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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 15, 2000
REGISTRATION NO. 2-87197
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 AND 15(D) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: OCTOBER 31, 1999 COMMISSION FILE NUMBER: 0-24015
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DUNN COMPUTER CORPORATION
(Exact Name of Registrant as Specified in its Charter)
VIRGINIA 54-1890464
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
1306 SQUIRE COURT
DULLES, VIRGINIA 20166
(Address of principal executive office) (Zip Code)
703-450-0400
Registrant's telephone number, including area code:
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SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT:
NONE
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SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE
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(Title of class)
Indicate by check mark whether the issuer (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past 12 months (or for such shorter period that the issuer was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes X No
Indicate by check mark if there is no disclosure of delinquent filers in
response to Item 405 of Regulation K contained in this form, and no disclosure
will be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. / /
The aggregate market value of the voting and non-voting common equity held
by non-affiliates computed at $2.63 per share, the closing price of the Common
Stock on January 31, 2000, was $16,933,384.
The number of shares of the issuer's Common Stock outstanding as of
January 31, 2000 was 9,419,509.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information called for by Part III of the Form 10-K will either be
filed with the Commission under Regulation 14A under the Securities Exchange Act
of 1934, as amended or by amendment to this Form 10-K, in either case on or
before February 28, 2000.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report regarding matters that
are not historical facts are forward-looking statements (as such term is defined
in the Private Securities Litigation Reform Act of 1995). Because such
statements include risks and uncertainties, actual results may differ materially
from those expressed or implied by such forward-looking statements. Factors that
could cause actual results to differ materially include, but are not limited to,
changes in component costs, the U.S. Government's available funding for
information technology purchases, the actions of competitors, the Company's
ability to retain its existing contracts and to procure additional contracts or
other selling vehicles and general economic conditions. These risks and others
are discussed in more detail in context throughout this document. The Company
disclaims any intent or obligation to update any forward-looking statement.
TABLE OF CONTENTS
PART I
Item 1. Business.................................................... p. 2
Item 2. Properties.................................................. p. 8
Item 3. Legal Proceedings........................................... p. 8
Item 4. Submission of Matters to a Vote of Security Holders......... p. 9
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... p. 10
Item 6. Selected Financial Data..................................... p. 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... p. 12
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ p. 16
Item 8. Financial Statements and Supplementary Data................. p. 16
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... p. 16
PART III
Item 10. Directors and Executive Officers of the Registrant..........
Item 11. Executive Compensation......................................
Item 12. Security Ownership of Certain Beneficial Owners and
Management..................................................
Item 13. Certain Relationships and Related Transactions..............
(Part III information is incorporated by reference to portions of the
Company's definitive Proxy Statement to be filed pursuant to Regulation
14A)
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... p. 17
1
PART I
ITEM 1. BUSINESS
GENERAL
Dunn Computer Corporation (together with its wholly-owned subsidiaries, the
"Company" or "Dunn") manufactures custom computer systems and provides related
services to departments, agencies and offices of the federal government (the
"Government") and selected businesses. The Company provides its customers with
single-source solutions by manufacturing its own brand of desktop and portable
computers and high performance network client servers and offering services,
which include network consulting, project implementation, and technical support.
The Company currently derives revenues from hardware sales to the Government and
to medium and large businesses. The Company sells its products and services to
more than 300 customers, including entities within the Department of Defense,
Administrative Office of the U.S. Courts, Lockheed Martin Corporation, Blue
Cross and Blue Shield Association and the District of Columbia Government.
In April 1997, the Company sold 1,000,000 shares of common stock ("Common
Stock") in an initial public offering for net proceeds of $3,917,664. In
connection with the offering, warrants were issued to the underwriter for
100,000 shares of common stock at an exercise price of $6.00 per share.
Beginning April 21, 1998, the warrants are exercisable for a period of four
years.
In September 1997, Dunn completed the acquisition of STMS, Inc. a
Virginia-based network services company ("STMS") which expanded Dunn's
capabilities to provide a wide variety of services including network consulting,
project implementation and technical support. The STMS acquisition provided the
Company new opportunities to sell computer hardware into the commercial
marketplace as part of a total package of information technology ("IT") hardware
and services tailored to meet the commercial customers' needs. By manufacturing
its own computer systems, the cost of which represents a significant portion of
the cost of a total project, the Company believes it has a sustainable
competitive advantage over other network service providers.
On May 1, 1998, Dunn acquired International Data Products, Corp. ("IDP Co.")
and the net assets of IDP Co.'s Puerto Rican affiliate, Puerto Rico Industrial
Manufacturing Operations, Corp. ("PRIMO" and together with IDP Co., "IDP"), for
approximately $22 million, consisting of a combination of cash and Common Stock
(the "IDP Acquisition"). When acquired, IDP was a leading supplier of portable
and desktop computers to the Government. In May 1998, in connection with the IDP
Acquisition, the Company completed a public offering of 3,491,493 shares of
Common Stock for net proceeds of $26,287,866.
In fiscal year 1999, the Company recorded a significant Goodwill impairment
charge of approximately $21 million associated with the IDP acquisition. This
was the result of the Company's loss of a significant contract with the U.S. Air
Force which was terminated for the convenience of the government during fiscal
1999. At acquisition date, the Company anticipated revenues from this contract
to be approximately $100 million had all option years been exercised. The
Company determined that the loss of this contract significantly impaired its
ability to recover the Goodwill associated with the purchase. Accordingly, the
Company recorded the Goodwill impairment charge. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
The Company seeks to establish itself as a leading provider of network
solutions to both the government and commercial markets. One of the key elements
of this strategy is integrating the Company's hardware and network services into
a total solution for its Government customers. In the commercial market,
management plans to leverage the Company's customer relationships developed
through sales of its network services to expand sales of its hardware products.
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PRODUCTS AND SERVICES
COMPUTER HARDWARE PRODUCTS
DESKTOPS: The Company manufactures a high performance line of Pentium II
and Pentium III based desktop computers that may be used on a standalone basis
or as part of a network. These systems are based on Intel motherboards to
guarantee high reliability and are "wired for management" to allow these
desktops, when connected to the network, to be monitored and controlled, by the
network. This technology helps ensure that desktops connected to a network are
properly configured and consistently operating the same level of software.
SERVERS: The Company markets a single, dual or quad processor version of
the Intel Pentium III and Zeon processor based systems. These servers are
designed to give the customer the highest level of performance and reliability
available in the market today. Based on Intel motherboards, these systems when
installed in conjunction with Dunn's desktops provide the "wired for management"
technology to ensure high availability and consistently configured systems on
the network. The Company believes that the server market offers opportunities
for higher profit margins compared to other sectors in the industry. With the
ever increasing popularity of the Internet, the server market represents a
significant growth sector for the Company. Additionally, servers sales
complement the Company's services business due to the complexity of server
installation and maintenance.
LAPTOPS: The Company assembles, on a brand name basis, a state-of-the-art
line of Laptops. These Laptops are produced in our Puerto Rico facility.
NETWORKING HARDWARE & SOFTWARE: The Company integrates, installs, and
maintains major brand networking hardware and software. The Company has
partnerships with companies like Network Associates, Inc (NAI), Cisco Systems,
Inc (Cisco Systems) and Marconi, Inc.
ORIGINAL EQUIPMENT MANUFACTURE (OEM): The Company manufactures, on an OEM
basis, hardware products for major network solutions providers.
TECHNICAL SERVICES
The Company provides network design, implementation, and support services
for wide-area and local-area networks. These services are provided to
commercial, federal government and state/local government clients in two
methods: Project-based and staffing-based engagements.
PROJECT-BASED ENGAGEMENTS: The Company provides network analysis, design,
and implementation services primarily in the form of short-term (less than three
months) projects. Specific completion criteria are achieved and deliverables
submitted to signify the end of the project. These network-engineering services
are performed for a fixed-fee upon completion or on an hourly labor basis at the
pre-negotiated price and estimated levels of effort.
Specific project-based services that the Company performs include network
design, systems implementation, integration, network security, software
migrations, and messaging system implementation. The Company strives to maintain
expertise in specific areas and technologies rather than be generalists in all
IT areas. By maintaining a focus, the Company can provide highly skilled
professionals and services that leverage our experience for maximum benefit to
the client. Project management is the key component of the Company's strategy
and success in project-based engagements.
STAFF AUGMENTATION: The Company provides network support services to our
clients in the form of fixed-rate hourly engineering services. Contracts with
commercial and Government clients typically range from one month to one year in
length. Staffing services consist of placing one or more network engineers, user
support technicians, or programmers on-site with a client. These professionals
perform work as a "virtual" employee for the client and typically work under the
direction and changing needs of the client's
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management. We provide skilled technical professionals to our customers, along
with technical support from our vendor partners such as Microsoft, Novell,
Cisco, and Network Associates.
Dunn's success in this area is achieved largely due to contract renewals and
increasing staffing requirements from existing customers. The market for
staffing is consistently increasing as customers try to focus on their core
business and contract Dunn to handle their IT support requirements.
GOVERNMENT CONTRACTS
In fiscal 1999, Dunn derived approximately 65% of its revenues from sales of
hardware and services to the Government pursuant to contracts with the General
Services Administration (GSA) or other agency-specific contracts. Most of these
contracts are leasing of equipment, blanket purchase agreement ("BPA") or
"indefinite delivery, indefinite quantity" ("IDIQ") contracts. Government
contracts, by their terms, generally can be terminated at anytime, without cause
for the convenience of the Government. If a Government contract is so
terminated, the contractor generally is entitled to receive compensation for the
services provided or certain costs incurred at the time of termination and a
reasonable profit on the contract work performed prior to the date of
termination. In addition, all Government contracts require compliance with
various contract provisions and procurement regulations and in certain cases,
accounting and audit requirements. If not cured, certain violations of these
regulations could result in the termination of the contract, imposition of
fines, and suspension or debarment from competing for or receiving awards of
additional Government contracts. Exclusion of the Company from federal
procurements, the termination of any of the Company's significant Government
contracts or the imposition of such penalties could have a material adverse
effect on the Company.
Substantially all of the Company's Government customers purchase equipment
and services from the Company on a long-term contract basis. By contrast, most
of the commercial customers purchase equipment and services by means of task and
open purchase orders.
DESKTOP V CONTRACT. Initially awarded to IDP, this contract was not renewed
in May 1999 and was officially terminated for the convenience of the Government
on October 8, 1999. The Company is currently negotiating a settlement with the
Government for recovery of certain costs incurred to support the contract. A
settlement proposal has been submitted to the Government, however, no agreement
has been reached as of January 31, 2000. The Company cannot estimate any
potential settlement amounts at this time.
Set forth below is a description of some of the Company's more significant
contracts as of October 31, 1999.
GSA CONTRACT. The Company has a multiple award schedule contract with GSA
(the "GSA" Contract). The Company's GSA contract was awarded in April 1996 and
is valid through March 31, 2002. GSA contracts enable Government IT purchasers
to acquire all of their requirements from a particular vendor and largely limits
the competition to selected vendors holding GSA contracts. For fiscal year 1999,
the Company's GSA contract had sales of $5.9 million, which accounted for
approximately 8.5% of the Company's revenues.
IT-21 CONTRACT. In January 1998, IDP was awarded a contract by the Fleet &
Industrial Supply Center, Norfolk Philadelphia Detachment for the IT-21 program
at the CINCLANTFLT Norfolk, VA. This contract is a five-year equipment lease
program in which the Company provides a full spectrum of IT products and
services to the CINCLANTFLT headquarters. A unique aspect of this program is its
"Technology Refresh" feature in which the Company periodically updates the
installed equipment to the latest technology at no incremental cost to the
Government. The leased equipment includes servers, workstations, desktops, hubs,
switches and printers. On-site sparing and 4-hour response time are also part of
the contract requirements. The contract to date total revenue is $4.5 million.
