMENTS AND CONTINGENCIES
Legal Proceedings
The Company is involved in certain routine legal proceedings which are
incidental to its business. All of these proceedings arose in the ordinary
course of the Company's business and, in the opinion of the Company, any
potential liability of the Company with respect to these legal actions will not,
in the aggregate, be material to the Company's financial condition or
operations.
On or about October 29, 1998, the Securities and Exchange Commission ("SEC")
informed the Company that it is conducting a formal private investigation of the
accounting irregularities experienced by the Company in the fiscal years 1996
and 1997, This inquiry is ongoing, and the Company is cooperating with the SEC
and providing information as requested.
35
<PAGE> 36
Year 2000
The Year 2000 issue relates to limitations in computer systems and applications
that may prevent proper recognition of the Year 2000. The potential effect of
the Year 2000 issue on the Company and its business partners will not be fully
determinable until the Year 2000 and thereafter. If Year 2000 modifications are
not properly completed either by the Company or entities with which the Company
conducts business, the revenues and financial condition could, be adversely
impacted.
NOTE Q - SUBSEQUENT EVENTS
During 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. On February 17, 1999, the
Company announced that it had agreed to a stipulation of settlement of the
consolidated securities class action lawsuits filed in 1998. The stipulation of
settlement has been filed in federal court in Detroit, Michigan. Although the
court gave preliminary approval for the proposed settlement, it is subject to
the court's later determination of the settlement's fairness at a hearing
currently set for May 12, 1999. Under the terms of the proposed settlement, and
subject to various conditions, the Company will create a settlement fund valued
at approximately $2 million. The fund will benefit a settlement class of
purchasers who bought the Company's stock during the period of May 16, 1996
through February 24, 1998. The fund would be comprised of $900,000 provided by
the Company's insurer, and at the defendants' option either 650,000 shares of
the Company's common stock or an additional $1.1 million. In agreeing to the
proposed settlement, the Company made no admission of any wrongdoing. As a
result of this tentative settlement, the Company has accrued $1,768,000 as the
estimate of its liability.
In February 1999, Data Systems and Alydaar Software Corporation, doing business
as Information Architects (Nasdaq/NMS: "ALYD") of Charlotte, North Carolina
announced the signing of a definitive merger agreement. Alydaar is a worldwide
developer of Enterprise Information Portals and provides management consulting,
design, development and deployment of Virtual Information Solutions.
Additionally, Alydaar assists organizations in modernizing their current legacy
information systems, and offers Y2K services utilizing SmartCode Technology.
36
<PAGE> 37
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On October 15, 1998, Plante & Moran, LLP ("Plante") informed the Board
of Directors of the Company that it would decline to stand for reappointment, if
asked, as auditors for the Company. Plante also notified the Company at that
time that, as of the date of such notification, the client-auditor relationship
between the parties was terminated. The Company placed no limitations on Plante
responding fully to inquiries of the successor accountant.
The reports of Plante on the Company's financial statements for each of
the past two fiscal years contained no adverse opinion or disclaimer of opinion
and were not qualified or modified as to uncertainty, audit scope or accounting
principle, except that, as issued, Plante's report dated August 20, 1998
included a modification addressing the Company's going concern uncertainty. The
Company's plans concerning these matters is described in the footnotes attached
to the financial statement referenced in that report.
In connection with its audits for the two most recent fiscal years and
through October 15, 1998, (i) there were no disagreements between the Company
and Plante 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 Plante would have caused them to make reference
thereto in their report on the financial statement for such fiscal years and
(ii) there were no reportable events as defined in Regulation S-K Item
304(a)(1)(v) except that Plante advised the Audit Committee of the Registrant's
Board of Directors, by letter dated May 21, 1998, of certain items it considered
to be material weaknesses in internal controls in 1997 relating to the Company's
general accounting practices then in place, including those relating to billing,
accounts, payable, and inventory. These items were discussed with the Audit
Committee on September 15, 1998. Management has addressed and will continue to
address the recommendations of Plante.
On March 13, 1998, KPMG Peat Marwick LLP ("KPMG") informed the Board of
Directors of the Company that it had resigned as the Company's independent
auditors. The reports of KPMG on the Company's financial statements for each of
the past two fiscal years were withdrawn as of February 24, 1998. Prior to such
withdrawal, such reports contained no adverse opinion or disclaimer of opinion
and were not qualified or modified as to uncertainty, audit scope or accounting
principle.
