<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C, 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended SEPTEMBER 30, 1999
Commission File Number 1-13424
DATA SYSTEMS NETWORK CORPORATION
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<S> <C>
Michigan 38-2649874
(State or other jurisdiction of Incorporation or organization) (IRS Identification Number)
</TABLE>
34705 W. 12 Mile Rd., Suite 300
Farmington Hills, Michigan 48331
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(248) 489-8700
Indicate by check mark whether the registrant (l) 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 them registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date:
Common Stock, $.01 Par Value - 5,509,224 shares as of November 11, 1999
<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
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<CAPTION>
<S> <C>
Consolidated Balance Sheets as of September 30, 1999 and December 31,1998 3
Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 1999 and September 30 1998 4
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1999 and September 30 1998 5
Notes to Consolidated Financial Statements for the Nine Months
Ended September 30, 1999 and September 30 1998 6
</TABLE>
<PAGE> 3
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
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ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 1,647,968 $ 2,695,863
Accounts receivable (net of allowance of $245,000 and $561,600
at September 30, 1999 and December 31, 1998 respectively). 9,262,399 11,339,484
Notes receivable 50,000 60,000
Inventories 827,099 1,296,145
Other current assets 1,253,041 347,983
----------- -----------
Total current assets 13,040,507 15,739,475
PROPERTY AND EQUIPMENT, net 1,501,320 2,522,978
GOODWILL, (net of amortization of $515,563 and $388,438 at
September 30, 1999 and December 31, 1998 respectively.) 2,874,445 3,001,570
OTHER ASSETS 361,780 1,202,298
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TOTAL ASSETS $17,778,052 $22,466,321
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank line of credit 5,009,473 3,231,287
Foothill term loan 706,096 -
Accounts payable 5,237,686 9,640,159
Accrued liabilities 2,008,640 2,390,906
Shareholder Settlement Liability - 1,768,000
Deferred maintenance revenues 1,820,296 3,865,320
----------- -----------
Total current liabilities 14,782,191 20,895,672
COMMITMENTS and CONTINGENCIES - -
STOCKHOLDERS' EQUITY
Preferred stock, authorized 1,000,000 shares, none outstanding Common stock
($.01 par value; authorized 10,000,000
shares; issued and outstanding 5,509,224 and 4,859,224
at September 30, 1999 and December 31, 1998 respectively.) 55,092 48,592
Additional paid-in capital 18,575,219 17,951,219
Accumulated deficit (15,634,450) (16,429,162)
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Total stockholders' equity 2,995,861 1,570,649
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $17,778,052 $22,466,321
=========== ===========
</TABLE>
See Accompanying Notes to the Consolidated Financial Statements.
<PAGE> 4
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
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<CAPTION>
FOR THE THREE MOHNTHS ENDED SEPTEMBER 30,
UNAUDITED UNAUDITED
1999 1998
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<S> <C> <C>
REVENUES:
Product revenue $ 7,076,828 $ 18,258,545
Service revenue 4,925,682 6,123,205
------------------- -------------------
Total revenues 12,002,510 24,381,750
COST OF REVENUES:
Cost of products 6,005,935 15,699,190
Cost of services 3,971,725 4,733,627
-------------------- --------------------
Total cost of revenues 9,977,660 20,432,817
GROSS PROFIT 2,024,850 3,948,933
OPERATING EXPENSES:
Selling expenses 1,109,725 2,588,608
General and administrative expenses 971,136 1,167,788
-------------------- --------------------
Total operating expenses 2,080,861 3,756,396
INCOME (LOSS) FROM OPERATIONS (56,011) 192,537
OTHER INCOME (EXPENSE):
Shareholder Settlement - -
Loss on Sale of Equipment - -
Interest income (expense) (122,753) (181,097)
Other income (expense) 209,105 139,780
-------------------- --------------------
86,352 (41,317)
Income (Loss) from continuing operations 30,341 151,220
(Loss) from operations of Unified Network Services - -
-------------------- --------------------
NET INCOME (LOSS) $ 30,341 $ 151,220
==================== ====================
Income (Loss) per common share - basic and diluted
Continuing operations 0.01 0.03
Discontinued operations - -
-------------------- --------------------
Net gain (loss) per common share $ 0.01 $ 0.03
==================== ====================
Weighted average shares outstanding 5,509,224 4,859,224
==================== ====================
<CAPTION>
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
UNAUDITED UNAUDITED
1999 1998
-------------------- -------------------