4
PRSTARNET CONTRACT. After several protest delays, the Company was awarded a
contract with the Puerto Rican Government on January 5, 2000. The Company was
selected as one of several vendors to supply the Puerto Rican school systems
with laptop computers. The terms of the contract require the Company to deliver
approximately 11,000 computers to the Puerto Rican school system by
August 2000. The Company anticipates that this contract will generate
approximately $16 million in revenues for fiscal year 2000.
This contract represents Phase I of the Puerto Rican Government's plan to
increase the technological education in their school system. The Company will
bid on Phase II during fiscal 2000, which will supply the school system with
desktop computers for all students. The Company cannot predict the outcome of
its bid proposal.
COMMERCIAL CONTRACTS
In fiscal year 1999, Dunn derived approximately 30% of its revenues from
sales of hardware and services to the commercial marketplace. The Company's
commercial customer base consists of several Fortune 500 companies as well as
certain small local commercial customers. The Company anticipates continuing to
further increase its commercial customer base in the upcoming fiscal year. The
Company has been successful in developing and maintaining key partnerships with
industry leading companies such as Microsoft, Cisco, Sun and Network Associates.
These partnerships will enable the Company to further diversify its product mix
and attract high quality customers.
MANUFACTURING AND PRODUCTION
The Company's production capacity is 100,000 units per year in the existing
Sterling County facility on a three-shift basis. The Company also leases an
approximately 34,000 square-foot facility in Guayama, Puerto Rico, which is used
for manufacturing, technical support, and personal computer board level repair.
The Guayama facility is ISO 9002 certified, and has the capability to
manufacture 200,000 systems per year.
COMPETITION AND MARKETING
The markets for the Company's products and services are highly competitive.
Many of the Company's competitors offer broader product lines, have
substantially greater financial, technical, marketing and other resources than
the Company and may benefit from component volume purchasing and product and
process technology license arrangements that are more favorable in terms of
pricing and availability than the Company's arrangements. The Company also
competes with a large number of computer systems integrators, resellers and IT
services companies. The Company believes that it is likely that these
competitive conditions will continue in the future. There can be no assurance
that the Company will continue to compete successfully against existing or new
competitors that may enter markets in which the Company operates.
FEDERAL GOVERNMENT MARKET. The Information Technology Reform Act (the
"ITRA") which took effect on August 8, 1996 has had a profound effect on the way
Government procures computers and related products and services. The most
sweeping changes were (1) the repeal of the Brooks Act that had granted sole
authority for purchasing IT to the GSA and, (2) the change in the GSA Schedule
from a single-year small purchase contracting program to a multi-year, IDIQ
contract with no limit on the value of purchases. Prior to the new legislation,
the GSA was responsible for overseeing all IT purchases as well as assuring fair
and open competition. The new legislation has expanded Dunn's ability to market
and sell its products to Government users directly through its GSA contract and
BPA's awarded under the GSA schedule. The Company continues to make marketing
and sales efforts to take advantage of these changes in the federal market.
Since the passage of the ITRA, the Government has increased the amount of
information products acquired through the GSA Schedule. Although Dunn believes
it has benefited from this reform, the
5
emergence of the GSA Schedule as a significant procurement vehicle has also
enabled traditional mass-market commercial computer companies to be more
responsive to Government requirements. The Company currently competes with
national commercial computer manufacturers such as Dell Computer Corporation
("Dell") and Gateway 2000, Inc. ("Gateway") for a portion of the Government
market.
There has been a consolidation in the industry as a result of acquisitions
and the failure of many firms. The competition for computer sales has settled
into a small group of competitors comprised of manufacturers and systems
integrators. The Company believes that the Government's selection criteria for
vendor selection consists of price, quality, familiarity with the vendor, and
size and financial capability of the vendor.
The following companies are significant competitors of the Company in the
Government market:
COMPANY TYPE
- ------- ----
Dell............................................. Manufacturer
Gateway.......................................... Manufacturer
Micron Technology, Inc. ("Micron")............... Manufacturer
Government Technology Services, Inc.............. Systems Integrator
Compaq........................................... Manufacturer
COMMERCIAL MARKET
The microcomputer products industry is highly competitive. Pricing is very
aggressive in the industry and the Company expects pricing pressures to continue
to intensify. The microcomputer products industry is also characterized by rapid
changes in technology and consumer preferences, short product life cycles and
evolving industry standards.
The commercial market for IT services is a highly fragmented market served
by thousands of small value-added resellers. These companies typically service a
small geographic area and resell national brand computer and/or network
hardware. The Company believes its technical services can compete effectively in
the local market because it provides engineering services in conjunction with
products from its strategic partners; e.g., Network Associates, Inc., Cisco,
Microsoft, Marconi, Sun and Intel. The Company believes that its ability to
integrate the computer hardware (Dunn brand or any other) and networking
products provides its technical services group a competitive advantage.
Microcomputers are marketed through several distribution channels including
direct marketing, traditional microcomputer retailers, computer superstores,
consumer electronic and office supply superstores and other resellers. There are
many manufacturers of microcomputers; substantially all of which have greater
financial, marketing and technological resources than the Company. The Company
competes with manufacturers such as Compaq, Dell, Gateway, IBM and Packard Bell
NEC, Inc. The principal elements of competition are product reliability and
quality, customization, price, customer service, technical support, IT services
and product availability. There can be no assurance that the Company will in the
future be able to compete effectively against existing competitors, especially
companies who have historically focused their energies on the commercial market.
MARKETING
The Company markets to select commercial accounts and a wide array of
Government organizations including agencies within the Department of Defense,
civilian agencies and the judicial branch of the Government. The Company also
views the commercial market as an increasingly important part of its business.
The Company uses an in-house sales force and program managers to market its
products and services. Although Dunn markets nationally, the Company's marketing
efforts are concentrated in the Washington, D.C. metropolitan area and in the
state of Florida. Sales were made primarily to target commercial accounts. In
light of the company's pursuit of new commercial business and the new
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procurement legislation, which gives different Government users the ability to
purchase directly from vendors, the Company believes that marketing is becoming
increasingly important to its Government as well as to its commercial business.
The Company strives to build a strong relationship with its customers. The
Company believes that a key to building customer loyalty is a team of
knowledgeable and responsive account executives and technical and support staff.
The Company assigns each customer a trained account executive, to whom
subsequent calls to the Company will be directed. The Company believes that
these strong one-on-one relationships improve the likelihood that the customer
may consider the Company for future purchases. Product support technicians are
available 24 hours per day, seven days a week. The Company intends to continue
to provide its customers with products and technical services that offer the
customer the best value.
The Company uses electronic commerce technologies and believes that both the
Government and commercial customers will continue to expand the utilization of
these technologies. Internet and on-line computer services are being used by the
Government and commercial accounts to advertise opportunities, reference vendor
information and in some cases make actual purchases. The Company maintains a web
site on the Internet wherein its GSA catalogue and products can be referenced.
In addition, the Company provides the capability for customers to download
updated software and drivers that become available. The Company believes that
its targeted customer base will have a greater acceptance of these interactive
services because its customers tend to have a greater familiarity with
technology products and services.
SUPPLIERS
The Company devotes significant resources to establishing and maintaining
relationships with its suppliers. The Company, where possible, purchases
directly from component manufacturers such as Intel, Microsoft, Hitachi-Nissei
Sanyo America, Ltd., Cisco and Chicony Corp. The Company also purchases multiple
products directly from large national and regional distributors such as TechData
Corporation, Ingram Micro Incorporated, Decision Support Systems Incorporated,
Wyle Electronics and Bell Micro.
Suppliers provide the Company with incentives in the form of discounts,
rebates, credits, and cooperative advertising and market development funds. In
accordance with the terms of certain of the Company's Government contracts, the
Company provides periodic reporting of pertinent supplier contract terms and
conditions to contracting officials. As a product reseller, the Company must
continue to obtain products at competitive prices from leading suppliers in
order to provide competitively priced products for its customers. In the event
the Company is unable to purchase components from these suppliers, the Company
has alternative suppliers it can rely upon. The Company believes its
relationships with its key suppliers to be good and believes that generally
there are multiple sources of supply available should the need arise.
INVENTORY
Dunn has traditionally and will continue to purchase inventory to fill
orders received from our customers. The Company minimizes their inventory held
for warranty purposes and does not purchase inventory for speculative purposes.
PATENTS, TRADEMARKS AND LICENSES
The Company does not maintain a traditional research and development group,
but works closely with computer product suppliers and other technology
developers to stay abreast of the latest developments in computer technology.
While the Company does not believe that its continued success will depend upon
the rights to a patent portfolio, there can be no assurance that the Company
will continue to have access to existing or new technology for use in its
products.
7
The Company conducts its business under the trademarks and service marks of
"Dunn", "Dunn Computer Corporation", "International Data Products," and "IDP."
The Company believes its trademarks and service marks have significant value and
are an important factor in the marketing of its products.
Because most software used on the Company's computers is not owned by the
Company, the Company has entered into software licensing arrangements with
several software manufacturers, including Microsoft.
EMPLOYEES
As of October 31, 1999, the Company employed 110 persons. Of such persons, 1
was employed in an executive capacity, 13 in sales and marketing, 19 in
administrative capacities, 30 in technical services and 47 in operations. As of
January 21, 2000 the Company employed 102 persons. None of Dunn's employees are
covered by a collective bargaining agreement. Dunn considers its relationships
with its employees to be good.
The Company believes that its future success will depend in large part upon
its continued ability to attract and retain highly qualified management,
technical and sales personnel. The computer industry is currently undergoing a
shortage of trained and experienced technicians. The Company endeavors to be
attractive to current and prospective employees and has an in-house training
program to produce its own supply of highly qualified technicians and service
providers. However, there can be no assurance that the Company will be able to
attract and retain the qualified personnel necessary for its business.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith, files annual and quarterly reports on Forms 10-K and 10-Q, proxy
statements and other information with the Securities and Exchange Commission
(the "Commission"). The public may read and copy any such materials filed with
the Commission at the Commission's Public Reference Room at 450 Fifth Street,
N.W., Washington, D.C. 20549. The public may obtain information on the operation
of the Public Reference Room by calling the Commission at 1-800-SEC-0330. In
addition, the Commission maintains an Internet site that contains reports, proxy
and information statements, and other information regarding issuers, such as the
Company, that file such materials electronically with the Commission. The
Commission's Internet address is http:\\www.sec.gov.
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases an approximately 35,000 square foot facility in Sterling,
Virginia which is used primarily for manufacturing and administrative services.
The lease expires in October 2004. During fiscal 1999, C&T Partnership, an
entity comprised of Thomas Dunne, the Company's President, and his wife Claudia
Dunne, the Company's Vice President, sold the facility and assigned the lease to
a third party building management company.
The Company also leases a 20,000 square-foot facility in Guayama, Puerto
Rico, which is used for manufacturing, technical support, and personal computer
board level repair. The Company believes that its current facilities are
adequate for its existing needs and that additional suitable space will be
available as required.
ITEM 3. LEGAL PROCEEDINGS
By letter dated April 15, 1998, DDI, a competitor of IDP, asserted that IDP
is bound by a settlement agreement entered into in connection with certain
litigation, calling for payments to the competitor of 1.8% of the first
$250 million of IDP's gross sales under the Desktop V contract. IDP and the
Company dispute this claim. On June 1, 1998, the Company filed a Complaint for
Declaratory Judgment in the U.S.
8
District Court of the Eastern District of Virginia seeking a declaration that
DDI is not entitled to receive payments under the settlement agreement. The
defendant counter-claimed against the Company claiming it did not breach the
settlement agreement and is entitled to the payments. These matters were
litigated and on February 26, 1999, DDI was awarded $1,500 in satisfaction of
its claim. DDI has filed an appeal of the judgment. While the Company believes
that it has a meritorious claim for declaratory judgment and meritorious
defenses to the counter-claim, there can be no assurance that the Company will
be successful in this litigation and, if the appeals court rules against the
Company, it may be required to pay a percentage of its past revenue under the
Desktop V contract to the defendant.
