1
EXHIBIT 99.2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors
Procom Technology, Inc.:
We have audited the accompanying consolidated balance sheets of Procom
Technology, Inc. (a California corporation) and its subsidiaries (the "Company")
as of July 31, 1997 and July 31, 1998, and the related consolidated statements
of operations, shareholders' equity and cash flows for each of the three years
in the period ended July 31, 1998. These financial statements and the schedule
referred to below are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and the
schedule 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 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 financial statements referred to above present fairly, in
all material respects, the financial position of Procom Technology, Inc. and its
subsidiaries as of July 31, 1997 and July 31, 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
July 31, 1998 in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The schedule listed in the
index to the consolidated financial statements is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic consolidated financial statements. This schedule has been subjected to
the auditing procedures applied in the audits of the basic consolidated
financial statements and, in our opinion, fairly states in all material respects
the financial data required to be set forth therein in relation to the basic
consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Orange County, California
October 8, 1998
2
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
JULY 31, 1997 JULY 31, 1998
------------- -------------
Current assets:
Cash .................................................. $ 227,000 $ 577,000
Short-term marketable securities,
held to maturity .................................... 18,550,000 22,785,000
Accounts receivable, less allowance
for doubtful accounts and sales
returns of $992,000 and $1,329,000,
respectively ........................................ 12,545,000 15,050,000
Inventories, net ...................................... 9,063,000 9,147,000
Deferred income taxes ................................. 1,405,000 1,852,000
Prepaid expenses ...................................... 588,000 748,000
Other current assets .................................. 49,000 223,000
----------- -----------
Total current assets .......................... 42,427,000 50,382,000
Property and equipment, net ............................. 816,000 2,211,000
Other assets ............................................ 31,000 1,846,000
----------- -----------
Total assets .................................. $43,274,000 $54,439,000
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit ........................................ $ -- $ 210,000
Accounts payable ...................................... 10,518,000 11,540,000
Accrued expenses and other current
liabilities ......................................... 764,000 2,949,000
Accrued compensation .................................. 1,462,000 1,321,000
Capital lease obligations ............................... 29,000 --
Deferred service revenues ............................. -- 931,000
Income taxes payable .................................. 434,000 756,000
----------- -----------
Total current liabilities ..................... 13,207,000 17,707,000
----------- -----------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value;
10,000,000 shares authorized, no
shares issued and outstanding ...................... -- --
Common stock, $.01 par value;
65,000,000 shares authorized,
11,024,562 and 11,178,742, shares
issued and outstanding,
respectively ........................................ 110,000 112,000
Additional paid in capital ............................. 16,467,000 17,751,000
Retained earnings ................................... 13,490,000 18,866,000
Foreign currency translation adjustment ............. -- 3,000
----------- -----------
Total shareholders' equity ..................... 30,067,000 36,732,000
----------- -----------
Total liabilities and shareholders' equity ............... $43,274,000 $54,439,000
=========== ===========
The accompanying notes are an integral part of
these consolidated balance sheets.
3
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED
-----------------------------------------------------
JULY 26, JULY 31, JULY 31,
1996 1997 1998
------------- ------------- -------------
Net sales ................... $ 73,456,000 $ 109,332,000 $ 111,886,000
Cost of sales ............... 51,489,000 72,684,000 75,527,000
------------- ------------- -------------
Gross profit ........... 21,967,000 36,648,000 36,359,000
Selling, general and
administrative expenses ... 15,401,000 19,155,000 22,257,000
Research and development
expenses .................. 1,635,000 3,922,000 4,788,000
Acquired research and
development ............... -- -- 1,693,000
------------- ------------- -------------
Operating income ....... 4,931,000 13,571,000 7,621,000
Interest income ............. -- 459,000 1,244,000
Interest expense ............ (282,000) (131,000) (15,000)
------------- ------------- -------------
Income before income
taxes ................ 4,649,000 13,899,000 8,850,000
Provision for income taxes .. 1,800,000 5,452,000 3,474,000
------------- ------------- -------------
Net income .................. $ 2,849,000 $ 8,447,000 $ 5,376,000
============= ============= =============
Net income per common
share Basic ............... $ 0.32 $ 0.83 $ 0.48
============= ============= =============
Diluted ..................... $ 0.31 $ 0.81 $ 0.48
============= ============= =============
Weighted average number of
common shares (Basic) ..... 9,000,000 10,205,000 11,114,000
============= ============= =============
Diluted ..................... 9,172,000 10,374,000 11,252,000
============= ============= =============
The accompanying notes are an integral part of
these consolidated financial statements.