<C> <C>
REVENUES:
Product revenue $ 24,296,691 $ 52,846,174
Service revenue 15,269,461 16,681,298
-------------------- -------------------
Total revenues 39,566,152 69,527,472
COST OF REVENUES:
Cost of products 19,558,779 43,423,438
Cost of services 11,960,840 14,211,756
-------------------- -------------------
Total cost of revenues 31,519,619 57,635,194
GROSS PROFIT 8,046,533 11,892,278
OPERATING EXPENSES:
Selling expenses 4,295,658 7,578,460
General and administrative expenses 3,623,913 4,908,937
-------------------- -------------------
Total operating expenses 7,919,571 12,487,397
INCOME (LOSS) FROM OPERATIONS 126,962 (595,119)
OTHER INCOME (EXPENSE):
Shareholder Settlement 1,137,500 -
Loss on Sale of Equipment (385,419) -
Interest income (expense) (311,689) (515,326)
Other income (expense) 227,358 254,278
-------------------- -------------------
667,750 (261,048)
Income (Loss) from continuing operations 794,712 (856,167)
(Loss) from operations of Unified Network Services - (80,750)
-------------------- -------------------
NET INCOME (LOSS) $ 794,712 $ (936,917)
==================== ===================
Income (Loss) per common share - basic and diluted
Continuing operations 0.16 (0.18)
Discontinued operations - (0.01)
-------------------- -------------------
Net gain (loss) per common share $ 0.16 $ (0.19)
==================== ===================
Weighted average shares outstanding 5,102,081 4,859,224
==================== ===================
</TABLE>
<PAGE> 5
DATA SYSTEMS NETWORK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
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<CAPTION>
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
1999 1998
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 794,712 $ (936,917)
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 806,899 861,534
Loss on disposition of assets 385,419 -
Gain on disposal of UNS - 866,335
Changes in assets and liabilities that provided (used) cash
net of effects of discontinued operations:
Investments - 6,203,361
Accounts receivable 2,077,085 7,078,388
Notes receivable 10,000 (20,768)
Inventories 469,046 (72,216)
Other current assets (905,058) 283,162
Service Parts - 80,167
Other assets 840,518 (674,187)
Accounts payable (4,402,473) (2,033,868)
Accrued liabilities (382,266) (759,461)
Shareholder Settlement (1,768,000) -
Deferred maintenance revenues (2,045,024) 1,091,842
------------------ ------------------
Net cash provided by (used in) operations (4,119,142) 11,967,371
------------------ ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment, net (43,535) (806,778)
Issuance of common stock and exercise of stock options, net 630,500 625
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Net cash provided by (used in) investing activities 586,965 (806,153)
------------------ ------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net current borrowings (repayment) under bank line of credit 1,778,186 (8,674,688)
Net current borrowings (repayment) under FCC term loan 706,096
Net proceeds (repayment) from capital lease obligation financing - (60,473)
------------------ ------------------
Net cash provided by (used in) financing activities 2,484,282 (8,735,161)
------------------ ------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALANTS (1,047,895) 2,426,057
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 2,695,863 5,349
------------------ ------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,647,968 $ 2,431,406
================== ==================
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS
Cash paid during the period for:
Interest $ 393,208 $ 707,113
================== ==================
Income taxes - -
================== ==================
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<PAGE> 6
DATA SYSTEMS NETWORK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR QUARTER ENDED SEPTEMBER 30, 1999
UNAUDITED
NOTE A - BASIS OF PRESENTATION
The consolidated financial statements included herein have been prepared by Data
Systems Network Corporation (the "Company") without audit, pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures normally included in the financial statements prepared
in accordance with generally accepted accounting principles have been omitted
pursuant to such rules and regulations.
The information provided in this report reflects all adjustments consisting of
normal recurring accruals which are, in the opinion of management, necessary for
the fair presentation of the Company's financial position as of September 30,
1999, and the results of its operations and its cash flows for the nine months
ended September 30, 1999 and 1998. These consolidated financial statements
should be read in conjunction with the Company's financial statements for the
year ended December 31, 1998 as filed with the Securities and Exchange
Commission.