On July 31, 1998, the Company received notice from the SBA that it was
denying the request of the U.S. Air Force to waive the requirement to terminate
IDP's Desktop V contract for the convenience of the Government upon the change
in control of IDP to the Company. The Company appealed the denial of the SBA to
the SBA's Office of Hearings and Appeals. On August 31, 1999, the SBA denied the
appeal and ruled that the U.S. Air Force must terminate-for-convenience the
Desktop V contract. Under a termination-for-convenience, the government is
required generally to reimburse a contractor for all costs incurred in the
performance of the contract. The Company is in the process of attempting to
recover from the government a portion or all of unreimbursed costs associated
with the Desktop V Contract. Prior to this ruling by the SBA, the U.S. Air Force
determined not to exercise any of the remaining option years under the
Desktop V contract on May 1, 1999.
In November 1998, a former employee of the Company filed a demand for
arbitration with the American Arbitration Association, alleging a breach of his
employment agreement with the Company and seeking in excess of $2,350,000 in
damages from the Company. The Company filed an answer denying the claimant's
allegations and stating a counterclaim against the former officer for breach of
the employment agreement and for conversion of certain of the Company's
property. In a Final Arbitration Award dated August 27, 1999, the arbitrator
found in favor of the former employee on certain of the issues presented at the
arbitration and awarded the former employee in excess of $1.6 million in damages
and attorneys' fees. On December 10, 1999, the Fairfax County Circuit Court
denied the Company's motion to vacate the award and confirmed the award. The
Company has filed a writ with the Virginia Supreme Court seeking an appeal of
the Circuit Court's ruling.
On December 18, 1998, the Office of the United States Attorney for the
District of Maryland, Northern Division (the "U.S. Attorney"), informed the
Company that it was of the view that a civil False Claims Act violation was
assessable against certain parties, including IDP, George and Oscar Fuster (the
former principal owners of IDP) and the Company involving allegations of
fraudulent misrepresentations by the Fusters in IDP's 1994 application for
participation in the Section 8(a) program administered by the SBA. On
February 26, 1999, the Company and the other parties entered into a settlement
agreement with respect to this matter with the U.S. Attorney pursuant to which
the matter was settled without determination of liability against or monetary
payment by the Company.
There are routine legal claims pending against the Company, but in the
opinion of management, liabilities, if any, arising from such claims will not
have a material adverse effect on the financial condition and results of
operation of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
9
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
Prior to the quotation of the Company's Common Stock beginning on April 22,
1997, there was no established trading market for the Company's common stock.
The Company's Common Stock is traded in the over-the-counter market and prices
are quoted on The Nasdaq National Market under the symbol DNCC. The following
table sets forth the high and low selling prices as reported by The Nasdaq
National Market for the fiscal quarter indicated. These quotations reflect
inter-dealer prices without retail mark-up, mark-down or commission and may not
represent actual transactions.
1998
-------------------
HIGH LOW
-------- --------
First Quarter.............................................. $ 10.50 $6.625
Second Quarter............................................. $10.375 $8.188
Third Quarter.............................................. $ 9.938 $7.483
Fourth Quarter............................................. $ 4.75 $1.938
1999
-------------------
HIGH LOW
-------- --------
First Quarter.............................................. $ 6.28 $2.781
Second Quarter............................................. $ 4.94 $2.031
Third Quarter.............................................. $ 2.75 $ 1.97
Fourth Quarter............................................. $ 2.41 $1.031
On January 31, 2000 the closing price of the Company's Common Stock as
reported by The Nasdaq National Market was $2.63 per share. There were
approximately 1,500 shareholders of the Common Stock of the Company as of such
date.
The Company has not paid cash dividends on its Common Stock and does not
intend to do so in the foreseeable future.
RECENT SALES OF UNREGISTERED STOCK
On May 1, 1998, in connection with the IDP acquisition, the Company acquired
all of the issued and outstanding capital stock of IDP Co. and substantially all
of the net assets of PRIMO. In consideration for the IDP acquisition, the
Company paid the former owners an aggregate of $14.9 million in cash and an
aggregate of 750,000 shares of Common Stock. In November 1998, the Company
received 350,000 shares of the stock previously issued to the Fusters in
connection with a Purchase Price Adjustment Agreement. The shares sold to the
Fusters in the IDP acquisition were sold in reliance upon the exemption from
registration afforded by Section 4(2) of the Securities Act of 1933, as amended.
10
ITEM 6. SELECTED FINANCIAL DATA
DUNN SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following selected consolidated financial data of Dunn should be read in
conjunction with the consolidated financial statements and the notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations". The consolidated statement of operations data set forth below with
respect to the fiscal years ended October 31, 1997, 1998 and 1999 and the
consolidated balance sheet data as of October 31, 1998 and 1999 is derived from
and is referenced to the audited consolidated financial statements of Dunn
included elsewhere in this Annual Report on Form 10-K. The consolidated
statement of income data set forth below with respect to the fiscal years ended
October 31, 1995 and 1996 and the consolidated balance sheet data as of
October 31, 1995, 1996 and 1997 is derived from audited consolidated financial
statements of Dunn not included in this annual report.
YEAR ENDED OCTOBER 31,
----------------------------------------------------
1995 1996 1997(2) 1998(3) 1999
-------- -------- -------- -------- --------
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenues................................... $7,491 $18,099 $21,766 $66,888 $ 34,475
Costs of revenues.............................. 6,046 14,103 17,549 54,969 27,981
Gross profit................................... 1,445 3,996 4,217 11,919 6,494
Selling, general and administrative............ 966 1,972 2,198 9,983 37,749
Income (loss) from operations.................. 479 2,024 2,019 1,936 (31,255)
Other income (expense)......................... 8 (9) 98 (270) (2,911)
Net income (loss) before income taxes.......... 487 2,015 2,117 1,666 (34,166)
Provision for (benefit from) income taxes...... 244 776 795 686 (559)
Net income (loss).............................. $ 243 $ 1,239 $ 1,322 $ 980 $(33,607)
Earnings (loss) per share(1)................... $ 0.06 $ 0.31 $ 0.29 $ 0.14 $ (3.57)
Earning (loss) per share assuming
dilution(1).................................. $ 0.06 $ 0.31 $ 0.28 $ 0.13 $ (3.57)
Weighted average shares outstanding(1)......... 4,000 4,000 4,552 7,231 9,404
Weighted average shares outstanding assuming
dilution(1).................................. 4,000 4,000 4,679 7,492 9,404
AT OCTOBER 31,
----------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
CONSOLIDATED BALANCE SHEET DATA:
Working capital................................ $ 512 $ 1,722 $ 4,339 $ 5,773 $ (1,422)
Total assets................................... 3,647 5,275 18,703 62,965 22,287
Long-term debt................................. 75 51 2,845
Total liabilities.............................. 3,047 3,335 10,465 24,592 17,470
Stockholders' equity........................... 600 1,939 8,238 38,373 4,817
- ------------------------
(1) The earnings per share amounts prior to Fiscal 1998 have been restated as
required to comply with Statement of Financial Accounting Standards
No. 128, EARNINGS PER SHARE. For further discussion of earnings per share
and the impact of Statement No. 128, see Note 2 to the Company's
consolidated financial statements.
(2) Includes the activity of STMS from September 12, 1997 (date of acquisition).
(3) Includes the activity of IDP and PRIMO from May 1, 1998 (date of
acquisition).
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements contained in this section are forward-looking statements
(as such term is defined in the Private Securities Litigation Reform Act of
1995). Because such statements include risks and uncertainties, actual results
may differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ materially
include, but are not limited to, risks associated with the integration of
businesses following an acquisition, competitors with broader product lines and
greater resources, the termination of any of the Company's significant contracts
or the Company's inability to attract and retain highly qualified management,
technical and sales personnel.
OVERVIEW OF FISCAL 1999
In fiscal year 1999, the Company experienced a significant change in its
financial results as compared to fiscal year 1998 as discussed below.
TERMINATION OF A SIGNIFICANT CONTRACT
In May 1999, the U.S. Air Force determined not to exercise the remaining
option years under the "Desktop V" (DTV) contract and therefore terminated the
contract for all participating vendors. Initially awarded to IDP, the DTV
contract was the Company's largest contract. Management believed at the date of
the IDP acquisition, the contract would be renewed by the government through
fiscal year 2003 and would generate over $100 million in revenues during that
time. As a result of the termination of this contract, the recoverability of the
Company's goodwill associated with the IDP acquisition was significantly
impaired. Accordingly, management recorded an impairment charge of approximately
$21 million during 1999.
Additionally, the Small Business Administration (SBA) ruled that the U.S.
Air Force must terminate the contract for the convenience of the government.
Under a termination for convenience, the government shall reimburse the Company
for all costs incurred in the performance of the contract. The Company is
currently negotiating a settlement with the government and has submitted its
reimbursement proposal. As of January 31, 2000, no settlement agreement has been
reached. The Company cannot anticipate the amount of the settlement, if any, at
this time.
Under the terms of the DTV contract, the Company was required to maintain
certain inventory spares for warranty purposes. Due to the termination of the
contract, a considerable amount of these spares became obsolete. Accordingly,
the Company recorded an inventory charge during fiscal 1999 of approximately
$2 million relating to these items. The Company is seeking reimbursement of such
items in the settlement with the government.
ARBITRATION AWARD
In November 1998, a former employee of the Company (who had been an employee
and stockholder of STMS) filed a demand for arbitration with the American
Arbitration Association, alleging breach of his employment agreement with the
Company and sought "in excess of $2,350,000" in damages from the Company. During
fiscal 1999, the arbitration hearing was conducted resulting in a judgment in
favor of the former employee for approximately $1.7 million. Of the
$1.7 million, approximately $400,000 related to lost wages and benefits for the
two remaining years under the agreement. The balance of the award,
$1.3 million, represented the proceeds from stock options (fair market value
less grant price) had the employee exercised all 550,000 options in
November 1998. The options were granted to the former employee in
September 1997 in conjunction with the STMS acquisition and had a three year
vesting period. Under the judgment, the vesting period was accelerated so that
the former employee became fully vested as of October 31, 1998. The calculation
of the proceeds was based on the fair market value of $6.50,
12
which was the highest selling price of the DNCC stock on the NASDAQ during the
month of November 1998. Although the Company is actively pursuing a settlement
with the former employee, management has properly accrued for the entire award
amount in fiscal 1999.
DELAY OF A CONTRACT AWARD
In January 1999, the Company was one of several vendors to be awarded a
contract to supply laptops to the Puerto Rican government. The contract was
protested and hence delayed due to negotiations between the government and
vendors in order to resolve the protest issues. The protest was ultimately
resolved and the Company was re-awarded the contract in January 2000. During
that 12-month delay period, management determined to continue operations at the
Company's Puerto Rican facility in anticipation of the contract. Accordingly,
the Company incurred significant costs to maintain the facility which resulted
in an operating loss for the Puerto Rican subsidiary for fiscal 1999.
CHANGES IN FEDERAL CONTRACTS
In fiscal year 1999, the Company's revenues from computer sales to the
federal government were adversely affected due to changes in procurement
policies. The changes in the policies included: (1) decentralization of
purchasing decisions outside of the Washington DC area, where Dunn has its most
significant sales coverage; (2) the ability of computer manufacturers (i.e.
Dell, Compaq) to sell directly to the federal government; (3) a continual
decline in PC prices throughout 1999 which resulted in the Company not
participating in certain government proposals for which adequate margins could
not be achieved. The Company believes that this trend will continue in future
periods. As such, the Company will focus its efforts on repeat federal
government business as well as maintaining relationships with its current
government customers which may provide additional opportunities within the
federal market.