In connection with its audits for the two most recent fiscal years and
through March 13, 1998, (i) there were no disagreements between the Company and
KPMG 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 KPMG would have caused them to make reference thereto in
their report on the financial statements for such fiscal years and (ii) there
were no reportable events as defined in Regulation S-K item 304(a)(1)(v), except
as follows:
As announced on February 24, 1998, the Company and KPMG became aware of
certain accounting irregularities, which may have affected previously issued
financial statements. Contemporaneously, KPMG advised the Company that its
auditor's report on the Company's
37
<PAGE> 38
consolidated financial statements as of December 31, 1996 and 1995 and for each
of the years in the two-year period ended December 31, 1996 should no longer be
relied upon. A special committee of the outside members of the Company's Board
of Directors was established to investigate the matter. In KPMG's March 13, 1998
letter of resignation, it advised the Board of Directors of the Company that it
had concluded that it could no longer rely on management's representations, and
that it was unwilling to be associated with the financial statements prepared by
management.
KPMG previously communicated to the Company two items which it
considered to be material weaknesses in internal control relating to the
Company's new accounting system and the schedules and other supporting
documentation. These items were subsequently discussed with the Audit Committee
of the Board of Directors.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following is a list of the members of the Board of Directors and the
executive officers of the Company and includes information regarding the
individual's age, principal occupation, other business experience, directorships
in other publicly-held companies and term of service with the Company. Each
director holds office until the next annual meeting of shareholders and until
his successor has been elected and qualified.
<TABLE>
<CAPTION>
Name Age Position
- -------------------- --- ----------------------------------------
<S> <C> <C>
Michael W. Grieves 49 Chairman of the Board,
President, Chief Executive
Officer and Director
Walter J. Aspatore 55 Director
Richard R. Burkhart 46 Director
John O. Lychos Jr. 43 Vice President - Finance, Chief
Financial Officer, Treasurer and Asst.
Secretary
Diane L. Grieves 49 Executive Vice President
and Secretary
Gregory D. Cocke 42 Vice President - Sales (Midwest)
Garrett L. Denniston 48 Vice President - Sales (Northeast)
</TABLE>
Mr. Grieves has served as the Company's President, Chief Executive
Officer and Chairman of the Board since its inception in 1986. Prior to 1986,
Mr. Grieves served in executive, managerial
38
<PAGE> 39
and technical capacities with Computer Alliance Corporation, a turnkey system
house, Quanex Management Sciences, a computer services bureau, and Lear Siegler
Corporation, and has more than 25 years of experience in the computer industry.
Mr. Grieves is married to Diane L. Grieves, the Company's Executive Vice
President and Secretary.
Mr. Aspatore, a Director of the Company since November 1994, has been
Managing Director of Amherst Capital Partners, which provides investment banking
services to medium and small businesses, since its founding in 1994. Prior to
the formation of Amherst Capital Partners, Mr. Aspatore was President of Onset
BIDCO, which supplies financing and management services to companies with strong
growth potential, from 1991 to November 1994. Mr. Aspatore was the President of
Cross & Trecker Corporation, a $500 million worldwide factory automation
company, from 1988 to 1991 and served that company in various capacities for
approximately 22 years. He has a total of more than 27 years of senior level
management experience in operations and finance in the worldwide factory
automation, automotive and aerospace industries.
Mr. Burkhart, a Director of the Company since 1986, has been a
management consultant with his own firm, Emerald Asset Management, Inc., since
1991 and for the last fifteen years Mr. Burkhart has specialized in managing
financially troubled businesses. Mr. Burkhart served as the Company's Treasurer
from 1986 until April 1997. Since 1992, Mr. Burkhart has served as President and
is a principal of New Century Metals, Inc. in Cleveland, Ohio. From 1986 to
1991, he was Chairman of the Pratt & Whitney Machine Tool Company in West
Hartford, Connecticut. Prior experiences included executive positions in finance
and planning with major manufacturing companies, including Quanex Corporation
and Republic Steel Corporation.
Mr. Lychos, the Company's Chief Financial Officer, Treasurer, Vice
President - Finance and Assistant Secretary has been with the Company since May
1998. Prior to joining the Company, he was a Vice President/Area Controller for
Waste Management Inc., and held a variety of other responsible financial
management positions with that company throughout his fifteen-year tenure.