Results for the interim period are not necessarily indicative of results that
may be expected for the entire year.
NOTE B - 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 a
technical helpdesk center in Louisiana, and 10 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 C).
Cash Equivalents and Restricted Cash
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. At September 30, 1999, cash of $1,576,000 was restricted in
connection with maintenance agreements. It will become unrestricted as revenue
is recognized according to the terms of the agreements.
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.
<PAGE> 7
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.
Earnings Per Share
The Financial Accounting Standards Board issued Statement No. 128, "Earnings per
Share" ("SFAS 128")which 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.
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.
NOTE C - DISCONTINUED OPERATIONS - SALE OF UNIFIED NETWORK SERVICES INC.
In June 1998, the Company sold its 70% interest in its large account network
management services operation, Unified Network Services Inc., for cash and
notes, and classified 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 $814,000 in 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 results of
operations of the discontinued operations for the nine months ended September
30, 1999 and 1998 are summarized below:
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<CAPTION>
For the nine months ended September 30, 1999 1998
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<S> <C> <C>
Revenues $ - $ 278,060
Loss from discontinued operations $ - $ (1,686,054)
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NOTE D - LINES OF CREDIT
On September 30, 1998 the Company and Foothill Capital Corporation ("Foothill")
entered into a new credit facility (the "Foothill 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. Borrowing limits under the
Foothill Agreement are determined based on a collateral formula, which includes
85% of qualified trade receivables. The available line of credit at September
30, 1999 was $5.5 million. Borrowings under the Foothill Agreement bear interest
at 1% over Norwest Bank's prime rate (9.25% at September 30, 1999) and have a
term extending to September 30, 2001.
<PAGE> 8
The Company is required to maintain certain financial ratios. At September 30,
1999, the Company was not in compliance with one of the financial ratios and
obtained a waiver from Foothill Capital Corporation.
The Company had also previously entered into a secured finance agreement with
IBM Credit Corporation, which was to be used exclusively for the acquisition of
inventory for resale. In May 1999, the Company was informed that its financing
agreement with IBM Credit Corporation would be terminated as of July 26, 1999
due to a change in the Company's method of handling the fulfillment of customer
orders as it relates to product sales. As a result of the IBM termination, the
Company entered into a term loan with Foothill on September 10, 1999. The amount
of the loan is $926,000 and will be repaid at the rate of $75,000 per week. The
payments will continue until the earlier of full repayment or December 1, 1999.
At December 1, any outstanding principal balance and all accrued and unpaid
interest shall be payable. The term loan bears interest at two percentage points
(2%) above Norwest Bank's prime rate.
NOTE E -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 (the "SEC")
informed the Company that it was conducting a formal private investigation of
the accounting irregularities experienced by the Company in fiscal years 1996
and 1997. This inquiry is ongoing, and the Company is cooperating with the SEC
and providing information as requested.
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.
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following analysis of financial condition and results of operations
of the Company should be read in conjunction with the Company's financial
statements and notes thereto included under "Item 1. Financial Statements."
RESULTS OF OPERATIONS
REVENUES. Total revenues decreased 50.8% to $12.0 million for the three months
ended September 30, 1999 from $24.4 million for the same period in 1998. For the
nine months ended September 30, 1999, total revenue decreased 43.1% to $39.6
million from $69.5 million in 1998. The majority of the decrease was due to the
expiration of the Company's blanket product purchase order with the State of
Michigan on September 30, 1998. Product sales to the State of Michigan during
the nine months ended September 30, 1998 totaled approximately $16.0 million.
Total revenue was also effected by the Company's realignment of its geographical
sales structure, change in its sales strategy and focus on core lines of
business, as described below. In addition, the Company completed non-recurring
project work in 1998.
In prior periods, the Company would sell equipment and absorb the full burden of
financing those sales to its government and major commercial customers. During
the nine months ending September 30, 1999, the Company worked with key vendors
to pass through hardware sales directly to the vendor. This allows the vendor to
absorb the risk and burden of financing the equipment component of the sale. As
a result, the Company recognized a commission on the sale without the risk and
cost associated with carrying a receivable. This change was implemented as part
of the Company's strategic move towards service sales with less emphasis on the
hardware component of its business. On an equalized basis, the assignment of the
pass through equipment sales would have accounted for approximately $9.9 million
in gross product revenue for the nine months ending September 30, 1999.