4
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK
------------------------ PAID IN RETAINED CURRENCY
SHARES AMOUNT CAPITAL EARNINGS ADJUSTMENT TOTAL
---------- -------- ----------- ----------- ---------- -----------
Balance at
July 28, 1995...... 9,000,000 3,000 -- 2,284,000 -- 2,287,000
Net income......... -- -- -- 2,849,000 -- 2,849,000
---------- -------- ----------- ----------- ---------- -----------
Balance at
July 26, 1996...... 9,000,000 3,000 -- 5,133,000 -- 5,136,000
Change in par
value to $.01
per share.......... -- 87,000 3,000 (90,000) -- --
Public offering
proceeds........... 2,000,000 20,000 16,166,000 -- -- 16,186,000
Compensatory
options expense.... -- -- 35,000 -- -- 35,000
Exercise of employee
stock options...... 24,562 -- 62,000 -- -- 62,000
Tax benefit from
stock options
exercise........... -- -- 201,000 -- -- 201,000
Net income........... -- -- -- 8,447,000 -- 8,447,000
---------- -------- ----------- ----------- ---------- -----------
Balance at
July 31, 1997...... 11,024,562 110,000 16,467,000 13,490,000 -- 30,067,000
---------- -------- ----------- ----------- ---------- -----------
Exercise of
employee stock
options............ 50,036 1,000 143,000 -- -- 144,000
Tax benefit from
stock options
exercise........... -- -- 242,000 -- -- 242,000
Acquisition
of Megabyte........ 104,144 1,000 899,000 -- -- 900,000
Foreign currency
translation
adjustment......... -- -- -- -- 3,000 3,000
Net income........... -- -- -- 5,376,000 -- 5,376,000
---------- -------- ----------- ----------- ---------- -----------
Balance at
July 31, 1998...... 11,178,742 $112,000 $17,751,000 $18,866,000 $ 3,000 $36,732,000
========== ======== =========== =========== ========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
5
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED
------------------------------------------------
JULY 26, JULY 31, JULY 31,
1996 1997 1998
------------ ------------ ------------
Cash flows from operating activities:
Net income .......................... $ 2,849,000 $ 8,447,000 $ 5,376,000
Adjustments to reconcile net
income to net cash provided
by (used in) operating activities:
Depreciation and amortization ... 194,000 248,000 605,000
Acquired research and development.. -- -- 1,693,000
Changes in assets and liabilities:
Accounts receivable .......... (3,727,000) (3,311,000) 270,000
Inventories .................. (5,464,000) 697,000 2,097,000
Deferred income taxes ........ (246,000) (800,000) (405,000)
Prepaid expenses ............. (38,000) (384,000) 175,000
Other current assets ......... 6,000 (37,000) (23,000)
Other assets ................. 186,000 (3,000) (20,000)
Accounts payable ............. 2,724,000 2,264,000 (2,524,000)
Accrued expenses and
compensation ............... 1,469,000 (841,000) 638,000
Deferred service revenue ..... -- -- 175,000
Income taxes payable ......... 366,000 (2,000) 255,000
------------ ------------ -----------
Net cash provided by
(used in) operating
activities ............. (1,681,000) 6,278,000 8,312,000
------------ ------------ -----------
Cash flows from investing activities:
Purchase of property and equipment .. (431,000) (588,000) (787,000)
Acquisitions, net of cash
acquired .......................... -- -- (633,000)
------------ ------------ -----------
Net cash used in investing
activities ............. (431,000) (588,000) (1,420,000)
------------ ------------ -----------
Cash flows from financing activities:
Principal payments for capital
lease obligations ................. (8,000) (5,000) (29,000)
Borrowings on lines of credit ....... 64,825,000 38,500,000 210,000
Payments made on lines of credit .... (62,124,000) (42,685,000) (2,877,000)
Public offering of common stock ..... -- 16,186,000 --
Stock options, exercises and related
tax benefits ...................... -- 298,000 386,000
----------- ------------ -----------
Net cash provided by
(used in) financing
activities ............. 2,693,000 12,294,000 (2,310,000)
Effect of exchange rate changes ..... -- -- 3,000
------------ ------------ -----------
Increase (decrease) in cash ......... 581,000 17,984,000 4,585,000
Cash at beginning of period ............. 212,000 793,000 18,777,000
------------ ------------ -----------
Cash at end of period ................... $ 793,000 $ 18,777,000 $23,362,000
============ ============ ===========
Supplemental disclosures of cash flow
information:
Cash paid during the year for:
Interest ............................ $ 248,000 $ 165,000 $ 15,000
Income taxes ........................ 1,472,000 5,947,000 3,312,000
The accompanying notes are an integral part of
these consolidated financial statements.