INCREASES IN MEMORY PRICES
Memory chip prices increased dramatically in late 1999. This resulted in the
Company's decision to hold and/or delay shipments until memory prices subsided
and each transaction remained profitable. However, in certain circumstances, the
Company reduced its gross profit margin on certain sales in order to meet
contractual requirements and accommodate the increasing price of memory. It
should be noted that the increase in memory prices have significantly subsided
subsequent to October 31, 1999.
The Company has taken the appropriate actions to avoid and/or mitigate its
exposure to these types of factors in future years. These actions include
greater saturation in the commercial markets, diversification of its product mix
and developing partnerships with key commercial organizations within the
industry. While the Company is confident that approach will mitigate its
exposure, there can be no assurance that the Company will be successful with the
implementation of these actions or that the profit levels from these actions
will increase.
13
RESULTS OF OPERATIONS
The following table sets forth for the fiscal years ended October 31, 1995,
1996, 1997, 1998 and 1999, certain income and expense items of Dunn as a
percentage of net revenues.
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
Net Revenues............................... 100.00% 100.00% 100.00% 100.00% 100.00%
Costs of revenues.......................... 80.71% 77.92% 80.63% 82.18% 81.16%
Gross profit............................... 19.29% 22.08% 19.37% 17.82% 18.84%
Selling, general and administrative........ 12.90% 10.90% 10.10% 14.92% 109.50%
Income (loss) from operations.............. 6.39% 11.18% 9.27% 2.90% -90.66%
Other income (expense)..................... 0.11% -0.05% 0.45% -0.40% -8.44%
Net income (loss) before income taxes...... 6.50% 11.13% 9.72% 2.50% -99.10%
Provision for (benefit from) income
taxes.................................... 3.26% 4.28% 3.65% 1.03% -1.62%
Net income (loss).......................... 3.24% 6.85% 6.07% 1.47% -97.48%
FISCAL YEAR ENDED OCTOBER 31, 1999 COMPARED TO FISCAL YEAR ENDED OCTOBER 31,
1998
Net revenues of Dunn for fiscal year ended October 31, 1999 ("fiscal 1999")
decreased approximately 48% to $34.5 million from $66.9 million for fiscal year
ended October 31, 1998 ("fiscal 1998"). This decrease was primarily due to loss
of the DTV contract with the U.S. Air Force. The Company anticipated that this
contract would generate revenues of approximately $65 million for fiscal years
1999, 2000 and 2001. Fiscal year 1998 and 1999 revenues under this contract were
approximately $18 million and $3 million, respectively.
Gross profit of Dunn for fiscal 1999 decreased by approximately 46% to
$6.5 million from $11.9 million. This decrease is in proportion with the
decrease in net revenues. Gross profit as a percentage of net revenues during
the same periods slightly increased to 18.8% from 17.8%. The gross profit
percentage increase is a direct result of greater proportion of higher-margin
sales of services.
Selling and marketing expense of Dunn decreased for fiscal 1999 by 37% to
$2.3 million from $3.7 million for fiscal 1998. During fiscal 1999, the Company
consolidated its sales and marketing departments with that of IDP which resulted
in an overall decrease of expenses.
General and administrative expense of Dunn for fiscal 1999 increased 171% to
$14.1 million from $5.2 million for fiscal 1998. As a percentage of net
revenues, general and administrative expense increased to 41% for fiscal 1999
from 7.8% for fiscal 1998. Dunn incurred significant general and administrative
costs during fiscal 1999. These costs were associated with the termination of
the DTV contract, the consolidation and integration of the IDP facilities and
resources, termination of certain benefit plans, and legal expenses associated
with all of these factors. Although the Company considers a majority of the 1999
general and administrative expenses to be nonrecurring, appropriate actions have
been taken to significantly reduce general and administrative expenses in future
periods.
Other expense including interest for fiscal 1999 increased to approximately
$2,911,000 from approximately $271,000 for fiscal 1998. The increase was
primarily due to the accrual of $2 million for the employee arbitration award.
In addition, overall interest expense increased as a result of interest expenses
required to support the debt assumed with the acquisition of IDP, interest
expenses associated with the new debt obtained in 1999, and interest expense
associated with certain operating leases. In fiscal 1999, the Company recorded
gains on the sale of certain leased assets which reduced the overall other
expense. In addition, the Company recorded an income tax benefit of
approximately $559,000 in fiscal 1999.
14
FISCAL YEAR ENDED OCTOBER 31, 1998 COMPARED TO FISCAL YEAR ENDED OCTOBER 31,
1997
Net revenues of Dunn for fiscal year ended October 31, 1998 ("fiscal 1998")
increased 206% to $66.9 million from $21.8 million for fiscal year ended
October 31, 1997 ("fiscal 1997"). This increase was primarily due to additional
revenue resulting from the third quarter acquisition of International Data
Products, Inc. Net revenues derived from IDP's operations for fiscal 1998
amounted to approximately $40.5 million.
Gross profit of Dunn for fiscal 1998 increased 183% to $11.9 million from
$4.2 million for fiscal 1997. However, the gross profit as a percentage of net
revenues during the same periods decreased to 17.8% from 19.4%. The decrease in
gross profit margin is a result of an increase in the percentage of lower margin
hardware sales by IDP and excess production capacity. The Company has closed the
production facility in Gaithersburg, Maryland.
Selling and marketing expense of Dunn increased for fiscal 1997 by 336% to
$3,672,000 from $842,000 for fiscal 1997. During the same periods, as a
percentage of net revenues, selling and marketing expenses increased to 5.5%
from 3.9%. The increase was primarily attributable to the acquisition of IDP,
increased advertising in selected publications, increased attendance at trade
shows and the development of a marketing campaign aimed at selected businesses.
General and administrative expense of Dunn for fiscal 1998 increased 365% to
$6.3 million from $1.4 million for fiscal 1997. As a percentage of net revenues,
general and administrative expense increased to 9.4% for fiscal 1998 from 6.2%
for fiscal 1997. The Company charged $564,776 of IDP acquisition integration
costs to G&A for the fiscal year. The Company also recognized approximately
$545,000 in amortization expense for fiscal 1998 as compared to $22,000 for
fiscal 1997. Dunn increased its costs in almost all aspects of general and
administrative expenses as a result of the IDP acquisition. The Company has
taken various actions to reduce general and administrative expenses in future
periods. See Item 1 "Business."
Other income (expense) including interest for fiscal 1998 decreased to an
expense of $271,000 from an income of $98,000 for fiscal 1997. The decrease was
a result of increased interest expense required to support the additional debt
assumed as a result of the acquisition of IDP, and interest expense associated
with certain operating leases. Dunn's effective tax rate increased to 41% for
fiscal 1998 from 37.5% for fiscal 1997 as a result of the increase in the
amortization of Goodwill which is not deductible for tax purposes. Dunn's net
income declined by 26% for fiscal 1998 to $980,000 from $1.3 million for fiscal
1997. Net income as a percentage of net revenues during the same periods
declined to 1.5% from 6.1%.
LIQUIDITY AND CAPITAL RESOURCES
In fiscal 1999, Dunn generated approximately $335,000 in cash flow from
operations. Dunn generated cash after the net loss from its reduction in
accounts receivable of approximately $11.8 million, a reduction of inventories
of approximately $5.4 million and a reduction of investment in sales-type leases
of approximately $3.1 million. The cash generated was used to reduce accounts
payable by $7.3 million. The Company used approximately $2.5 million in its
investing activities for the purchase of certain property, equipment and
equipment to be leased.
The Company's financing activities during fiscal 1999 were provided by the
Company's bank line of credit with First Union Bank. The line of credit expires
on November 30, 2000 and currently bears interest at prime plus 1%. As of
January 31, 2000, Dunn had an outstanding balance on the line of credit of
$2.3 million and available borrowing capacity of approximately $115,000.
In fiscal 1999, Dunn's subsidiary, IDP, had borrowing agreements with
Deutsche Financial Services (DFS) for an aggregate of $25 million. The
outstanding balance as of October 31, 1999 was approximately $4.7 million.
Subsequent to year end, the Company executed an agreement terminating the
borrowing agreement whereby $3.25 million was repaid to DFS prior to
December 31, 1999. Approximately $832,000
15
of the outstanding balance at December 31, 1999 was converted to a 24 month note
accruing interest at the prime rate and the remaining principal of approximately
$750,000 was forgiven by DFS.
As of October 31, 1999, the Company had working capital deficit of
$1.4 million. The Company believes the bank facility, together with cash on
hand, cash generated from operations, sale of certain lease agreements and
significant income tax refunds due will provide sufficient financial resources
to finance the current operations of the Company through fiscal 2000.
Dunn has obligations under its operating lease commitments of approximately
$600,000 and obligations under its existing employment contracts of
approximately $190,000 for fiscal 2000. In addition, there is an outstanding
judgment against Dunn Computer Corporation for approximately $1.7 million.
The Company expects to generate liquidity in fiscal 2000 through the
issuance of preferred stock and through the recovery of income taxes previously
paid.
From time to time, the Company may pursue strategic acquisitions or mergers
which may require significant additional capital, additional capital may be
required to satisfy unusual or infrequent expenses. In such event, the Company
may seek additional financing of debt and/or equity.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS
FINANCIAL STATEMENTS OF DUNN COMPUTER CORPORATION
PAGE
--------
Report of Ernst & Young LLP, Independent Auditors........... F-1
Consolidated Balance Sheets................................. F-2
Consolidated Statements of Operations....................... F-3
Consolidated Statements of Stockholders' Equity............. F-4
Consolidated Statements of Cash Flows....................... F-5
Notes to the Consolidated Financial Statements.............. F-6
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL ISSUES
None.
PART III
The Notice and Proxy Statement for the 1999 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A under the Securities and Exchange Act of
1934, as amended, which is incorporated by reference in this Annual Report on
Form 10-K pursuant to General Instruction G (3) of Form 10-K, will provide the
information required under Part III, including Item 10 (directors and executive
officers of the Company), Item 11 (Executive Compensation), Item 12 (security
ownership of certain beneficial owners and management), and Item 13 (certain
relationships and related transactions).
16
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report
1. Financial Statements
Dunn Computer Corporation
Report of Ernst & Young LLP, Independent Auditors
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Schedule II--Valuation and Qualifying Accounts
Statements not listed above have been omitted because they are not
applicable or the information required to be set forth therein is included in
the Consolidated Financial Statements or the notes thereto under Item 8.
3. Exhibits.
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
2.1 Acquisition Agreement, dated March 9, 1998, by and among
Dunn, the Company, George D. Fuster, D. Oscar Fuster, Carol
N. Fuster and Wendy E. Fuster (refiling to add index of
exhibits and schedules). (Filed as Exhibit 2.1 to the
Company's Registration Statement on Form S-1, Amendment No.
2, dated April 23, 1998 (File No. 333-47631) and hereby
incorporated by reference.)
2.2 Agreement of Merger, dated as of March 18, 1998, by and
among Dunn Merger Corp., a Delaware corporation, Dunn and
the Company. (Filed as Exhibit 2.2 to the Company's
Registration Statement on Form S-1, Amendment No. 2, dated
April 23, 1998 (File No. 333-47631) and hereby incorporated
by reference.)
2.3 Stock Purchase Agreement, dated September 12, 1997, by and
among STMS Acquisition Corp., Dunn, STMS, Inc., John
Signorello, Timothy McNamee, Steve Salmon and certain other
stockholders of Dunn. (Filed as Exhibit 2.3 to Dunn's
Current Report on Form 8-K, dated September 12, 1997, filed
September 27, 1997 (File No. 0-22263) and hereby
incorporated by reference).
3.1 Articles of Incorporation of the Company, dated February 25,
1998, and effective as of February 26, 1998. (Filed as
Exhibit 3.1 to the Company's Registration Statement on
Form S-1, Amendment No. 1, dated April 23, 1998 (File
No. 333-47631) and hereby incorporated by reference.)