Product sales decreased $11.2 million, or 61.2%, and $28.5 million, or 54.0%,
respectively, for the three and nine months ended September 30, 1999. The
majority of the decrease was directly related the termination of the Company's
State of Michigan blanket product purchase order and the pass through of
equipment sales. Also contributing to this decrease was the completion of
non-recurring project work in 1998. Service revenues decreased to $4.9 million
and accounted for 41.0% of total revenues in the three months ended September
30, 1999 compared to $6.1 million, or 25.1% of total revenues, in the
corresponding period of 1998. For the nine months ended September 30, 1999,
service revenues decreased to $15.3 million from $16.7 million for the same
period in 1998. However, service revenues as a percentage of total revenues
increased for the nine months ended September 30, 1999 to 38.6% from 24.0% for
the same period in 1998 due to the Company's change in sales strategy described
above.
COST OF REVENUES. The cost of revenues decreased to 83.1% of total revenues for
the three months ended September 30, 1999, from 83.8% during the corresponding
period of 1998. For the nine months ended September 30, 1999, the cost of
revenues decreased to 79.7% from 82.9% during the corresponding period of 1998.
The cost of product sales decreased to 84.9% of product sales revenue for the
three months ended September 30, 1999 compared to 86.0% for the same period in
1998. The cost of product sales for the nine months ended September 30, 1999
decreased to 80.5% from 82.2% for the same period in 1998. The Company
attributes the respective three and nine-month decreases primarily to the
success of its efforts to negotiate discounts from suppliers and involve key
vendors in financing large equipment sales. The cost of service revenue
increased to 80.6% of service revenues for the three months ended September 30,
1999, from 77.3% for the same period in 1998. The Company attributes this
increase to non-recurring low margin third party services. For the nine months
ended September 30, 1999, the cost of service revenue decreased to 78.3% from
85.2% for the same period in 1998. The decrease was due primarily to the
Company's continued effort to manage external labor costs, increase internal
technical workforce utilization and increase high end network service work.
Internal productivity improved, as only 3.8% of the total technical cost for the
nine months ended September 30, 1999 was attributed to pre- and post-sale field
support, compared to approximately 10% during the same period in the prior year.
<PAGE> 10
OPERATING EXPENSES. Selling, general and administrative expense increased to
17.3% of total revenue for the three months ended September 30, 1999 compared to
15.4% of total revenue for the same period in 1998. For the nine months ended
September 30, 1999, selling, general and administrative expenses increased to
20.0% of total revenues from 18.0% of total revenues for the same period in
1998. Total cost of selling, general and administrative expenses decreased for
the three and nine months ended September 30, 1999 as the Company continued to
manage overhead. The change in percent of revenue was due to the decline in
product sales during the first nine months of 1999.
OTHER (EXPENSE) INCOME. Interest expense decreased almost $60,000 or 32% for the
three months ending September 30, 1999 compared to the same period in 1998. For
the nine months ended September 30, 1999, interest expense was $.3 million lower
than for the same period in 1998. The decrease reflects lower average borrowings
in 1999. Other income reflected a $69,000 or 49.6% increase for the three months
ended September 30, 1999 over the same period in 1998. The increase resulted
from the negotiated settlement of a vendor dispute, which was accrued for in
1998 and resolved during the third quarter of 1999.
FINANCIAL CONDITION
As of September 30, 1999, cash and investments totaled $1.7 million, a
decrease of $1.0 million from December 31, 1998. Cash used in operating
activities during the first nine months of 1999 was $4.1 million. The primary
use of the cash was the reduction in accounts payable of $4.4 million. The
Company, in accordance with the Foothill Agreement, applies all available cash
to its outstanding line of credit balance. Daily working capital requirements
are managed through daily borrowings.
The Company finances its working capital needs primarily through its
line of credit agreement with Foothill. 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. As of September 30, 1999, the line of credit
under the Foothill Agreement bore interest at a rate of 9.25%. As of September
30, 1999, the line of credit collateral formula permitted borrowings of up to
$5.5 million, of which $5.0 million was outstanding.