6
PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Procom Technology, Inc. (the "Company") was incorporated in California in
1987. The Company designs, manufactures and markets enterprise-wide data storage
and information access solutions that are compatible with all major hardware
platforms, network protocols and operating systems.
Principles of Consolidation
The consolidated financial statements include the accounts of Procom
Technology, Inc. and its wholly-owned subsidiaries, Megabyte Computerhandels,
AG, a German corporation, Invincible Technologies Acquisition Corporation, a
Massachusetts corporation and Procom Technology FSC, a foreign sales
corporation. All significant intercompany transactions have been eliminated in
consolidation.
Fiscal Year
For fiscal 1996, the Company's fiscal year ended on the Friday of, or
nearest to, July 31. Fiscal 1996 had 52 weeks. In May 1997, the Company modified
its accounting periods so that the last day of its fiscal quarter and fiscal
year would end on the last day of the calendar month. As a result, the 1997
fiscal year contains four additional days.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments - Cash and short-term marketable
securities, held to maturity
The carrying amount of cash and cash equivalents approximates fair value
for all periods presented because of the short-term maturities (less than 90
days) of these financial instruments.
Accounts Receivable
The allowance for doubtful accounts includes management's estimate of the
amount expected to be lost on specific accounts and for losses on other as yet
unidentified accounts included in accounts receivable. In estimating the
potential losses on specific accounts, management relies on in-house prepared
analyses and review of other available information. The allowance for sales
returns includes management's estimates of the anticipated sales returns
relating to each reporting period. In estimating the allowance for sales
returns, management relies on historical experience. The amounts the Company
will ultimately realize could differ materially in the near term from the
amounts assumed in arriving at the allowance for doubtful accounts and sales
returns in the accompanying financial statements.
Inventories
Inventories are valued at the lower of cost (on a first-in, first-out
(FIFO) basis) or market. Allowances for obsolete inventory are based on
management's estimate of the amount considered obsolete based on specific
reviews of inventory items. In estimating the allowance, management relies on
its knowledge of the industry (including technological and design changes) as
well as its current inventory levels. The amounts the Company will ultimately
realize could differ materially in the near term from amounts estimated by
management.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using
the straight-line method over the respective estimated useful lives of the
assets, which range from three to seven years. Leasehold improvements and assets
under capital leases are amortized using the straight-line method over the
lesser of the lease term or the estimated useful life of the assets.
Expenditures for major renewals and betterments are capitalized, while
minor replacements, maintenance and repairs that do not extend the assets' lives
are charged to operations as incurred. Upon sale or disposition, the cost and
related accumulated depreciation are removed from the Company's accounts and any
gain or loss is included in the statement of operations.
7
Income Taxes
The Company reports certain expenses differently for financial and tax
reporting purposes and, accordingly, provides for the related deferred income
taxes. Income taxes are accounted for under the liability method in accordance
with Statement of Financial Accounting Standards No. 109.
Revenue Recognition
The Company recognizes revenue from product sales upon shipment, or in the
case of certain distributors, their receipt of the goods shipped. All sales are
denominated in either U.S. dollars or German marks. The Company has established
a program that, under specified conditions, enables distributors and resellers
to return products to the Company for credit against additional purchases or, in
the event the Company reduces its selling prices, to receive credits for the
reduction in selling price. The amount of potential product returns, including
returns under the Company's warranty program, and credits for selling price
reductions are estimated and provided for in the period of the sale. The amounts
the Company will ultimately realize could differ materially in the near term
from the amounts estimated. Under an evaluation program, products may be shipped
to customers on a trial basis and returned within a specified period if the
customers are not satisfied. Evaluation units shipped are not recorded as sales
until the customer has paid for such units.
Deferred Service Revenue
The Company markets and sells service contracts for certain of its products
which require the Company to service previously sold products for a specified
period of time, usually one to three years. Revenue from such contracts are
billed to customers at the time of sale, but earned ratably over the life of the
service agreement. A corresponding liability reflecting the unearned revenue is
recorded as a current liability, since the portion of the unearned revenue
relating to service after twelve months is not material.