Ms. Grieves, the Company's Executive Vice President and Secretary, has
held executive positions in sales, operations, and administration at the Company
since its inception. From 1984 to 1985, Ms. Grieves was Vice President of Sales
at Executive Data Solutions, Inc., a computer sales organization. Prior to that,
Ms. Grieves held numerous sales and sales management positions with American
Telephone and Telegraph and the Bell operating companies. Ms. Grieves is married
to Michael W. Grieves, the Company's Chairman, President and Chief Executive
Officer.
Mr. Cocke, the Company's Vice President - Sales (Midwest), has held
various sales management and executive positions with the Company since its
inception. Prior to 1986, Mr. Cocke was employed in sales and sales management
capacities at Inacomp Computer Centers, Inc. and Executive Data Solutions, Inc.,
both computer sales organizations.
Mr. Denniston, the Company's Vice President - Sales (Northeast), has
held various sales management and executive positions with the Company since
1996. Prior to 1996, Mr. Denniston was employed in sales and sales management
capacities at Memorex-Telex, Inc.
39
<PAGE> 40
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers and directors, and persons who own more than 10% of a
registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission.
Officers, directors and greater than 10% shareholders are required by SEC
regulation to furnish the Company with copies of all Section 16(a) forms they
file. Based solely on its review of the copies of such forms received by it
since January 1, 1998, or written representations from certain reporting persons
that no Forms 5 were required for those persons, the Company believes that its
officers, directors, and greater than 10% beneficial owners filed all reports
required under Section 16(a).
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY
The following table sets forth the compensation paid by the Company to
the Chief Executive Officer and other executive officers who earned more than
$100,000 in salary and bonus during 1998 (collectively the "Named Officers").
Summary Compensation Table
<TABLE>
<CAPTION>
Name and Annual Long Term
Principal Position Compensation Compensation Awards
Securities
Year Salary Bonus Underlying Options
<S> <C> <C> <C> <C>
Michael W. Grieves 1998 $160,000 - -
Chairman, President and 1997 $160,000 30,000 8,000
Chief Executive Officer 1996 $121,000 - -
Diane L. Grieves 1998 $120,000 30,000 -
Executive Vice President 1997 $120,000 15,375 7,500
And Secretary 1996 $120,000 - 15,000
Gregory D. Cocke 1998 $150,000 60,500 -
Vice President - Sales (MW) 1997 $108,750 28,500 11,250
1996 $130,000 - 15,000
Garret L. Denniston 1998 $150,000 80,000 -
Vice-President - Sales (NE) 1997 $150,000 60,000 -
1996 $ 50,000 - -
</TABLE>
OPTION HOLDINGS
The following table provides information with respect to the
unexercised options held as of the end of 1998 by the Named Officers.
40
<PAGE> 41
Aggregated Option/SAR Exercises In
Last Fiscal Year and Fiscal Year-End option/SAR Values
<TABLE>
<CAPTION>
VALUE OF
NUMBER OF UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTIONS/SARS AT
SHARES FISCAL YEAR END FISCAL YEAR END
ACQUIRED SHARES VALUE REALIZED --------------------------- EXERCISABLE/
NAME ON EXERCISE (#) ($) EXERCISABLE UNEXERCISABLE UNEXERCISABLE
- -------------------- -------- ------------ -------------- ----------- ------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Michael Grieves 14,000 4,000 -
Diane L. Grieves 22,500 7,500 -
Gregory D. Cocke 22,500 11,250 -
Garrett L. Denniston 8/26/96 1,000 13,625 26,000 25,000 -
</TABLE>
(a) Value was determined by multiplying the number of shares subject to the
option by the difference between the last sale price of the Common
Stock reported for December 31, 1998 on the Over-the-Counter Bulletin
Board and the option exercise price.
DIRECTOR COMPENSATION
Customarily, the Company has paid non-employee directors an annual
retainer of $1,000 and a fee of $500 for each Board or committee meeting
attended. On the date of each annual shareholders meeting, each non-employee
director elected or reelected as such will also receive an option under the 1994
Stock Option Plan to purchase 1,000 shares of Common Stock, exercisable
beginning one year after the grant date, at an exercise price equal to the fair
market value on the grant date. The Company also reimburses out-of- pocket
expenses related to non-employee directors in attendance at such meetings.