The Foothill Agreement 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 September 30, 1999, due primarily to the
Company's action to fund the settlement fund created as part of the settlement
of a shareholder lawsuit in June 1999, the Company was not in compliance with
the EBITDA covenant. However, the Company has received the necessary waivers
from Foothill and the Company's access and use of the line of credit has not
been affected. 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
Foothill 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.
<PAGE> 11
The Company had also previously entered into a secured finance agreement with
IBM Credit Corporation, which was to be used exclusively for the acquisition of
inventory for resale. Use of this credit line was at the Company's option. In
May 1999, the Company was informed that its financing agreement with IBM Credit
Corporation would be terminated as of July 26, 1999 due to a change in the
Company's method of handling the fulfillment of customer orders as it relates to
product sales. As a result of the IBM termination, the Company entered into a
term loan with Foothill on September 10, 1999. The amount of the loan is
$926,000 and will be repaid at the rate of $75,000 per week. The payments will
continue until the earlier of full repayment or December 1, 1999. At December 1,
any outstanding principal balance and all accrued and unpaid interest shall be
payable. The term loan bears interest at two percentage points (2%) above
Norwest Bank's prime rate. The Company has also secured increased credit lines
with certain current vendors and continues to negotiate with other vendors for
additional lines of credit.
The Company's working capital deficiency as of September 30, 1999 was
$1.7 million. Despite the termination of the Company's planned merger with
Information Architects (see Part II, Item 5 - "Other Information"). 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.
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 correctly 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 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. Those plans have been developed and implementation has been
completed except for a phone system, which is being replaced as discussed below.
Phase III, which is scheduled 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 only area that remains to be tested is the security systems in place at the
Company's individual offices. This Y2K compliance audit and remediation effort
for the security system is currently in progress. In implementing its
three-phase program, 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 applications area, most applications were identified as Y2K
compliant due to their recent implementation. In addition, the Company's core
financial and reporting system was completely replaced as of January 1, 1999
which brought this critical area into Y2K compliance. In the customer
relationships and equipment applications area, the Company has completed all
remediation and testing efforts except for the phone system being utilized by
the Grand Rapids office. This system is scheduled for replacement by November 1,
1999 when the Grand Rapids office is moved. The new phone system is certified
Year 2000 ready by its manufacturer. 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 relationships area, most of the parties
contacted by the Company stated 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.
<PAGE> 12
The Company spent approximately $154,000 in 1998 to replace its core
financial and reporting systems and has spent 780 man hours through September
30, 1999 to bring the systems network, and financial and informational system
applications into Y2K compliance at an estimated cost of $39,000. Because of the
Company's expertise in this area, internal personnel are undertaking the
majority of this work. The Company estimates a minimal amount of Y2K compliance
costs to be incurred during the remainder of the year.
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's contingency plan is in progress and
will continue into the Year 2000.
The foregoing disclosure contains information regarding Y2K readiness
that constitutes a "Year 2000 Readiness Disclosure" as defined in the Year 2000
Readiness Disclosure Act.
FORWARD-LOOKING STATEMENTS
The foregoing discussion and analysis contain a number of "forward
looking statements" within the meaning of the Securities Exchange Act of 1934,
as amended, and are subject to a number of risks and uncertainties. These
include, among others, general business conditions, continuing favorable
economic conditions, the ability of 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 operates, 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 Y2K date
functions on the Company's current products and internal systems, the
willingness of the Company's bank lender to continue to lend under the credit
facility or the Company's ability to secure alternative working capital
financing, the relative uncertainties in the market direction of emerging
technologies, the Company's ability to retain its commercial and governmental
contracts, continued market acceptance of the Company's products and services,
the ability of the Company to successfully realign its geographical sales
structure, change its sales strategy and focus on its core lines of business,
changes in business strategy or development plans, business disruptions, adverse
publicity, and liability and other claims asserted against the Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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.
<PAGE> 13
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 for the nine months ending September 30, 1999 would decrease by
approximately $66,000 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.
PART II. OTHER INFORMATION
ITEM 1. - LEGAL PROCEEDINGS
On or about October 29, 1998, the Securities and Exchange Commission
("SEC") informed the Company that it was 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.