Research and Development Costs
Costs and expenses that can be clearly identified as research and
development, including software development costs, are charged to research and
development expenses as incurred.
Concentration of Credit Risk
Three customers accounted for approximately 47% and 36% of the Company's
total accounts receivable on July 31, 1997 and July 31, 1998, respectively, and
one customer accounted for approximately 12% and 9% of the Company's net sales
for fiscal 1997 and 1998, respectively. The loss of any one of the Company's
significant customers could have an adverse effect on the Company's business.
Net income per Common Share
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128").
SFAS 128 replaced the previously reported primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. The adoption of SFAS 128
did not have a material impact on the Company's earnings per share. For the
periods presented, basic net income per share was based on the weighted average
number of shares of common stock outstanding during the period. For the same
periods, diluted net income per share further included the effect of stock
options outstanding during the period.
Weighted average number of shares for basic and diluted earnings per share
are calculated as follows:
FISCAL YEAR
----------------------------------------
1996 1997 1998
---------- ---------- ----------
Weighted average common shares
outstanding during the period .......... 9,000,000 10,205,000 11,114,000
Potential dilution ............ 172,000 169,000 138,000
---------- ---------- ----------
9,172,000 10,374,000 11,252,000
========== ========== ==========
8
Employee Stock Plan
In accordance with the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company applies APB Opinion No. 25 and related
interpretations to account for its employee stock option plan. Note 9 of the
Consolidated Financial Statements contains a summary of the pro forma effects to
reported net income and earnings per share as if the Company had elected to
recognize compensation expense based on the fair value of the options granted at
grant date as prescribed by SFAS No. 123.
Impact of Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130"). SFAS 130 requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. SFAS 130 is effective for fiscal years beginning
after December 15, 1997 and will be adopted by the Company for its fiscal 1999.
Adoption of this pronouncement is not expected to have a material impact on the
Company's financial statements.
Also in June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS 131"). SFAS 131 replaces Statement of Financial Accounting
Standards No. 14 and changes the way public companies report segment
information. SFAS 131 is effective for fiscal years beginning after December 15,
1997 and will be adopted by the Company for its fiscal 1999 which commenced July
4, 1998. Adoption of this pronouncement is not expected to have a material
impact on the Company's financial statements.
9
2. INVENTORIES
A summary of inventories is as follows:
JULY 31, JULY 31,
1997 1998
---------- ----------
Raw materials ........... $5,218,000 $3,643,000
Work-in-process ......... 380,000 430,000
Finished goods .......... 3,465,000 5,074,000
---------- ----------
$9,063,000 $9,147,000
========== ==========
3. PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
JULY 31, JULY 31,
1997 1998
----------- -----------
Computer equipment ............................. $ 819,000 $ 1,884,000
Furniture and fixtures ......................... 567,000 955,000
Office equipment ............................... 710,000 1,079,000
Vehicles ....................................... 82,000 20,000
Leasehold improvements ......................... 77,000 128,000
----------- -----------
2,255,000 4,066,000
Less accumulated depreciation .................. (1,439,000) (1,855,000)
----------- -----------
Total ................................ $ 816,000 $ 2,211,000
=========== ===========
Depreciation expense for fiscal 1996, 1997 and 1998 totaled $194,000,
$248,000, and $543,000, respectively. In fiscal 1998, amortization of goodwill
was $62,000.
4. INCOME TAXES
The components of the provision for income taxes for fiscal 1996, 1997 and
1998 are summarized as follows:
FISCAL YEAR
---------------------------------------------
1996 1997 1998
----------- ----------- -----------
Current:
Federal .......................... $ 1,612,000 $ 5,006,000 $ 3,151,000
State ............................ 434,000 1,246,000 770,000
----------- ----------- -----------
2,046,000 6,252,000 3,921,000
----------- ----------- -----------
Deferred:
Federal .......................... (223,000) (670,000) (436,000)
State ............................ (23,000) (130,000) (11,000)
----------- ----------- -----------
(246,000) (800,000) (447,000)
----------- ----------- -----------
Provision for income taxes ......... $ 1,800,000 $ 5,452,000 $ 3,474,000
=========== =========== ===========
Components of the Company's deferred income tax benefit are presented
below:
FISCAL YEAR
---------------------------------------
1996 1997 1998
--------- --------- ---------
State tax payments ................. $ 137,000 $ 241,000 $(175,000)
Depreciation ....................... (3,000) (40,000) (12,000)
Inventory reserves ................. 36,000 14,000 14,000
Reserves for bad debts and returns . 102,000 313,000 126,000
Stock option exercises ............. -- 140,000 (140,000)
Amortization of intangibles......... -- -- 570,000
Deferred service revenue ........... -- -- 138,000
Other .............................. (26,000) 132,000 (74,000)
--------- --------- ---------
Deferred income tax benefit ........ $ 246,000 $ 800,000 $ 447,000
========= ========= =========
10
The following table reconciles the federal statutory income tax rate to the
effective tax rate of the provision (benefit) for income taxes.