Due to the unique nature of events at the close of 1997, the Company
did not hold an annual shareholder meeting in 1998. Directors were not paid
their retainer or fees, nor were they awarded options under the stock option
plan. However, due to the additional responsibilities assigned to Mr. Aspatore
by the other outside Directors, which included leading the special investigation
regarding accounting irregularities, the Board awarded Mr. Aspatore 40,000
options in a one-time special grant in recognition of the special circumstances
and responsibilities assumed. The options were granted at the end of the second
quarter with an option price of $.875 per share, exercisable one year after the
grant date, which is consistent with the terms of the Company's 1994 Stock
Option Plan.
ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of March 1, 1999, certain information
with respect to the beneficial ownership of Common Stock by each Director of the
Company, each of the Named Officers, all current directors and current executive
officers as a group and all other persons known by the Company to beneficially
own more than 5% of the outstanding shares of Common Stock (each, a 5% Owner).
41
<PAGE> 42
<TABLE>
<CAPTION>
Number of Percent of
Name Shares (a) Class (b)
- ---- ---------- ----------
<S> <C> <C>
Michael W. Grieves(c) 699,000 14.4%
Walter J. Aspatore 6,000 .1%
Richard R. Burkhart 143,625 3.0%
Gregory D. Cocke(c) 383,750 7.9%
Diane L. Grieves 22,500 .5%
Garret L. Denniston(c) 26,000 .5%
All executive officers and
Directors as a group (7 persons) 1,280,875 26.4%
</TABLE>
(a) The column sets forth shares of common Stock which are deemed to be
"beneficially owned" by the persons named in the table under Rule 13d-3
of the SEC. This column includes option shares of common stock that may
be acquired upon the exercise of stock options that are presently
exercisable or become exercisable within 60 days.
(b) For purposes of calculating the percentage of Common Stock beneficially
owned, the shares issuable to such person under stock options or
warrants exercisable within 60 days are considered outstanding and
are added to the shares of common stock actually outstanding.
(c) The address for Messrs. Grieves, Denniston and Cocke is the Company's
address.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
A portion of the consideration for certain 13% subordinated promissory
notes of the Company acquired by Mr. Grieves, the Company's Chairman, President
and Chief Executive officer, pursuant to the Company's Plan of Reorganization in
1992 was a $200,000 promissory note (the "Grieves Note"). The Grieves Note bears
interest at the Internal Revenue Service annual imputed rate, payable annually,
and does not become due unless the maker fails to pay interest in accordance
with its terms and demand is made by the holder. The principal amount due under
the Grieves Note would be reduced in the event and to the extent that a third
party (MTS-SWS, Inc., a Delaware Corporation) would make payment on certain
indebtedness owed to Mr. Grieves or the Company. Mr. Grieves' interest in such
note has been assigned to the Company. There is $200,000 outstanding under the
Grieves Note as of March 17, 1999, which is the largest amount outstanding under
the Grieves Note since the beginning of 1998.
42
<PAGE> 43
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) and Item 10.21 ("Employment Agreement between the Company and
John O. Lychos Jr. dated May 12, 1998") 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.
The following filings occurred in the fourth quarter of 1998:
<TABLE>
<CAPTION>
Date Information Reported
---------------- --------------------
<S> <C>
October 7, 1998 Items 5 and 7
October 22, 1998 Items 4 and 7
November 3, 1998 Items 4 and 7
November 4, 1998 Items 4 and 7
December 1, 1998 Items 5 and 7
</TABLE>
No financial statements were filed with these Reports on Form 8-K.
43
<PAGE> 44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereto duly authorized.
DATA SYSTEMS NETWORK CORPORATION
By: /s/ Michael W. Grieves
--------------------------------
Michael W. Grieves
Chairman, President and Chief
Executive Officer
Dated - March 30, 1999
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following person on behalf of the
Registrant an in the capacities indicated as of March 30, 1999.
By:/s/ Michael W. Grieves
Michael W. Grieves
Chairman of the Board, Director, President and Chief
Executive Officer (Principle Executive Officer)
By:/s/ John O. Lychos Jr.
John O. Lychos Jr.