3.2 By-laws of the Company, effective as of March 5, 1998.
(Filed as Exhibit 3.2 to the Company's Registration
Statement on Form S-1, Amendment No. 2, dated April 23, 1998
(File No. 333-47631) and hereby incorporated by reference.)
4.1 Specimen common stock certificate for the Company. (Filed as
Exhibit 4.1 to the Company's Registration Statement on Form
S-1, Amendment No. 2, dated April 23, 1998 (File
No. 333-47631) and hereby incorporated by reference.)
17
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
10.1 GSA Schedule (Filed as Exhibit 10.2 to Dunn's Registration
Statement on Form SB-2, Amendment 1, dated March 14, 1997
(File No. 333-19635) and hereby incorporated by reference).
10.2 Agreement, dated November 21, 1995, by and between GCH
Systems, Inc. and Dunn regarding Lockheed (Filed as Exhibit
10.4 to Dunn's Registration Statement on Form SB-2,
Amendment 1, dated March 14, 1997 (File No. 333-19635) and
hereby incorporated by reference).
10.3 Agreement, dated March 25, 1997, by and between Dunn and the
Social Security Administration (Filed as Exhibit 10.5 to
Dunn's Registration Statement on Form SB-2, Amendment 2,
dated April 4, 1997 (File No. 333-19635) and hereby
incorporated by reference).
10.4 Agreement, dated June 12, 1995, by and between Dunn and the
Administrative Office of the U.S. Courts (Filed as Exhibit
10.6 to Dunn's Registration Statement on Form SB-2,
Amendment 2, dated April 4, 1997 (File No. 333-19635) and
hereby incorporated by reference).
10.5 Agreement, dated September 29, 1994, by and between Dunn and
the Health Care Finance Administration (Filed as Exhibit
10.7 to Dunn's Registration Statement on Form SB-2,
Amendment 2, dated April 4, 1997 (File No. 333-19635) and
hereby incorporated by reference).
10.6 Agreement effective September 8, 1997, by and between
Virginia Contracting Authority and Dunn (Filed as Exhibit
10.6 to Dunn's Form 10-KSB, dated January 30, 1998 (File
No. 0-22263) and hereby incorporated by reference).
10.7 Employment Agreement by and between Dunn and John D. Vazzana
(Filed as Exhibit 99.1 to Dunn's Registration Statement on
Form SB-2, Amendment 2, dated April 4, 1997 (File No.
333-19635) and hereby incorporated by reference).
10.8 Employment Agreement by and between Dunn and Thomas P. Dunne
(Filed as Exhibit 99.2 to Dunn's Registration Statement on
Form SB-2, Amendment 2, dated April 4, 1997 (File
No. 333-19635) and hereby incorporated by reference).
10.9 Deed of Lease, dated October 31, 1994, between C&T
Partnership and Dunn and addenda thereto (Filed as Exhibit
10.9 to Dunn's Form 10-KSB, dated January 30, 1998 (File
No. 0-22263) and hereby incorporated by reference).
10.10 Deed of Lease, dated February 7, 1997, between APA
Properties No. 6 L.P. and STMS, Inc. and First Amendment
thereto, dated July 23, 1997 (Filed as Exhibit 10.10 to
Dunn's Form 10-KSB, dated January 30, 1998 (File
No. 0-22263) and hereby incorporated by reference).
10.11 1997 Stock Option Plan, as amended. (Filed as Exhibit 10.11
to the Company's Registration Statement on Form S-1,
Amendment No. 2, dated April 23, 1998 (File No. 333-47631)
and hereby incorporated by reference.)
10.12 General Service Administration Schedule for International
Data Products, Corp. (Filed as Exhibit 10.12 to the
Company's Registration Statement on Form S-1, Amendment No.
2, dated April 23, 1998 (File No. 333-47631) and hereby
incorporated by reference.)
10.13 Agreement, dated May 5, 1997, by and between International
Data Products, Corp. and the U.S. Air Force, the Desktop V
Contract. (Filed as Exhibit 10.13 to the Company's
Registration Statement on Form S-1, Amendment No. 2, dated
April 23, 1998 (File No. 333-47631) and hereby incorporated
by reference.)
10.14 Agreement, dated January 6, 1998, by and between
International Data Products, Corp. and the Department of the
Navy. (Filed as Exhibit 10.14 to the Company's Registration
Statement on Form S-1, Amendment No. 2, dated April 23, 1998
(File No. 333-47631) and hereby incorporated by reference.)
10.15 Deed of Lease, dated January 31, 1995, between Northtech
Business Park and International Data Products. (Filed as
Exhibit 10.15 to the Company's Registration Statement on
Form S-1, Amendment No. 2, dated April 23, 1998 (File No.
333-47631) and hereby incorporated by reference.)
18
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
10.16 Deed of Lease, dated July 15, 1994, between Puerto Rico
Industrial Development Company and Puerto Rico Industrial
Manufacturing Operations, Corp. (Filed as Exhibit 10.16 to
the Company's Registration Statement on Form S-1, Amendment
No. 2, dated April 23, 1998 (File No. 333-47631) and hereby
incorporated by reference.)
10.17 Agreement, dated July 11, 1995, by and between International
Data Products, Corp. and the Social Security Administration.
(Filed as Exhibit 10.17 to the Company's Registration
Statement on Form S-1, Amendment No. 2, dated April 23, 1998
(File No. 333-47631) and hereby incorporated by reference.)
10.18 Form of Employment Agreement by and between the Company and
each of George D. Fuster and D. Oscar Fuster (refiling to
reflect revised form). (Filed as Exhibit 10.18 to the
Company's Registration Statement on Form S-1, Amendment
No. 2, dated April 23, 1998 (File No. 333-47631) and hereby
incorporated by reference.)
10.19 Consent Agreement by and among Dunn, the Company, Network 1
Financial Securities, Inc., a Texas corporation, and Damon
Testaverde, William Hunt and Richard Hunt, dated as of April
20, 1998. (Filed as Exhibit 10.20 to the Company's
Registration Statement on Form S-1, Amendment No. 2, dated
April 23, 1998 (File No. 333-47631) and hereby incorporated
by reference.)
10.20 Loan and Security Agreement, dated as of May 28, 1996 by and
between Dunn and SIGNET BANK and Amendment Nos. 1, 2 and 3
thereto (Filed as Exhibit 4.2 to Dunn's Form 10-KSB, for the
fiscal year ended October 31, 1997 (File No. 0-22263) and
hereby incorporated by reference).
10.21 Amendment No. 4, dated February 28, 1998 to the Loan and
Security Agreement by and between Dunn and First Union
National Bank, successor by merger to Signet Bank, dated as
of May 28, 1996. (Filed as Exhibit 10.23 to the Company's
Registration Statement on Form S-1, Amendment No. 2, dated
April 23, 1998 (File No. 333-47631) and hereby incorporated
by reference.)
10.22 Employee Stock Purchase Plan.
10.23 Employment Agreement, Termination Agreement, by and among
the Company, George D. Fuster and D. Oscar Fuster, dated as
of November 23, 1998.
10.24 Purchase Price Adjustment Agreement by and among the
Company, George D. Fuster and D. Oscar Fuster, dated as of
November 23, 1998.
10.25 Termination agreement, Promissory Note, dated December 29,
1999 by and between Dunn and Deutsche Financial Services.
10.26 Loan and Security Agreement, dated May 27, 1999 by and
between Dunn and First Union Commercial Corporation.
10.27 Modification Agreement, dated February 11, 2000 by and
between Dunn and First Union National Bank.
10.28 PR Starnet Contract, dated January 5, 2000, by and between
Dunn and Office of Budget and Management of Puerto Rico.
*21.1 List of Subsidiaries.
*23.1 Consent of Ernst & Young LLP, Independent Auditors.
*23.2 Consent of Ernst & Young LLP, Independent Auditors.
*27.1 Financial Data Schedule.
- ------------------------
* Filed herewith
(b) Reports on Form 8-K
None
19
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DUNN COMPUTER CORPORATION
By:
-----------------------------------------
Thomas P. Dunne
Date: February 15, 2000 PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to and in accordance with the requirements of the Securities
Exchange Act of 1934, this report has been signed by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
---- ----- ----
/s/ THOMAS P. DUNNE
------------------------------------------- President, Chief Executive February 15, 2000
Thomas P. Dunne Officer and Director
/s/ CLAUDIA N. DUNNE
------------------------------------------- Vice President and Director February 15, 2000
Claudia N. Dunne
/s/ JOHN VAZANNA
------------------------------------------- Director February 15, 2000
John Vazanna
/s/ VADM E. A. BURKHALTER
------------------------------------------- Director February 15, 2000
VADM E. A. Burkhalter USN (Ret.)
/s/ DANIEL SINNOTT
------------------------------------------- Director February 15, 2000
Daniel Sinnott
/s/ BENJAMIN KREIGER
------------------------------------------- Director February 15, 2000
Benjamin Kreiger
20
INDEX TO FINANCIAL STATEMENTS
DUNN COMPUTER CORPORATION (A VIRGINIA CORPORATION)
Report of Ernst & Young LLP, Independent Auditors........... F-1
Consolidated Balance Sheets as of October 31, 1998 and
1999...................................................... F-2
Consolidated Statements of Operations for the three years in
the period ended October 31, 1999......................... F-3
Consolidated Statements of Stockholders' Equity for the
three years in the period ended October 31, 1999.......... F-4
Consolidated Statements of Cash Flows for the three years in
the period ended
October 31, 1999.......................................... F-5
Notes to Consolidated Financial Statements.................. F-6
21
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors
Dunn Computer Corporation
We have audited the accompanying consolidated balance sheets of Dunn
Computer Corporation (a Virginia Corporation) as of October 31, 1998 and 1999,
and the related consolidated statements of operations, stockholders' equity and
cash flows for the three years in the period ended October 31, 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Dunn Computer Corporation as of October 31, 1998 and 1999, and the consolidated
results of its operations and its cash flows for the three years in the period
ended October 31, 1999, in conformity with accounting principles generally
accepted in the United States.
/s/ ERNST & YOUNG LLP
February 1, 2000, except for Note 6
as to which the date is February 11, 2000
McLean, Virginia
F-1
DUNN COMPUTER CORPORATION
CONSOLIDATED BALANCE SHEET
OCTOBER 31,
-------------------------
1998 1999
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents................................. $ -- $ 655,450
Accounts receivable, net of allowance for doubtful
accounts of $46,000 and $100,000 as of October 31, 1998
and 1999, respectively.................................. 16,675,204 5,063,041
Employee and stockholder advances......................... 71,287 --
Other receivables......................................... 117,685 --
Investment in sales-type leases, net--current portion..... 959,243 --
Inventory, net............................................ 10,928,736 5,497,634
Deferred tax asset........................................ 630,000 1,282,695
Income tax receivable..................................... 597,325 585,769
Prepaid expenses and other current assets................. 248,143 118,594
----------- -----------
Total current assets........................................ 30,227,623 13,203,183
Property and equipment, net................................. 1,927,148 1,323,696
Equipment on lease, net..................................... 4,096,483 3,906,011
Investment in sales-type leases, net--long term portion..... 2,140,099 --
Goodwill and other intangible assets, net................... 24,231,852 3,559,005
Investments................................................. 150,000 150,000
Other assets................................................ 191,395 145,121
----------- -----------
Total assets................................................ $62,964,600 $22,287,016
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $12,151,163 $ 4,822,979
Accrued expenses.......................................... 4,726,765 2,515,653
Accrued litigation costs.................................. -- 2,000,000
Line of credit............................................ 3,256,060 3,790,705
Notes payable, current portion............................ 33,514 324,933
Notes payable, related parties............................ 905,960 --
Unearned revenue.......................................... 3,381,291 1,170,417
----------- -----------
Total current liabilities................................... 24,454,753 14,624,687
Notes payable, long-term portion............................ 51,265 545,250
Line of credit--long term................................... -- 2,300,000
Other long-term liabilities................................. 85,890 --
Stockholders' equity:
Preferred stock $.001 par value; 2,000,000 shares
authorized, no shares issued and outstanding............ -- --
Common stock, $.001 par value; 20,000,000 shares
authorized, 9,391,493 and 9,419,509 shares issued and
outstanding at October 31, 1998 and 1999,
respectively............................................ 9,392 9,420
Additional paid-in capital.................................. 37,670,245 37,721,749
Treasury stock, 400,000 shares at October 31, 1998 and 1999,
respectively.............................................. (3,432,500) (3,432,500)
Retained earnings........................................... 4,125,555 (29,481,590)
----------- -----------
Total stockholders' equity.................................. 38,372,692 4,817,079
----------- -----------
Total liabilities and stockholders' equity.................. $62,964,600 $22,287,016
=========== ===========
SEE ACCOMPANYING NOTES.