FISCAL YEAR
--------------------------------
1996 1997 1998
------ ------ ------
Federal statutory income tax rate ................ 34.0% 34.0% 34.0%
State income taxes, net of federal benefit ....... 6.1 6.1 5.8
Foreign sales benefit ............................ (1.1) (0.3) (0.3)
Nondeductible amortization ....................... -- -- 3.1
Research and development tax credit .............. (0.6) (1.8) (5.6)
Other ............................................ 0.3 1.2 2.3
------ ------ ------
Effective tax rate ............................. 38.7% 39.2% 39.3%
====== ====== ======
Deferred tax assets are summarized below:
JULY 26, JULY 31, JULY 31,
1996 1997 1998
---------- ---------- ---------
Deferred tax assets:
State tax payments ........................ $ 171,000 $ 338,000 $ 175,000
Depreciation .............................. 68,000 26,000 11,000
Inventory reserves ........................ 121,000 225,000 230,000
Reserves for bad debts and returns ........ 201,000 496,000 695,000
Stock option exercises .................... -- 201,000 --
Amortization of intangibles................ -- -- 570,000
Deferred service revenue sales ........... -- -- 138,000
Other .................................... 44,000 119,000 33,000
---------- ---------- ---------
Deferred income taxes .................. $ 605,000 $1,405,000 $1,852,000
========== ========== ==========
5. OTHER ASSETS
Other assets consist of the following:
JULY 31, JULY 31,
1997 1998
----------- -----------
Goodwill ..................... $ -- $ 1,636,000
Accumulated amortization ..... -- (62,000)
Other assets ................. 31,000 272,000
----------- -----------
$ 31,000 $ 1,846,000
=========== ===========
Goodwill relates to two acquisitions completed by the Company in fiscal
1998. Goodwill will be amortized on a straight line basis over 7 years.
6. LINE OF CREDIT
The Company has established a revolving line of credit with an
institutional lender. The line is based on a percentage of the Company's
eligible accounts receivable and inventory, up to a maximum of $10,000,000 in
working capital loans. The line of credit accrues certain commitment fees,
unused facility fees, and interest on outstanding amounts at the lender's prime
rate (8.5% at July 31, 1997) plus 1.5%. The initial term of the line of credit
expires on November 29, 1997, but automatically renews for successive one year
periods unless terminated by either party within a specified period in advance
of the automatic renewal date. The institutional lender also makes available to
the Company various flooring commitments pursuant to which the Company may
finance the purchase of up to $15.0 million in inventory (less any amounts
outstanding in working capital loans) from certain of the Company's vendors who
have credit arrangements with the institutional lender. The combined line of
credit may not exceed $20.0 million and contains restrictive covenants that,
among other provisions, require compliance with certain financial covenants,
including the maintenance of working capital of at least $20,000,000. The
combined line of credit is collateralized by all the assets of the Company. At
July 31, 1997 and July 31, 1998, the Company owed $0 and $0 under the line of
credit and $3,840,000 and $2,300,000, which is included in accounts payable,
under the flooring agreements, respectively (see Note 7). In addition to the
Finova line of credit, Megabyte has two lines of credit, utilized primarily for
overdraft and short-term cash needs, with two German banks. The lines allow
Megabyte to borrow up to 1,000,000 German marks (approximately $550,000 US
dollars), with interest at approximately 8.5%, and is not guaranteed by Procom.
At July 31, 1998, there was 375,000 DM (approximately $ 210,000 US dollars)
outstanding under one of the lines and $0 under the second line of credit.
11
7. COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company leases a facility under a noncancellable operating lease that
expires in fiscal 1999. The facility lease contains an option to extend the
lease under the same terms for four months. The Company has exercised the
option, extending the lease until November 30, 1998. In addition, the Company
leases facilities in Munich, Germany and Boston, Massachusetts, and various
other sales offices.