Vice President, Treasurer and Chief Financial Officer
(Principle Financial Officer and Principle Accounting Officer)
By:/s/ Walter J. Aspatore
Walter J. Aspatore
Director
By:/s/ Richard M. Burkhart
Richard M. Burkhart
Director
44
<PAGE> 45
Schedule II
Data Systems Network Corporation
Valuation and Qualifying Accounts
Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Additions
-------------------------
Balance at Charged to Charged to
beginning of costs and other Balance at end
Description period expenses accounts Deduction of period
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1998
Allowance for doubtful receivables $ 800,000 $ 204,981 $ -- $ (443,381) $ 561,600
Valuation Allowance for deferred tax asset $3,797,000 $ 280,000 $ -- $ -- $4,077,000
Year ended December 31, 1997
Allowance for doubtful receivables $ 67,609 $1,227,223 $ -- $ (494,832) $ 800,000
Valuation Allowance for deferred tax asset $2,203,000 $1,594,000 $ -- $ -- $3,797,000
Year ended December 31, 1996
Allowance for doubtful receivables $ 39,967 $ 91,335 $ -- $ (63,693) $ 67,609
Allowance for inventory obsolescence $ 978,446 $ -- $ -- $ (978,446) $ --
Valuation Allowance for deferred tax asset $1,077,000 $1,126,000 $ -- $ -- $2,203,000
</TABLE>
45
<PAGE> 46
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF EXHIBITS
2.3 Agreement and Plan of Merger, dated January 31, 1999, by and among the
Company and Alydaar Software Inc. Schedules to the Agreement, listed on
pp 4-5 of the Table of Contents of the Agreement, were not filed, but
will be provided to the Commission supplementally upon request. (7)
3.1 Articles of Incorporation, as amended (1)
3.2 Bylaws, as amended (1)
4.5 Form of Warrant issued to former unsecured creditors pursuant to Third
Amended Plan of Reorganization (5)
10.3(a) Form of non-qualified stock option agreement under 1994 Stock Option
Plan. (2)
10.3(c) 1994 Stock Option Plan, as amended and restated April 1997. (4)
10.3(d) Form of non-qualified stock option agreement under 1994 Stock Option
Plan (April 1997 version). (4)
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.(3)
10.15 Stock Purchase Agreement, dated February 22, 1996, among the Company
and Unified Network Services.(3)
10.20 Loan and Security Agreement by and between the Company and Foothill
Capital Corporation dated as of September 30, 1998. (6)
10.21 Employment Agreement between the Company and John O. Lychos Jr. dated
May 12, 1998 *
27 Financial Data Schedule *
* Filed herewith.
(1) Incorporated by reference from the Company's Registration Statement on
Form 5-1, No. 33-81350, as amended.
(2) Incorporated by reference from the Company's Annual Report on Form 10-K
for the year ended December 31. 1995.
(3) Incorporated by reference from the Company's Quarterly Report on Form
l0-Q for the period ended March 31, 1996.
(4) Incorporated by reference from the Company's Quarterly Report on Form
l0-Q for the period ended June 30, 1997.
(5) Incorporated by reference from the Company's Annual Report on Form 10-K
for the year ended December 31, 1997.
(6) Incorporated by reference from the Company's Quarterly Report on Form
l0-Q for the period ended September 30, 1998.
(7) Incorporated by reference from the Company's Current Report on Form 8-K
filed March 18, 1999.
<PAGE> 1
Exhibit 10.21
DATA SYSTEMS NETWORK CORPORATION
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT (this "Agreement') dated as of this 12th day
of May, 1998, between Data Systems Network Corp., a Michigan corporation
(hereinafter referred to as the "Company"), and John 0. Lychos, Jr.
(hereinafter referred to as the "Executive"):
WITNESSETH:
WHEREAS, the Executive is serving as Vice President of Finance and
Chief Financial Officer of the Company; and
WHEREAS, the Executive has extensive experience with respect to the
management and operations of the Company which it considers extremely valuable
to the continued prosperity of the Company; and
WHEREAS, the Company wishes to ensure that it will continue to have the
Executive available to perform for the Company, duties as Vice President of
Finance and Chief Financial Officer; and
WHEREAS, the Company and the Executive desire to set forth in this
Agreement the terms, conditions and obligations of the parties with respect to
such employment and this Agreement is intended by the parties to supersede all
previous agreements and understandings, whether written or oral, concerning such
employment.
NOW, THEREFORE, for and in consideration of the premises and the mutual
covenants contained herein, the parties agree as follows:
1. EMPLOYMENT. The Company (or "Employer") shall continue to employ the
Executive upon the terms and conditions hereinafter set forth. The Executive
shall perform such duties and responsibilities for the Employer, which are
commensurate with his position as may be assigned him by the Company's President
and CEO. The Executive shall report to the President and CEO of the Company.
Incident to the performance of such duties, the Employer shall provide the
Executive with office space, facilities and secretarial assistance commensurate
with that currently being provided to the Executive.