ITEM 5. - OTHER INFORMATION
As previously reported, on September 15, 1999, the Company and
Information Architects of Charlotte, North Carolina mutually agreed to terminate
their Agreement and Plan of Merger dated January 31, 1999. As a result of the
termination, Information Architects signed a promissory note due Data Systems in
the amount of $250,000 as reimbursement for expenses incurred as a result of the
terminated merger. The note will be repaid in 10 equal installments of $25,000
commencing October 1, 1999 and ending July 1, 2000. The note will accrue
interest of 10% per annum on the unpaid principal portion.
On October 11, 1999, the Company announced the resignation of
Mr. Richard Burkhart, Outside Director of the Company from the Board of
Directors. Mr. Burkhart sighted personal reasons for his decision and sighted no
disagreement with the Company on any matter relating to the Company's operating
policies or practices as the basis for his action. The Company also announced
the appoinment of Mr. Steve Ross to the Board of Directors.
<PAGE> 14
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
A list of the exhibits required to be filed, as part of this Form 10-Q
is included under the heading "Exhibit Index" in this Form 10-Q and incorporated
herein by reference.
(b) REPORTS ON FORM 8-K
The company filed the following report on Form 8K in the third
quarter of 1999:
<TABLE>
<CAPTION>
Date Information Reported
---- --------------------
<S> <C>
October 1, 1999 Item 5
</TABLE>
<PAGE> 15
SIGNATURES
Pursuant to the requirements 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 Date: November 12, 1999
----------------------
Michael W. Grieves
Chairman of the Board, President and Chief
Executive Officer (Duly Authorized Officer)
By: /s/ Michael Jansen
-----------------------
Vice President, Interim Chief Financial Officer Date: November 12, 1999
(Principle Financial Officer)
<PAGE> 16
Exhibit Index
-------------
<TABLE>
<CAPTION>
Exhibit No.
- -----------
<S> <C>
10.1 Consolidated Termination agreement and Release,
dated September 15, 1999, filed as Exhibit 99.1 to the
Company's Current report on Form 8K on October 1,
1999 (File no. 1-13424) and incorporated herein by
reference.
10.2 Amendment No. 1 to Loan and Security
Agreement dated September 10, 1999
27.1 Financial Data Schedule.
</TABLE>
<PAGE> 1
EXHIBIT 10.2
AMENDMENT NO. 1 TO
LOAN AND SECURITY AGREEMENT
AMENDMENT NO. 1, dated as of September 10, 1999, to the LOAN
AND SECURITY AGREEMENT, dated as of September 30, 1998 (hereafter modified,
amended and/or restated from time to time, the "Loan and Security Agreement"),
between FOOTHILL CAPITAL CORPORATION, a California corporation ("Foothill"), and
DATA SYSTEMS NETWORK CORPORATION, a Michigan corporation ("Borrower").
Preamble
Pursuant to the Loan and Security Agreement, Foothill
established a revolving line of credit for the benefit of Borrower. As of the
Closing Date, Borrower was also indebted to IBM Credit Corporation, which such
indebtedness was secured by certain Collateral, necessitating the negotiation
and execution of the Intercreditor Agreement pursuant to which the relative
rights and duties of Foothill and IBM Credit Corporation were set forth.
Borrower has now requested Foothill to make a term loan to Borrower, the
proceeds of which will be used to satisfy in full all outstanding indebtedness
of Borrower to IBM Credit Corporation. Based upon the terms and conditions set
forth herein, Foothill has agreed to extend to Borrower a term loan in the sum
of $926,000. Accordingly, Borrower and Foothill hereby agree as follows:
1. Definitions. All terms used herein which are defined
in the Loan and Security Agreement and not otherwise defined herein are used
herein as defined therein.
2. Definitions. Section 1.1 of the Loan and Security
Agreement is hereby amended (a) by inserting the words "the Term Loan and all
other" immediately after the words "'Obligations' means" in the definition of
the term Obligations and (b) by inserting the following definitions for the
terms "First Amendment Effective Date" and "Term Loan" where each would appear
in correct alphabetical order:
"'First Amendment Effective Date' means the
date upon which all of the conditions set forth in Section 5
of Amendment No. 1 to this Agreement shall have been satisfied
in full.