F-2
DUNN COMPUTER CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED OCTOBER 31,
----------------------------------------
1997 1998 1999
----------- ----------- ------------
Net revenues.......................................... $21,766,465 $66,888,478 $ 34,475,297
Costs of revenues..................................... 17,549,655 54,969,061 27,981,691
----------- ----------- ------------
Gross profit.......................................... 4,216,810 11,919,417 6,493,606
Selling and marketing................................. 842,281 3,671,765 2,311,091
General and administrative............................ 1,332,975 5,201,745 14,112,227
Amortization of goodwill and other intangible
assets.............................................. 22,448 544,687 675,743
Acquisition integration costs......................... -- 564,776 --
Impairment of goodwill................................ -- -- 20,649,335
----------- ----------- ------------
Income (loss) from operations......................... 2,019,106 1,936,444 (31,254,790)
Other income (expense):
Interest income..................................... 109,877 104,606 27,998
Interest expense.................................... (11,813) (494,504) (962,004)
Settlement of litigation............................ -- -- (2,000,000)
Gain on sale of assets.............................. -- -- 193,516
Other, net.......................................... -- 119,375 (170,621)
----------- ----------- ------------
Net income (loss) before income taxes................. 2,117,170 1,665,921 (34,165,901)
Provision for (benefit from) income taxes............. 794,870 686,000 (558,756)
----------- ----------- ------------
Net income (loss)..................................... $ 1,322,300 $ 979,921 $(33,607,145)
=========== =========== ============
Earnings (loss) per share............................. $ 0.29 $ 0.14 $ (3.57)
Earnings (loss) per share--assuming dilution.......... $ 0.28 $ 0.13 $ (3.57)
SEE ACCOMPANYING NOTES.
F-3
DUNN COMPUTER CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ADDITIONAL
-------------------- PAID-IN TREASURY RETAINED
SHARES AMOUNT CAPITAL STOCK EARNINGS TOTAL
--------- -------- ----------- ----------- ------------ ------------
Balance at October 31, 1996... 4,000,000 $4,000 $ 111,857 -- $ 1,823,334 $ 1,939,191
Issuance of common stock,
net of offering expenses
of $1,083,336............. 1,000,000 1,000 3,916,664 -- -- 3,917,664
Issuance of stock related to
acquisition of STMS....... 150,000 150 974,850 -- -- 975,000
Issuance of options related
to acquisition of STMS,
recorded at fair value.... -- -- 84,000 -- -- 84,000
Net income.................. -- -- -- -- 1,322,300 1,322,300
--------- ------ ----------- ----------- ------------ ------------
Balance at October 31, 1997... 5,150,000 5,150 5,087,371 -- 3,145,634 8,238,155
Repurchase of common stock
originally issued in the
acquisition of STMS....... -- -- -- (457,500) -- (457,500)
Repurchase of stock option
originally issued in the
acquisition of STMS....... -- -- (75,750) -- -- (75,750)
Issuance of common stock,
net of offering expenses
of $1,330,229............. 3,491,493 3,492 26,284,374 -- -- 26,287,866
Issuance of stock related to
acquisitions of IDP and
PRIMO..................... 750,000 750 6,374,250 -- -- 6,375,000
Return of common stock
originally issued in the
acquisitions of IDP and
PRIMO..................... -- -- -- (2,975,000) -- (2,975,000)
Net income.................. -- -- -- -- 979,921 979,921
--------- ------ ----------- ----------- ------------ ------------
Balance at October 31, 1998... 9,391,493 9,392 37,670,245 (3,432,500) 4,125,555 38,372,692
Issuance of common stock
under employee stock
purchase plan............. 28,016 28 51,504 -- -- 51,532
Net loss...................... -- -- -- -- (33,607,145) (33,607,145)
--------- ------ ----------- ----------- ------------ ------------
BALANCE AT OCTOBER 31, 1999... 9,419,509 $9,420 $37,721,749 $(3,432,500) $(29,481,590) $ 4,817,079
========= ====== =========== =========== ============ ============
SEE ACCOMPANYING NOTES.
F-4
DUNN COMPUTER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED OCTOBER 31,
-----------------------------------------
1997 1998 1999
----------- ------------ ------------
OPERATING ACTIVITIES
Net income (loss).................................... $ 1,322,300 $ 979,921 $(33,607,145)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization of property and
equipment...................................... 46,029 1,139,210 2,779,926
Amortization of goodwill and other intangibles... 22,448 544,687 675,743
Impairment of goodwill........................... -- -- 20,649,335
Gain on sale of assets........................... -- -- (193,516)
Changes in operating assets and liabilities:
Accounts receivable............................ (5,354,279) 2,057,540 11,801,135
Employee and stockholder advances.............. -- 10,234 --
Income tax receivable.......................... -- 316,461 11,556
Investment in sales-type leases................ -- (3,099,342) 3,099,342
Inventory...................................... (2,865,750) 7,015,014 5,431,102
Prepaid expenses and other assets.............. (85,966) 31,480 175,823
Accounts payable............................... 3,920,267 (9,542,573) (7,328,184)
Accrued expenses............................... 51,930 900,886 (211,112)
Income taxes payable........................... (519,308) (13,290) --
Deferred tax asset (credit).................... 88,914 (761,714) (652,695)
Unearned revenue and other liabilities......... (110,734) 2,958,384 (2,296,764)
----------- ------------ ------------
Net cash provided by (used in) operating
activities......................................... (3,484,149) 2,536,898 334,546
INVESTING ACTIVITIES
Purchases of property and equipment.................. (93,389) (945,794) (2,532,509)
Acquisitions, net of cash acquired................... (928,550) (14,185,021) (652,231)
Proceeds from sale of assets......................... -- 7,315 740,023
----------- ------------ ------------
Net cash used in investing activities................ (1,021,939) (15,123,500) (2,444,717)
FINANCING ACTIVITIES
Proceeds from issuance of common stock............... 3,917,664 26,287,866 51,532
Proceeds of loans for purchase of certain assets..... 64,226 -- --
Repurchase of common stock and options............... -- (533,250) --
Payments on notes payable............................ (10,551) (928,980) (46,248)
Payments on notes payable to related parties......... -- (587,181) (905,960)
Proceeds from (repayments on) lines of credit, net... -- (11,993,819) 3,666,297
Payments on capital leases........................... (20,949) -- --
----------- ------------ ------------
Net cash provided by financing activities............ 3,950,390 12,244,636 2,765,621
Net increase (decrease) in cash and cash
equivalents........................................ (555,698) (341,966) 655,450
Cash and cash equivalents at beginning of year....... 897,664 341,966 --
----------- ------------ ------------
Cash and cash equivalents at end of year............. $ 341,966 $ -- $ 655,450
=========== ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid........................................ $ 11,813 $ 494,504 $ 962,004
----------- ------------ ------------
Income taxes paid.................................... $ 1,323,308 $ 525,000 $ 223,850
=========== ============ ============
SEE ACCOMPANYING NOTES
F-5
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997, 1998 AND 1999
1. ORGANIZATION
Dunn Computer Corporation (the "Corporation") was incorporated on July 27,
1987 under the laws of the Commonwealth of Virginia. On January 3, 1997, Dunn
Computer Corporation ("Dunn"), a Delaware corporation, was formed as a holding
company for the stock of Dunn Computer Corporation, the Virginia corporation. On
January 6, 1997, the Board of Directors and stockholders of the Corporation
approved and effected a 2,799.160251 for 1 stock exchange with Dunn whereby the
holders of the Corporation's common stock would receive 2,799.160251 shares of
common stock in Dunn for each share of common stock in the Corporation.
On September 12, 1997, Dunn acquired all of the outstanding stock of
STMS, Inc. (STMS), a Virginia Corporation.
On February 26, 1998, Dunn Computer Corporation (the "Company") was
incorporated in the Commonwealth of Virginia to become a holding company for
Dunn and International Data Products Corp. ("IDP"), as provided for in the
Acquisition Agreement. Simultaneous with the Company's formation, the
Corporation was renamed Dunn Computer Operating Company, a Virginia Corporation.
The Acquisition Agreement provided for the acquisition of all of the stock
of IDP by the Company and the acquisition of substantially all of the net assets
of Puerto Rico Industrial Manufacturing Operations, Corp. ("PRIMO"), an
affiliate of IDP, by the Company. Effective May 1, 1998, the Company's
acquisitions of IDP and PRIMO were consummated. Each outstanding share of common
stock of Dunn was exchanged on a one-for-one basis for a share of common stock
of the Company and each outstanding option and warrant of Dunn was converted
into an option or warrant, respectively, of the Company on substantially the
same terms as applied to each option or warrant of Dunn immediately prior to the
merger. Dunn became a wholly-owned subsidiary of the Company. All references in
the accompanying consolidated financial statements as to the number of shares of
common stock and per-share amounts have been restated to reflect the stock
exchanges described above. Also, the Company authorized 2,000,000 shares of
preferred stock with rights and preferences to be determined by the Board of
Directors at a later date. The Company expects to issue preferred stock in
fiscal 2000 to raise equity capital.
The Company is engaged in the business of selling build-to-order computer
systems and related equipment and providing computer training and maintenance
service to businesses and government agencies. In addition, the Company provides
Information Technology (IT) support and services to certain government and
commercial entities. The Company operates in a competitive environment subject
to technological change and the emergence of new technologies, although the
Company believes that its products and services are, or would be, upgradable to
new technologies.
2. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of the consolidated 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 consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
F-6
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
CASH AND CASH EQUIVALENTS
The Company maintains demand deposits with several financial institutions.
At times, deposits exceed federally insured limits, but management does not
consider this a significant concentration of credit risk. The Company considers
all highly liquid investments with a maturity of three months or less at the
time of purchase to be cash equivalents. At October 31, 1998, the Company's cash
management process resulted in an overdraft of $741,000 included in accounts
payable.
INVESTMENTS
At October 31, 1998 and 1999, investments consisted of shares of common
stock of a privately-held internet company, Worldwide Internet Solutions
Network, Inc. ("WIZnet"), with a cost basis of approximately $150,000. The
Company believes that this carrying amount represents the lower of cost or
market. The Company is accounting for this investment using the cost method
since the Company's investment represents less than 20% of the privately-held
internet company's outstanding stock. The President and Chief Executive Officer
of WIZnet is a member of the Company's Board of Directors.
INVENTORY
Inventory is stated at the lower of cost or market as determined by the
first-in first-out (FIFO) method. The Company periodically evaluates its
inventory obsolescence reserve to ensure inventory is recorded at net realizable
value.
IMPAIRMENT OF LONG-LIVED ASSETS
Each year, management determines whether any property and equipment or any
other assets have been impaired based on the criteria established in Statement
of Financial Accounting Standards No. 121 (SFAS 121), ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF. The
Company made no adjustments to the carrying values of the assets during the
years ended October 31, 1997 and 1998. During fiscal year 1999, management
determined that goodwill associated with the purchase of IDP was impaired.
Accordingly, the Company recorded an impairment charge of approximately
$20.6 million (see Note 5).