2. TERM. Subject only to the provisions hereof set forth in Section 7,
the term of this Agreement (herein the "Term") shall be for a period beginning
on the date hereof and ending on May 11, 2003 or, if earlier, on the Executive's
62nd birthday on which birthday this Agreement shall terminate unless earlier
terminated in accordance with the terms hereof,
3. COMPENSATION. During the Term, the Executive's salary shall be
payable at intervals not less often than semi-monthly. The Executive's salary
shall be established by either the Executive Committee of the Company, or in the
event the Executive is among the
<PAGE> 2
Company officers whose compensation is subject to review by the Compensation and
Stock Option Committee of the Board of Directors of the Company, by such
Committee (the applicable committee being referred to herein as the "Committee")
and all adjustments thereto, and all aspects of the Executive's incentive or
performance compensation shall be established by the Committee in its sole
discretion. In the event there is no Committee in existence at any time, the
term Committee shall be deemed to mean the Chief Executive Officer of the
Company. During the Term, the Executive shall also receive such benefits and
perquisites (the "Benefits") which are made available to similarly positioned
executives of the Employer including, without limitation, incentive
compensation, loans, awards, insurance, stock options, stock purchase plans,
benefits from qualified plans or non-qualified plans or other benefit plans now
or hereafter existing which are adopted by the Employer for the benefit of its
employees generally, and for the benefit of the Employer's officers, all such
Benefits to be provided in such amounts, as may be determined from time to time
by the Committee in its sole discretion.
4. EXTENT OF SERVICE. During the Term, the Executive shall devote his
full time, attention, and energy to the business of the Employer and the
Executive shall not be engaged in any other business activity pursued for gain,
profit, or other pecuniary advantage which activity in any way interferes with
the Executive's duties and responsibilities provided for herein.
5. NON-COMPETITION AND NON-SOLICITATION. The Executive agrees that:
(a) During the Term and for a period of one year thereafter or during
any Severance Period, if longer (the "Restricted Period"), the Executive agrees
that he will not (without the written consent of the Chairman of the Board)
engage directly or indirectly in any business within the United States
(financially as an investor or lender or as an employee, director, officer,
partner, independent contractor, consultant or owner or in any other capacity
calling for the rendition of personal services or acts of management, operation
or control) which is directly competitive with the business, at any time during
the Restricted Period, conducted by the Company or any Affiliates as defined
below. Notwithstanding the foregoing, the Executive shall be entitled to own
securities of any corporation conducting a business competitive with the
business of the Company or any of its subsidiaries or Affiliates so long as the
securities of such corporation are listed on a national securities exchange and
the securities owned directly or indirectly by the Executive do not represent
more than two percent (2%) of any class of the outstanding securities of such
company.
(b) During the Restricted Period, in addition to the obligations
pursuant to Subsection 5(a), the Executive agrees that neither he nor any
business in which he engages directly or indirectly will (i) directly or
indirectly induce any customers of the Company or of corporations or businesses
which directly or indirectly control or are controlled by or under common
control with the Company ("Affiliates") to patronize any business similar to
that of the Company, (ii) canvass, solicit or accept any similar business from
any customer of the Company or any Affiliates, (iii) directly or indirectly
request or advise any customer of the Company or Affiliates to withdraw, curtail
or cancel such customer's business with the
<PAGE> 3
Company or Affiliates, (iv) directly or indirectly disclose to
any other person, firm or corporation the names or addresses of any of the
customers of the Company or Affiliates, or (v) compete with the Company or
Affiliates in acquiring or merging with any other business or acquiring the
assets of such other business.
(c) During the Restricted Period, in addition to the
obligations pursuant to Subsections 5(a) and 5(b), the Executive agrees that
neither he nor any business in which he engages directly or indirectly will, (i)
hire or attempt to hire any employee of the Company or its Affiliates nor, (ii)
directly or indirectly encourage any employee of the Company or its Affiliates
to terminate employment with the Company or its Affiliates. Notwithstanding the
foregoing, it shall not be deemed a violation of this subsection if a business,
which employs the Executive, hires or attempts to hire an employee of the
Company or its Affiliates and the Executive has no knowledge of, control over or
involvement with such solicitation.
(d) In the event that any of the provisions of this Section 5
should ever be deemed to exceed the time, geographic or occupational limitations
permitted by applicable laws, then such provisions shall be and are hereby
reformed to the maximum time, geographic or occupational limitations permitted
by law.