"'Term Loan' has the meaning set forth in
Section 2.3."
3. Term Loan. A new Section 2.3 to the Loan and
Security Agreement is hereby added as follows:
"2.3 TERM LOAN.
(a) Term Loan. Subject to the
terms and conditions of this Agreement, including but not
limited to Amendment No. 1 hereto, Foothill agrees to make a
term loan (the "Term Loan") to Borrower on the First Amendment
Effective Date, in an amount equal to $926,000. Foothill, upon
<PAGE> 2
satisfaction of the applicable conditions precedent set forth
herein and in Amendment No. 1 hereto, shall make the proceeds
of such Term Loans available to Borrower by transferring same
day funds equal to the proceeds of such Term Loan as directed
in writing by Borrower. All amounts outstanding under the Term
Loan shall constitute Obligations.
(b) Amortization. The Term
Loan shall be repaid in installments of principal in the
amount of $75,000. Each such installment shall be due and
payable on the first Business Day of each week commencing on
the first Business Day of the first week following the First
Amendment Effective Date and continuing on the first Business
Day of each succeeding week. On the earlier to occur of (x)
termination of this Agreement, whether by its terms, by
prepayment, by acceleration, or otherwise, or (y) December 1,
1999, the outstanding principal balance, and all accrued and
unpaid interest under the Term Loan, shall be due and payable
in full.
(c) Prepayments of Term Loan.
The unpaid principal balance of the Term Loan may be prepaid
in whole or in part without penalty or premium at any time
during the term of this Agreement upon three (3) days prior
written notice by Borrower to Foothill. All partial
prepayments of principal on the Term Loan will be applied to
installments due on the Term Loan in the inverse order of
their maturity."
4. Interest on Term Loan. (a) Section 2.6(a) is hereby amended
by adding the following sentence at the end thereof:
"Notwithstanding the foregoing, the Term Loan shall bear
interest at a per annum rate of two percentage points (2.0%)
above the Reference Rate."
(a) Section 2.6(c) is hereby amended by adding the following
sentence at the end thereof:
"Notwithstanding the foregoing, upon the occurrence and during
the continuation of an Event of Default, the Term Loan shall
bear interest at a per annum rate of five percentage points
(5.0%) above the Reference Rate."
5. Conditions. This Amendment shall become effective only upon
satisfaction in full of the following conditions precedent (the first date upon
which all such conditions have been satisfied being herein called the "First
Amendment Effective Date"):
(a) The representations and warranties contained in this
Amendment and in Section 5 of the Loan and Security Agreement and each other
Loan Document shall be correct on and as of the First Amendment Effective Date
as though made on and as of such date (except where such representations and
warranties relate to an earlier date in which case such representations and
warranties shall be true and correct as of such earlier date); no Default or
-2-
<PAGE> 3
Event of Default shall have occurred and be continuing on the First Amendment
Effective Date or result from this Amendment becoming effective in accordance
with its terms.
(b) Foothill shall have received two (2) counterparts of this
Amendment, duly executed by Borrower.
(c) Foothill shall have a received a term loan origination fee
in the sum of Thirty Thousand Dollars ($30,000).
(d) Foothill shall have received a payoff letter from IBM
Credit Corporation and the proceeds of the Term Loan shall be used to satisfy,
in full, all of the outstanding Indebtedness and other obligations due IBM
Credit Corporation from Borrower.
(e) The Intercreditor Agreement shall have been terminated in
writing and IBM Credit Corporation shall have released all of its liens of
record which relate to the Collateral.
(f) All legal matters incident to this Amendment shall be
satisfactory to Foothill and its counsel.
6. Representations and Warranties. Borrower hereby represents
and warrants to Foothill as follows:
(a) Borrower (i) is a corporation duly organized, validly
existing and in good standing under the laws of the State of Michigan and (ii)
has all requisite corporate power, authority and legal right to execute, deliver
and perform this Amendment, and to perform the Loan and Security Agreement, as
amended hereby.