Future minimum lease payments at July 31, 1998, under these leases were as
follows:
CAPITAL OPERATING
LEASE LEASES
--------- ---------
Fiscal year ending:
1999 .............................................. $ -- $ 476,000
2000 .............................................. -- 114,000
2001 .............................................. -- 119,000
--------- ---------
Total minimum lease payments ...................... -- $ 739,000
=========
Less, amounts representing interest ............... --
---------
Present value of future minimum capital lease
obligations ..................................... $ --
=========
Rent expense was $398,000, $447,000 and $525,000 for fiscal 1996, 1997 and
1998, respectively.
Flooring Agreements
As is customary in the computer reseller industry, the Company is
contingently liable at July 31, 1998 under the terms of repurchase agreements
with several financial institutions providing inventory financing for dealers of
the Company's products. The contingent liability under these agreements
approximates the amount financed, reduced by the resale value of any products
that may be repurchased, and the risk of loss is spread over several dealers and
financial institutions. Losses under these agreements have been immaterial in
the past.
Litigation
The Company is a defendant in an action filed in Orange County Superior
Court by Miradco International Corporation, a private company based in Newport
Beach, California, consisting of two principals ("Miradco"), which alleges that
the Company breached an alleged oral contract with Miradco. In its complaint,
Miradco has asserted that it is entitled to receive 280,000 shares of the
Company's Common Stock, which Miradco contends has a value in excess of $5.6
million, as payment for financial advisory services allegedly rendered to the
Company by Miradco. During discovery in the legal action, Miradco has claimed
that it is entitled to receive up to 7% of the Company's Common Stock, with a
minimum of 280,000 shares. The Company vigorously denies the existence of any
oral contract with Miradco, and believes any oral contract claim of Miradco and
the suit are entirely without merit. The Company intends to defend itself
vigorously in this action. The Company has expended approximately $100,000 for
legal costs for this action in the fiscal year ended July 31, 1998, and expects
that it will incur significant additional legal expenses relating to this claim
in fiscal 1999. Trial has been set initially for January 1999. While the Company
believes that Miradco's claims are without merit, there can be no assurance
about the outcome of this case, nor the effect it may have on the financial
condition or results of operations of the Company. If the claims of Miradco were
held to be valid, a judgment for a significant amount could be entered against
the Company, and such judgment could have a material adverse effect on the
Company's results of operations and financial condition.
The Company is involved in routine litigation arising in the ordinary
course of its business. While the outcome of litigation cannot be predicted with
certainty, the Company believes that none of the other pending litigation will
have a material adverse effect on the Company's financial position or results of
operations.
12
Employment Agreements
The Company has employment agreements with the Company's President and
three Executive Vice Presidents. Each agreement is for a three year term with an
automatic renewal provision which provides that the agreement will perpetually
maintain a three-year term unless terminated. Each agreement contains severance
provisions that require the payment of 35 months of base salary in the event of
the termination of the covered executives. Should all four executives be
terminated, the aggregate commitment arising under the severance provisions
would be approximately $2.6 million and, in addition, the Company would be
obligated to pay a pro rata bonus for the year of termination and the
continuation for up to two years of all life insurance and medical benefits.
8. RETIREMENT PLAN
The Company has a defined contribution plan covering substantially all
full-time employees with more than one year of service. Each participant can
elect to contribute up to 15% of his or her annual compensation. While employer
contributions to the plan are discretionary, during fiscal 1995, 1996 and 1997,
the Company elected to make matching contributions equivalent to between 38% and
50% of the first 4% of the employee's contribution. Total expense for fiscal
1996, 1997 and 1998 was $47,000, $72,000, and $95,000, respectively.
9. STOCK SPLIT AND STOCK OPTION PLAN
In September 1995, the shareholders of the Company approved a stock split,
whereby each shareholder was issued 10,000 shares of common stock for each share
held.
During fiscal 1996, the Company instituted the 1995 Stock Option Plan (the
"1995 Plan") for its key employees and reserved 540,000 shares for grant under
the 1995 Plan. In fiscal 1998, the Board approved, and the Company's
shareholders approved, the reservation of an additional 450,000 shares for grant
under the 1995 Plan. Pursuant to the terms of the 1995 Plan, options to purchase
the Company's common stock may be granted with exercise prices equal to the fair
market value of the stock on the date of grant. Options expire ten years from
the date of the grant and generally vest over a period of four years. During
fiscal 1998, the Board authorized the repricing of previously granted options
priced in excess of $8.50 per share. The new price was $8.50 per share, the fair
value of the Company's stock on the date of such repricing.