6. CONFIDENTIAL INFORMATION. The Executive acknowledges that in his
employment he is or will be making use of, acquiring or adding to the Company's
confidential information which includes, but is not limited to, memoranda and
other materials or records of a proprietary nature and records and policy
matters relating to finance, personnel, management and operations. Therefore, in
order to protect the Company's confidential information and to protect other
employees who depend on the Company for regular employment, the Executive agrees
that he will not in any way utilize any of said confidential information except
in connection with his employment by the Employer, and except in connection with
the business of the Company he will not copy, reproduce or take with him the
original or any copies of said confidential information and will not disclose
any of said confidential information to anyone.
7. TERMINATION.
(a) Death or Disability. If the Executive should become
physically or mentally disabled and unable to perform his duties hereunder for a
continuous period in excess of ninety (90) days (in the reasonable opinion of
the Committee), or if the Executive should die while an employee of the
Employer, this Agreement and the Executive's employment with the Employer shall
immediately terminate.
(b) Termination by the Employer for Cause. The following
events shall create in the Company a right to terminate the Executive's
employment under this Agreement prior to the expiration of the Term: (i) the
commission of fraud, embezzlement or theft by the Executive in connection with
the Executive's duties; (ii) the intentional wrongful damage to property of the
Company, and/or Affiliates by the Executive; (iii) the intentional wrongful
disclosure by the Executive of any secret process or confidential information of
the Company, and/or Affiliates; or (iv) the violation of the Executive's
non-disclosure, non-solicitation and non-competition covenants set forth in
Sections 5 and 6. In the event of such a Termination for
<PAGE> 4
cause pursuant to this Subsection, all of the obligations of the Company under
this Agreement shall immediately terminate.
(c) Other Termination by Employer. In the event the Company
shall elect to terminate the Executive's employment for any reason other than
those specified in Subsection 7(a) or 7(b), it shall provide written notice of
such termination to the Executive. In the event that there occurs without the
written consent of the Executive:
(i) a change in the Executive's title, a change in the
Executive's duties or responsibilities, a change in
the Executive's reporting relationships, or a change
in control of the Company (as defined below), any of
which results in or reflects a diminution of the
scope or importance of the Executive's position,
duties and responsibilities;
(ii) a reduction in the Executive's then current annual
base salary (other than as part of reductions in
annual base salary affecting the Employer's officers
generally);
(iii) a reduction in the level of benefits available or
awarded under employee and officer benefit plans and
programs, including, but not limited to annual and
long-term incentive and stock-based plans and
programs (other than as part of reductions in such
benefit plans or programs affecting the Employer's
officers generally); or
(iv) a relocation of Executive's primary employment
location to a location which is more than 50 miles
from his current location,
then, the Executive may deliver written notice of termination to the Company
within three months of such event (which shall be effective even if such three
months expire after the end of the Term). In either case and subject to the
execution and delivery by the Executive to the Company of the release described
in Section 9 hereof, the Company shall provide Executive with severance
compensation and benefits as follows:
(u) the Executive shall receive an amount equal to six month's
current base salary, payable at intervals not less frequently
than monthly over a period of months equal to the number of
months of severance pay (not less than six) provided for by
this subsection, (such period herein after referred to as the
" Severance Period");
(v) the Executive shall receive, with respect to any participation
rights in the Company's annual bonus or long-term incentive
plans, an award under any such plan, payable upon notice of
termination or, of exercise of any condition herein, an amount
equal to the pro-rated share earned during the months of
employment calculated by dividing the total annual award by
twelve (12) multiplied by the number of full and partial
months employed, less any amounts already paid for and during
the current year to date. In the event that termination occurs
after
<PAGE> 5
there has been a change in control, as defined by a change in
the Chief Executive Officer, a change in two-thirds or more of
the Company's Board of Directors, or, a change of more than
thirty percent (30%) of the total shares outstanding, an
amount equal to the annual award as if all pre-requisite
conditions have been met, and as if the total annual award
were earned in full with out any deductions for any amounts
previously paid, shall be paid to the Executive;
(w) with respect to the Executive's stock options, the Company
will recommend to the Compensation and Stock Option Committee
of the Board of Directors of the Company that the
exercisability of the Executive's outstanding stock options be
accelerated, such options shall remain exercisable during the
Severance Period (unless they shall expire earlier by their
terms) and such options shall otherwise be treated in
accordance with the terms of their respective grants;
(x) the Executive's medical, dental and/or other Benefits shall be
continued on the same basis as offered to active salaried
employees for the Severance Period or until such earlier time
as the Executive becomes employed and eligible for such
benefits under a plan of the new employer; and continuation
coverage under COBRA shall commence at the end of the
Severance Period;
(y) all other Benefits shall be paid or continued only to the
extent the terms thereof provide for payment or continuation
following the termination of employment.