(b) The execution, delivery and performance of this Amendment
by Borrower, and the performance by Borrower of the Loan and Security Agreement,
as amended hereby (i) have been duly authorized by all necessary corporate
action, (ii) do not and will not contravene its charter or by-laws or any
applicable law, and (iii) except as provided in the Loan Documents, do not and
will not result in the creation of any Lien upon or with respect to any of its
respective properties.
(c) This Amendment and the Loan and Security Agreement, as
amended hereby, constitute the legal, valid and binding obligations of Borrower,
enforceable against Borrower in accordance with its terms.
(d) No authorization or approval or other action by, and no
notice to or filing with, any governmental authority or other Person is required
in connection with the due execution, delivery and performance by Borrower of
this Amendment and the performance by the Borrower of the Loan and Security
Agreement as amended hereby.
(e) The representations and warranties contained in Section 5
of the Loan and Security Agreement and each other Loan Document are correct on
and as of the First Amendment Effective Date as though made on and as of the
First Amendment Effective Date (except to the extent such representations and
warranties expressly relate to an earlier date in which case such
-3-
<PAGE> 4
representations and warranties shall be true and correct as of such earlier
date), and no Default or Event of Default has occurred and is continuing on and
as of the First Amendment Effective Date or will result from this Amendment
becoming effective in accordance with its terms.
(f) The proceeds of the Term Loan will be used to satisfy, in
full, all of the outstanding Indebtedness and other obligations due IBM Credit
Corporation from Borrower.
7. Continued Effectiveness of the Loan and Security Agreement
and Loan Documents. Borrower hereby (i) confirms and agrees that each Loan
Document to which it is a party is, and shall continue to be, in full force and
effect and is hereby ratified and confirmed in all respects except that on and
after the First Amendment Effective Date of this Amendment all references in any
such Loan Document to "the Loan and Security Agreement", the "Agreement",
"thereto", "thereof", "thereunder" or words of like import referring to the Loan
and Security Agreement shall mean the Loan and Security Agreement as amended by
this Amendment, (ii) confirms and agrees that to the extent that any such Loan
Document purports to assign or pledge to Foothill, or to grant a security
interest in or Lien on, any collateral as security for the obligations of
Borrower from time to time existing in respect of the Loan and Security
Agreement and the Loan Documents, such pledge, assignment and/or grant of the
security interest or Lien is hereby ratified and confirmed in all respects, and
(iii) confirms that Foothill is authorized, at its option, without prior notice
to Borrower, to charge any fees payable by Borrower pursuant to Section 8(d) of
this Amendment to Borrower's Loan Account.
8. Miscellaneous.
(a) This Amendment may be executed in any number of
counterparts and by different parties hereto in separate counterparts, each of
which shall be deemed to be an original but all of which taken together shall
constitute one and the same agreement. Delivery of an executed counterpart of
this Amendment by telefacsimile shall be equally as effective as delivery of an
original executed counterpart of this Amendment.
(b) Section and paragraph headings herein are included for
convenience of reference only and shall not constitute a part of this Amendment
for any other purpose.
(c) This Amendment shall be governed by, and construed in
accordance with, the laws of the State of New York.
(d) Borrower will pay on demand all reasonable fees, costs and
expenses of Foothill in connection with the preparation, execution and delivery
of this Amendment including, without limitation, reasonable fees disbursements
and other charges of Schulte Roth & Zabel LLP, counsel to Foothill.
-4-
<PAGE> 5
IN WITNESS WHEREOF, the parties hereto have caused this
Amendment No. 1 to be executed and delivered as of the date set forth on the
first page hereof.
DATA SYSTEMS NETWORK CORPORATION,
a Michigan corporation
By: Michael Jansen
--------------------------------------
Name: Michael Jansen
Title: Vice President, Interim Chief
Financial Officer
FOOTHILL CAPITAL CORPORATION,
a California corporation
By:
--------------------------------------
Name:
Title:
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 1,647,968
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<RECEIVABLES> 9,507,399
<ALLOWANCES> 245,000
<INVENTORY> 827,099
<CURRENT-ASSETS> 13,040,507
<PP&E> 3,824,853
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0
0
<COMMON> 55092
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<TOTAL-LIABILITY-AND-EQUITY> 17,778,052
<SALES> 7,076,828
<TOTAL-REVENUES> 12,002,510
<CGS> 6005,935
<TOTAL-COSTS> 12,058,521
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