The following table is a summary of stock option activity for the three
years ended July 31, 1998: Year ended July 31,
1996 1997 1998
------------------------ ------------------------ ----------------------
Weighted-Avg. Weighted-Avg. Weighted-Avg.
Shares Exercise Price Shares Exercise Price Shares Exercise Price
-------- -------------- -------- -------------- ------ --------------
Outstanding at beginning of year ........ -- $ -- 227,700 $2.68 247,013 $4.19
Granted ............................ 235,050 $2.67 87,750 $8.55 351,800 $9.64
Exercised ......................... (--) $ -- (24,562) $2.53 (50,036) $2.83
Cancelled .......................... (7,350) $2.50 (43,875) $5.26 (46,500) $7.38
-------- -------- --------
Outstanding at end of year ........ 227,700 $2.68 247,013 $4.19 502,277 $6.53
======== ======== ========
Exercisable end of year ........... -- $ -- 36,338 $2.76 47,090 $4.06
======== ======== ========
Weighted fair value per option
granted ......................... $ .56 $6.13 $4.77
July 31, 1998
----------------------------------------------------------------------
Options Outstanding Options Exercisable
----------------------------------------------------------------------
Weighted-Average Weighted- Weighted-
Range of Remaining Average Average
Exercise Prices Number Years Exercise Price Number Exercise Price
--------------- ------- ---------------- -------------- ------ --------------
$2.50-3.00 110,077 7.14 $2.52 29,152 $2.53
$4.50-7.56 155,250 9.64 $6.36 8,626 $4.50
$8.33-8.50 236,950 9.09 $8.49 9,313 $8.47
$2.50-8.50 502,277 8.83 $6.53 47,091 $4.06
During the years ended July 31, 1997 and July 31, 1998, the Company
realized tax benefits of $201,000 and $ 242,000, respectively, from the gains
resulting from exercises by employees of non-qualified stock options. The tax
benefit is recorded as an increase in paid-in-capital.
13
In addition to the September 1995 stock split discussed above, the Company
filed amended and restated articles of incorporation on November 13, 1996,
which, among other things, effected a stock split pursuant to which each
shareholder was issued three shares of common stock for each common share held.
All share and per share amounts have been restated to give retroactive effect to
this stock split as well as the September 1995 stock split.
Pro forma information regarding net income and earnings per share is
required by SFAS 123 for stock options granted after June 30, 1996 as if the
Company had accounted for its stock options under the fair value method of SFAS
123. The fair value of the Company's stock options was estimated using the
Black-Scholes option valuation model. The Black-Scholes option valuation model
was developed for use in estimating the fair value of traded options which have
no vesting restrictions and are fully transferable. In addition, the
Black-Scholes model requires the input of highly subjective assumptions,
including the expected stock volatility. Because the Company's stock options
granted to employees have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its stock options granted to employees. The fair value of the Company's stock
options granted to employees was estimated assuming no expected dividends and
the following weighted average assumptions:
STOCK OPTION
PLAN SHARES
-----------------------
1997 1998
------- -------
Expected life (in years) ..... 4.0 4.0
Risk-free interest rate ....... 6.0% 6.0%
Volatility .................... .91 .79
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting period. The Company's pro forma
information follows:
1997 1998
---------- ----------
Pro forma net income ....... $8,325,000 $5,197,000
Pro forma primary net income
per share ............. $ .81 $ .46
The effects on pro forma disclosures of applying SFAS 123 are not likely to
be representative of the effects on pro forma disclosures of future years.
10. GEOGRAPHIC
Export sales as a percentage of net sales amounted to 11%, 7% and 17% for
fiscal years 1996, 1997 and 1998, respectively. A summary of the Company's net
sales and gross profit by geographic area is as follows (in thousands):
YEAR ENDED
----------------------------------------
JULY 26, JULY 31, JULY 31,
1996 1997 1998
-------- -------- --------
Net sales
United States ...... $ 65,072 $101,147 $ 92,928
Foreign ............ 8,384 8,185 18,958
-------- -------- --------
Total ......... $ 73,456 $109,332 $111,886
======== ======== ========
Gross profit
United States ...... $ 20,004 $ 34,409 $ 32,968
Foreign ............ 1,963 2,239 3,391
-------- -------- --------
Total ......... $ 21,967 $ 36,648 $ 36,359
======== ======== ========
Operating income
United States ...... $ 3,554 $ 12,405 $ 7,366
Foreign ............ 1,377 1,166 255
-------- -------- --------
Total ......... $ 4,931 $ 13,571 $ 7,621
======== ======== ========
14
International sales were primarily to European customers and secondarily to
Middle Eastern, Latin American and Pacific Rim customers. During fiscal 1996 and
1997, the Company had no material identifiable assets used in connection with
the Company's foreign operations. As a result of the Company's February 1998
acquisition of the outstanding stock of Megabyte, at July 31, 1998, the Company
had identifiable assets used in connection with its foreign operations of
approximately $4,844,000.