The foregoing shall be in lieu of all salary, bonuses or incentive or
performance based compensation for the remainder of the Term. If Executive
should die during the Severance Period, any remaining severance payments
described in (u) and (v) above, shall be made to Executive's surviving spouse
or, if none, to his estate.
(d) Voluntary Termination. If during the Term the Executive
should voluntarily terminate his employment with the Employer for any reason,
including retirement, other than as described in Subsection 7(c) hereof, the
obligations of the Employer and the Company under this Agreement shall terminate
forthwith, other than obligations to (i) pay the Executive's base salary to the
date of termination, (ii) pay all incentive compensation earned by the Executive
for performance periods which are completed prior to the date of termination, at
such times and on the same basis amounts as such incentive compensation becomes
payable to other executives of the Employer and (iii) pay or make available to
the Executive all Benefits which by their terms or under applicable law survive
the voluntary termination of the Executive's employment; and the Executive shall
remain bound by his non-disclosure, non-solicitation and non-competition
covenants set forth in Sections 5 and 6 hereof. The exercisability of the
Executive's outstanding stock options shall be treated in accordance with the
terms of their respective grants or awards, except that in the case of
retirement on or after age 62, the Company will recommend to the Compensation
and Stock Option Committee of the Board of Directors of the Company that the
exercisability of Executive's outstanding stock options be accelerated.
<PAGE> 6
9. GENERAL RELEASE AND COOPERATION AGREEMENT. Notwithstanding anything
in Subsection 7(c) to the contrary and in consideration therefor, severance
benefits thereunder shall only become payable by the Company if the Executive
executes and delivers to the Company a General Release and Cooperation Agreement
on or after the date of written notice of termination of the Executive's
employment and in substantially the form attached as Exhibit A hereto.
10. NOTICES. Any notice required or permitted to be given under this
Agreement shall be in writing and shall be deemed to have been given when
deposited in the U.S. mail in a registered, postage prepaid envelope addressed:
If to the Executive, at his address set forth below, and if to the Company, c/o
Chairman of the Board, Data Systems Network Corporation, 34705 West Twelve Mile
Road, Suite 300, Farmington Hills, Michigan, 48333.
11. ASSIGNMENT. The Executive may not assign his obligations hereunder.
The rights of the Executive and the rights and obligations of the Company
hereunder shall inure to the benefit of and shall be binding upon their
respective heirs, personal representatives, successors and assigns.
12. MISCELLANEOUS.
(a) This Agreement shall be subject to and governed by the laws of the
State of Michigan.
(b) Failure to insist upon strict compliance with any provisions hereof
shall not be deemed a waiver of such provisions or any other provision
hereof.
(c) This Agreement may not be modified except by an agreement in writing
executed by the parties hereto.
(d) The invalidity or unenforceability of any provision hereof shall not
affect the validity or enforceability of any other provision.
(e) This Agreement shall supersede any and all prior employment agreements
or understandings, written or oral, with the Executive.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
day and year first above written.
DATA SYSTEMS NETWORK CORPORATION
------------------------
Michael W. Grieves,
Chairman, President and CEO
------------------------
John O. Lychos Jr.
22598 Bertram Drive
Novi, Michigan 48374
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,695,863
<SECURITIES> 0
<RECEIVABLES> 11,961,084
<ALLOWANCES> 561,600
<INVENTORY> 1,296,145
<CURRENT-ASSETS> 15,739,475
<PP&E> 5,004,148
<DEPRECIATION> 2,481,170
<TOTAL-ASSETS> 22,466,321
<CURRENT-LIABILITIES> 20,895,672
<BONDS> 0
0
0
<COMMON> 48,592
<OTHER-SE> 1,522,057
<TOTAL-LIABILITY-AND-EQUITY> 22,466,321
<SALES> 63,530,818
<TOTAL-REVENUES> 85,323,500
<CGS> 52,213,508
<TOTAL-COSTS> 86,910,601
<OTHER-EXPENSES> 2,111,482
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 692,737
<INCOME-PRETAX> (3,698,582)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,698,582)
<DISCONTINUED> (980,311)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,678,893)
<EPS-PRIMARY> (.96)
<EPS-DILUTED> (.96)
</TABLE>