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangibles represent the unamortized excess of the cost
of acquiring subsidiary companies over the fair values of such companies' net
tangible assets at the dates of acquisition. Goodwill related to the Company's
acquisitions as described in Note 5 is being amortized on a straight-line basis
over periods ranging from ten to twenty years. Other intangibles, including
contracts, are being amortized on a straight-line basis over a five year period.
F-7
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACQUISITION-RELATED LIABILITIES
During fiscal year 1998, the Company recorded $1,376,000 of
acquisition-related liabilities in connection with the IDP Acquisition. These
liabilities were recorded after certain actions had been identified, quantified
and approved by management of the Company having authority to commit the Company
to the plan. Those certain actions included closing the IDP facility in
Maryland, integrating IDP and the Company's production, warehouse, sales,
marketing and administrative functions, eliminating duplicative jobs and
expanding space in the Company's office space in Virginia. During fiscal years
1998 and 1999, $232,000 and $894,000, respectively, of costs were charged
against the liability. The acquisition-related liabilities remaining at
October 31, 1999 amounted to $250,000, consisting of severance payments to be
made in future periods.
STOCK COMPENSATION
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 (SFAS 123), ACCOUNTING FOR STOCK-BASED
COMPENSATION. SFAS 123 allows companies to account for stock-based compensation
under either the new provisions of SFAS 123 or the provisions of Accounting
Principles Board Opinion No. 25 (APB 25), ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES, but requires pro forma disclosure in the footnotes to the
consolidated financial statements as if the measurement provisions of SFAS 123
had been adopted. The Company continues accounting for its stock-based
compensation in accordance with the provisions of APB 25.
REVENUE RECOGNITION
The Company generally recognizes revenues from computer sales and sales-type
leases at the time of shipment. Revenues are earned principally pursuant to
various contracts with agencies of the Federal government and commercial
customers. The length of the Company's contracts generally range from one to
three years.
Service revenues are recognized over the contractual period as the services
are provided. Revenues from operating leases are recognized over the contract
term. In 1998, the Company assigned payments from one of its operating leases to
a financing company in exchange for the present value of the minimum lease
payments. The Company recorded this amount as unearned revenues and recognized
revenues over the lease term as payments were received by the financing company.
As of October 31, 1999, revenues associated with this transaction have been
fully recognized.
The products sold are generally covered by a warranty for periods ranging
from one to three years. The Company accrues a warranty reserve for revenues
recognized during the year to record estimated costs to provide warranty
services.
Unearned revenue also relates to cash received from credit card sales as of
year end for which the related inventory was shipped subsequent to year end and
advance payments on operating leases.
During the year ended October 31, 1997, the Company had revenues from one
agency of the Federal government and one Federal government contractor which
represented 21% and 11% of total revenues, respectively. As of October 31, 1997,
accounts receivable from agencies of the Federal government represented 64% of
total accounts receivable. During the year ended October 31, 1998, the Company
had revenues from one agency of the Federal government which represented 40% of
total revenues. As of
F-8
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
October 31, 1998, accounts receivable from agencies of the Federal government
represented 67% of total accounts receivable. During the year ended October 31,
1999, the Company had revenues from two Federal government agencies which
approximated 12% of total revenues. As of October 31, 1999, accounts receivable
from agencies of the Federal government represented approximately 40% of total
accounts receivable.
For the years ended October 31, 1998 and 1999, approximately 27% and 9%,
respectively, of the Company's revenues were from Federal contracts that were
awarded under Section 8(a) of the Small Business Act.
ADVERTISING EXPENSES
The Company expenses advertising costs as incurred. Advertising costs
amounted to approximately $61,000, $468,000 and $130,000 during fiscal 1997,
1998 and 1999, respectively.
INCOME TAXES
The Company provides for income taxes in accordance with the liability
method.
EARNINGS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 (SFAS 128), EARNINGS PER SHARE. SFAS 128
replaced the calculation of 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, warrants and
convertible securities. The definition of diluted earnings per share is very
similar to the previous definition of fully diluted earnings per share. All
earnings per share amounts for all periods have been presented and, where
appropriate, restated to conform to the SFAS 128 requirements.
FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations
of credit risk consist primarily of cash, investments and accounts receivable.
The cash is held by high credit quality financial institutions. For accounts
receivable, the Company performs ongoing credit evaluations of its customers'
financial condition and generally does not require collateral. The Company
maintains reserves for credit losses. The concentration of credit risk is
mitigated by the diverse customer base and the amount of receivables due by the
Federal government. The carrying amount of the receivables approximates their
fair value.
F-9
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SUPPLEMENTAL INFORMATION OF NON-CASH INVESTING AND FINANCING ACTIVITIES
YEARS ENDED OCTOBER 31,
------------------------
1997 1998
---------- -----------
Fair value of assets acquired............................... $5,970,000 $58,951,000
Less: Cash paid............................................. 1,044,000 14,900,000
Stock issued, net of value of stock returned (See Note
10)....................................................... 1,059,000 3,400,000
---------- -----------
Liabilities assumed (including $1,376,000 of
acquisition-related liabilities in 1998).................. $3,867,000 $40,651,000
========== ===========
RECENT PRONOUNCEMENTS
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, REVENUE
RECOGNITION IN FINANCIAL STATEMENTS, ("SAB 101"). SAB 101 requires that four
basic criteria must be met before revenue can be recognized: (1) persuasive
evidence of an arrangement exists, (2) delivery has occurred or services have
been rendered, (3) the fee is fixed and determinable, and (4) collectibility is
reasonably assured. The Company is required to comply with SAB 101 for
transactions entered into on or after February 1, 2000, but does not expect it
to have a material impact on the Company's consolidated financial position or
results of operation.
3. PROPERTY AND EQUIPMENT AND EQUIPMENT ON LEASE
Property and equipment, including leasehold improvements, are stated at
cost. Property and equipment are depreciated and amortized using the
straight-line method over the estimated useful lives ranging from five to seven
years. Leasehold improvements are amortized over the lesser of the related lease
term or the useful life.
Property and equipment consisted of the following:
OCTOBER 31,
-----------------------
1998 1999
---------- ----------
Computer and office equipment............................... $1,443,992 $1,515,017
Furniture and fixtures...................................... 302,741 302,741
Leasehold improvements...................................... 454,913 491,059
Other....................................................... 416,018 412,766
---------- ----------
2,617,664 2,721,583
Less accumulated depreciation and amortization.............. (690,516) (1,397,887)
---------- ----------
$1,927,148 $1,323,696
========== ==========
The Company owns equipment that is currently at customer sites under
operating lease agreements (See Note 2 Revenue Recognition). The cost of the
equipment was $6,821,801 and $5,085,287 at October 31, 1999 and 1998,
respectively. The related accumulated depreciation on the equipment was
$2,915,790 and $988,804 at October 31, 1999 and 1998, respectively.
F-10
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets were comprised of:
OCTOBER 31,
------------------------
1998 1999
----------- ----------
Goodwill............................................ $24,198,986 $3,485,855
Contracts........................................... 600,000 600,000
Less accumulated amortization....................... (567,134) (526,850)
----------- ----------
$24,231,852 $3,559,005
=========== ==========
See discussion of goodwill impairment recorded during fiscal 1999 in
Note 5.
5. ACQUISITIONS
STMS
On September 12, 1997, the Company acquired all of the outstanding stock of
STMS, Inc., a Virginia corporation ("STMS"), for 150,000 shares of the Company's
common stock, options to purchase 25,000 shares of the Company's common stock,
and $1,044,500 in cash used specifically to repay certain debt of STMS. The
transaction was accounted for using the purchase method. The 150,000 shares of
common stock were valued at the market price of Company's common stock or
$975,000 on the date of the transaction. The options to purchase 25,000 shares
of common stock were issued to a stockholder/creditor of STMS and were valued at
fair value of $84,000 using the Black-Scholes option-pricing model. The purchase
price was allocated to the assets and liabilities acquired based on their
estimated fair values. In conjunction with the acquisition, the Company recorded
goodwill in the amount of $2,397,287 and other intangible assets (contracts) in
the amount of $600,000. The operations of STMS are included in the consolidated
financial statements of the Company beginning September 12, 1997 (date of
acquisition).
The Company granted options to purchase an aggregate of 1,330,000 shares of
the Company's common stock, at an exercise price equivalent to its fair market
value at the date of grant, to the former stockholders of STMS in conjunction
with their three-year employment agreements. The options vest over a three-year
period. Certain of these options were repriced during fiscal 1999 in accordance
with the employment agreements (see Note 10).
During February 1998, the Company repurchased an aggregate of 50,000 shares
of common stock and the option to purchase 25,000 shares of common stock
originally issued in connection with the STMS acquisition (see Note 10).
IDP AND PRIMO
On May 1, 1998, the Company acquired all of the outstanding stock of IDP and
substantially all of the net assets of PRIMO for $14.9 million in cash and
750,000 shares of common stock of the Company, both subject to adjustment in the
event that the combined net assets of IDP and PRIMO fell below a certain level
stipulated in the Acquisition Agreement (See Note 10). The transaction was
accounted for using the purchase method. The 750,000 shares of common stock were
valued at the market price of the Company's common stock ($8.50 per share) on
the date of the transaction. The purchase price was preliminarily allocated to
the assets and liabilities acquired based on their estimated fair values. In
conjunction with the
F-11
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. ACQUISITIONS (CONTINUED)
acquisition, the Company recorded goodwill (as adjusted) in the amount of
$22,453,929. The operations of IDP, including PRIMO, are included in the
consolidated financial statements of the Company beginning May 1, 1998 (date of
acquisition).
In connection with the IDP acquisition, two of the IDP sellers entered into
employment agreements with the Company pursuant to which they each received
options to purchase 300,000 shares of the Company's common stock. The grant
price of the options was equivalent to the fair market value of the underlying
common stock on the grant date and the options vested immediately.
During November 1998, the Company entered into an Employment Agreement
Termination Agreement and a Purchase Price Adjustment Agreement with the two
former stockholders of IDP whereby employment of the former stockholders of IDP
was terminated and the former IDP stockholders agreed to return 350,000 shares
of the Company's common stock originally issued in connection with the IDP
Acquisition. See Note 10 for additional information.
The selected unaudited pro forma information for the years ended
October 31, 1997 and 1998 includes the operating results of the Company as if
the Company acquired STMS, IDP, and PRIMO on November 1, 1996.
YEARS ENDED
OCTOBER 31,
------------
1998
------------
(UNAUDITED)
Pro Forma net revenues...................................... $110,310,000
Pro Forma net income (loss)................................. $ (6,768,000)
Pro Forma earnings per share................................ $ (0.75)
Pro Forma earnings per share assuming dilution.............. $ (0.75)
Pro Forma weighted average shares outstanding............... 8,981,000
Pro Forma weighted average shares outstanding assuming
dilution.................................................. 8,981,000
IMPAIRMENT OF GOODWILL
Statement of Financial Accounting Standards No. 121 (SFAS 121) ACCOUNTING
FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED
OF, requires that long-lived assets and certain identifiable intangibles to be
held and used by an entity be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable.
In May 1999, the U.S. Government determined not to exercise the remaining
option years on one of the Company's significant contracts. This contract was a
significant component of the Company's acquisition of IDP. At the date of
termination, the Company anticipated that the contract would have generated
future revenues of approximately $65 million had all option years been renewed.
The former IDP operations have been substantially curtailed as a result of this
contract loss. In addition, significant future business is not expected from IDP
operations as the majority of its sales force has separated from the Company.
The Company determined that these factors indicated that the carrying amount
of goodwill associated with the IDP and PRIMO acquisition may not be
recoverable. The Company performed an analysis of the goodwill in accordance
with SFAS 121 and determined that the fair value of the remaining goodwill
F-12
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. ACQUISITIONS (CONTINUED)
(estimated using the present value of expected future cash flows) was
approximately $1.1 million at the time of the analysis. Accordingly, the Company
recorded an impairment charge of approximately $20.6 million during fiscal year
1999.