11. ACQUISITIONS
During fiscal 1998, the Company completed two acquisitions. In February
1998, the Company purchased 100% of the outstanding shares of Megabyte
Computerhandels AG, a German distributor of high-end networking solutions. The
transaction was accounted for as a purchase, and was effected by the Company's
issuance of 104,144 shares of the Company's common stock valued at $900,000. The
Company recorded the assets and liabilities of Megabyte at their fair values on
the date of acquisition. The purchase price in excess of the fair values of the
net assets acquired was approximately $713,000, which has been recorded as
goodwill, and will be expensed on a straight line basis over 7 years. In June
1998, the Company completed the acquisition of substantially all the assets and
liabilities of Invincible Technologies Corporation ("ITC"), a Massachusetts
based developer and reseller of high capacity, fault tolerant network storage
solutions. The transaction was accounted for as a purchase of assets. The
purchase price paid consisted of cash of approximately $1.0 million, and the
Company assumed liabilities in excess of net assets acquired of approximately
$1.6 million, for a total purchase price of approximately $2.6 million. ITC had
experienced significant losses in its fiscal year ended March 31, 1998. The
Company employed an appraiser to identify the values of the assets acquired,
including, among other assets, certain in-process research and development
costs. The amount of purchase price allocated to in-process research and
development was determined by estimating the stage of development of
Invincible's research and development projects, estimating future cash flows
from future projected revenues, and discounting those cash flows to present
value. Invincible had been primarily developing a software cluster management
system to extend the capability of UNIX clustering. In determining the
appropriate value, the Company considered the prior losses of Invincible, the
investment of Invincible toward the development of the outstanding software
system, as well as the estimated completion costs which the Company expects to
incur to complete the outstanding research and development projects. The Company
further estimated the future revenues and cash flows attainable from the
research and development projects, and discounted those revenues significantly
to take into account Invincible's lack of financing to attain the projections.
The Company has determined that $1.7 million of the purchase price was related
to the Company's research and development efforts which had not attained
technological feasibility, and for which no alternative future use was expected.
The Company has expensed the value of the research and development as of the
date of the acquisition of Invincible and has capitalized the fair value of the
other assets acquired as determined by the appraiser, including the value of
Invincible's assembled work force and goodwill of approximately $913,000, which
will be expensed on a straight line basis over 7 years. The Company will include
the results of operations and balance sheets of Megabyte and Invincible for
periods subsequent to the date of the respective acquisitions. Prior periods
have not been restated.
The following is a summary of the net fair value of the assets acquired,
the goodwill on the date of acquisition, and the total consideration paid for
the acquisitions made during fiscal 1998:
Megabyte Invincible Total
-------- ---------- -----
Fair value of noncash assets acquired $4,755,000 $5,431,000 $10,186,000
Liabilities assumed, including lines of credit (4,008,000) (4,643,000) (8,651,000)
Common stock issued (902,000) -- (902,000)
----------- ----------- -----------
Cash consideration paid, net of cash acquired (155,000) 788,000 633,000
=========== =========== ===========
The following unaudited pro forma information has been prepared assuming
that the acquisitions of Megabyte and Invincible had taken place at the
beginning of the respective periods presented. The pro forma financial
information is not necessarily indicative of the combined results that would
have occurred had the acquisitions taken place at the beginning of the period,
nor is it necessarily indicative of results that may occur in the future.
(UNAUDITED)
PRO FORMA FOR THE YEARS ENDED
July 31, 1997 July 31, 1998
------------- -------------
(in thousands, except per share data)
Revenues $160,584 $135,576
Operating income $ 10,193 $ 5,381
Net income $ 5,982 $ 3,732
Net income per share--diluted $ .57 $ .33
12. CHANGE IN PAR VALUE
The Company's amended and restated articles of incorporation, filed on
November 13, 1996, as discussed above in Note 10, also effected a change in
common stock from no par value to par value of $.01 per share. In fiscal 1997,
$89,700 was transferred from retained earnings to common stock and
paid-in-capital to reflect the change in par value.