6. BANK LINES OF CREDIT AND NOTES PAYABLE
IDP LINE OF CREDIT
In conjunction with the purchase of IDP, the Company assumed a credit
facility of $25,000,000 secured by inventory and accounts receivable of IDP. The
outstanding balance on this line of credit at October 31, 1998 and 1999 was
approximately $3,055,000 and $4,622,000, respectively. The interest rate
applicable to this line of credit as of October 31, 1998 and 1999 was 7.33% and
8.05%, respectively.
On November 8, 1999, the Company executed an agreement with the financial
institution to terminate this facility. Under the terms of the agreement, the
Company repaid approximately $3.0 million of the principal outstanding at
October 31, 1999 prior to December 31, 1999. In addition, outstanding principal
totaling approximately $832,000 was converted to a term note bearing interest at
the prime rate and maturing in January 2002. The remaining amount of
approximately $750,000 was forgiven by the financial institution and will be
reflected as a gain on debt restructuring in fiscal year 2000. The Company has
classified this facility between short and long-term based on the revised
payment terms.
OPERATING LINE OF CREDIT
In April 1996, the Company entered into a line of credit agreement with a
bank that was subsequently amended in December 1997. The amended credit
agreement expired on February 28, 1999. Accordingly, the Company established a
new credit agreement with the same financial institution. The agreement allows
the Company to borrow an amount limited to the minimum of its borrowing base or
$15,000,000. As of October 31, 1999, the Company's borrowing base, which is
based on certain percentages of total accounts receivable less overdue accounts,
is approximately $2.5 million. Outstanding borrowings bear interest at the prime
rate.
As of October 31, 1998, the Company had borrowed $201,000 against this line
of credit facility and had an unused borrowing capacity of $758,843. As of
October 31, 1999, the Company had borrowed $2.3 million against this line of
credit facility and had an unused borrowing capacity of approximately $200,000.
The Company pays a commitment fee based on the unused borrowings under the line
of credit facility. The line of credit is secured by all assets of the Company
and its subsidiaries. On February 11, 2000, the Company amended the line of
credit facility whereby the maximum availability was reduced to $5 million and
the interest rate was increased to the prime rate plus 1%. The amended line of
credit expires Novmeber 30, 2000. The Company has classified this line of credit
as long term based on the amended maturity date.
F-13
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. BANK LINES OF CREDIT AND NOTES PAYABLE (CONTINUED)
Notes payable consisted of the following:
OCTOBER 31,
-------------------
1998 1999
-------- --------
Bank term note, bearing interest at the prime rate; payable
in monthly installments of $34,652 plus accrued interest,
due in January 2002....................................... $ -- $831,652
Asset loans, bearing interest at annual interest rates
ranging from 7.9% to 10.46%; due in aggregate monthly
payments of $2,695 and $1,303 at October 31, 1998 and
1999, respectively, due through August 2002,
secured by certain assets of the Company.................. 78,549 38,531
Other....................................................... 6,230 --
------- --------
84,779 870,183
Less current portion........................................ 33,514 324,933
------- --------
Notes payable, long-term.................................... $51,265 $545,250
======= ========
Principal payments on the long-term debt for each of the fiscal years from
2000 to 2002 are due as follows:
YEAR ENDED
OCTOBER 31,
-----------
2000........................................................ $324,933
2001........................................................ 429,960
2002........................................................ 115,290
--------
Total....................................................... $870,183
========
Notes payable to related parties are payable to certain stockholders and
their relatives, and employees. These notes payable were assumed by the Company
in the IDP Acquisition. All notes payable to related parties are classified as
current liabilities as the outstanding balances are due upon demand. Notes
payable to related parties bear interest at annual interest rates ranging from
8% to 11%. The total amounts outstanding on these related parties' notes payable
were approximately $905,960 and $0 at October 31, 1998 and 1999, respectively.
Interest expense on these notes payable amounted to $58,297 during the period
from May 1, 1998 through October 31, 1998. The total amounts outstanding on
these notes payable were repaid in fiscal year 1999 (See Note 10).
F-14
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. RELATED PARTY TRANSACTION
Thomas Dunne, the Company's President, and his wife, Claudia Dunne, the
Company's Vice President, acquired a building for the purpose of leasing office
space to the Company. In connection with the acquisition of the building, the
Company guaranteed the building's $1 million mortgage. The term of the mortgage
is 25 years. The Company subsequently executed a noncancelable operating lease
with Mr. and Mrs. Dunne. The Company believes that the lease agreement is on
terms no less favorable to the Company than could be obtained from an
unaffiliated third party. In June 1999, the building was sold by Mr. and
Mrs. Dunne and the lease was assigned to the new owner, an unaffiliated third
party.
8. COMMITMENTS
OPERATING LEASES
The Company leased office space under a noncancelable operating lease
agreement with two stockholders (see Note 7). In June 1999, the two stockholders
sold the building and assigned the lease to the new owner, an unaffiliated third
party, under the same terms. The lease agreement was renewed in October 1999 for
an additional five years under the renewal option within the original lease.
Additionally, the Company leases various office equipment and other office space
under non-cancelable operating leases. Rent expense under these leases was
approximately $175,000, $499,100 and $321,000 for the years ended October 31,
1997, 1998 and 1999, respectively.
Future minimum lease payments under noncancelable operating leases,
including the leases assumed in the STMS and IDP acquisitions, at October 31,
1999 are as follows:
2000........................................................ $ 595,245
2001........................................................ 613,102
2002........................................................ 631,495
2003........................................................ 573,085
2004 and thereafter......................................... 455,166
----------
Total....................................................... $2,868,093
==========
In addition, the Company will receive $1,446,516 in aggregate sublease
income through fiscal 2003.
EMPLOYMENT AGREEMENTS
The Company has employment agreements with certain key executives under
which the Company is required to pay a fixed annual base salary. Commitments
under these arrangements are approximately $620,000 for fiscal year 2000. All
contracts expire prior to October 31, 2000.
F-15
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INVESTMENTS IN SALES-TYPE LEASES
During 1998, the Company leased equipment to certain customers under
sales-type leases. The components of the Company's net investment in sales-type
leases at October 31, 1998 were as follows:
OCTOBER 31,
1998
-----------
Total minimum lease payments receivable..................... $3,446,095
Less unearned interest.................................... (346,753)
----------
Net investment in sales-type leases......................... 3,099,342
Less current portion...................................... 959,243
----------
$2,140,099
==========
In fiscal year 1999, the Company sold all of its investment in sales-type
leases resulting in net gains of approximately $213,000. Accordingly, the
Company's investment in sales-type leases at October 31, 1999 was $0.
10. STOCKHOLDERS' EQUITY
EQUITY TRANSACTIONS
On April 21, 1997, the Company sold 1,000,000 shares of common stock in an
initial public offering for net proceeds of $3,917,664. In connection with the
offering, warrants were issued to the underwriter for 100,000 shares of common
stock at an exercise price of $6.00 per share. Beginning April 21, 1998, the
warrants are exercisable for a period of four years.
During February 1998, the Company repurchased 50,000 shares of its common
stock held by former stockholders of STMS. The shares were repurchased at the
current market price of $9.15 per share. The Company accounted for the
repurchase as a treasury stock transaction. The Company also repurchased options
to purchase 25,000 shares of the Company's common stock that were originally
issued in connection with the STMS acquisition. The repurchase price of $75,750
represents the difference between the fair market value of the underlying common
stock on the repurchase date and the grant price multiplied by the 25,000
options. The Company accounted for the repurchase as a reduction of additional
paid-in capital.
The IDP Acquisition Agreement provided for an adjustment of the purchase
price if the combined net worth of IDP and PRIMO exceeded or was below a
specified level. Since the net worth on the closing balance sheet of IDP and
PRIMO was below the specified level, the Company and the former IDP stockholders
agreed to adjust the purchase price. In November 1998, the Company entered into
a Purchase Price Adjustment Agreement with the two former stockholders of IDP
whereby 350,000 shares of the Company's common stock originally issued in
connection with the IDP acquisition were returned to the Company. The Company
accounted for the return as a treasury stock transaction and valued such shares
at the fair market value of the Company's common stock on the date of
acquisition. In connection with the transaction, the Company and the two former
stockholders also agreed to cancel the employment agreements in exchange for
payments totaling $500,000, for which the Company recorded an adjustment to its
purchase price allocation. In addition, the Company agreed and paid the balance
of the notes payable to related parties of $905,960 in full by November 25,
1998. The two former stockholders retained their
F-16
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCKHOLDERS' EQUITY (CONTINUED)
options to purchase the Company's common stock subject to all original terms and
conditions. (See Note 5)
In connection with the acquisitions of IDP and PRIMO, the Company completed
a public offering of 3,491,493 shares of common stock for net proceeds of
$26,287,866.
STOCK OPTIONS
On January 6, 1997, the Company adopted the 1997 Stock Option Plan (the
Option Plan) which permits the Company to grant up to 600,000 options to
officers, directors and employees who contribute materially to the success of
the Company. In September 1997, the Company increased the number of options
available for grant under the plan to 2,200,000. Stock options are generally
granted at prices which the Company's Board of Directors believes approximates
the fair market value of its common stock at the date of grant. The options vest
ratably over a stated period of time not to exceed four years. The contractual
term of the options is five years.
Common stock option activity was as follows:
WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
---------- ----------------
Outstanding at October 31, 1997................... 1,857,000 $6.18
Options granted................................. 865,400 7.46
Options exercised............................... -- --
Options canceled or expired..................... (226,583) 5.35
---------- -----
Outstanding at October 31, 1998................... 2,495,817 $6.70
Options granted................................. 413,000 2.87
Options exercised...............................
Options canceled or expired..................... (1,026,384) 5.56
---------- -----
Outstanding at October 31, 1999................... 1,882,433 $5.22
========== =====
Exercisable at October 31, 1999................... 1,289,098 $6.00
========== =====
The total options outstanding include 600,000 options granted to the former
IDP stockholders that are not included in the Option Plan.
As of October 31, 1999, there were 317,567 options available for future
grants under the Option Plan.
During fiscal 1999, the Company repriced approximately 750,000 stock options
granted to certain executives in accordance with their employment agreements. No
compensation expense was recognized as the exercise price for the repriced
options was at or above fair market value of the underlying stock on the date
repriced.
F-17
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes information about fixed-price stock options
outstanding at October 31, 1999:
NUMBER AVERAGE WEIGHTED-
OUTSTANDING REMAINING AVERAGE
AT OCTOBER 31, CONTRACTUAL EXERCISE
RANGE OF EXERCISE PRICES 1999 LIFE PRICE
- ------------------------ -------------- ----------- ---------
$1.75-$4.15................................ 1,087,933 6.60 $3.17
$4.50-$6.50................................ 189,500 3.49 5.73
$6.75-$8.75................................ 605,000 8.95 8.73
--------- ---- -----
$1.75-$8.75................................ 1,882,433 7.05 $5.22
========= ==== =====
Had compensation expense related to the stock options been determined based
on the fair value at the grant date for options granted during the years ended
October 31, 1997, 1998, and 1999 consistent with the provisions of SFAS 123, the
Company's net income and earnings per share would have been as follows:
YEARS ENDED OCTOBER 31,
---------------------------------------
1997 1998 1999
---------- ----------- ------------
Net income (loss) --pro forma.......... $1,098,900 $(2,535,579) $(34,865,823)
Earnings (loss) per share--pro forma... $ 0.24 $ (0.35) $ (3.71)
Earnings (loss) per share--assuming
dilution pro forma................... $ 0.23 $ (0.35) $ (3.71)
The effect of applying SFAS 123 on pro forma net income as stated above is
not necessarily representative of the effects on reported net income for future
years due to, among other things, the vesting period of the stock options and
the fair value of additional options in the future years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing fair value model with the following
weighted-average assumptions used for grants in 1997, 1998 and 1999: dividend
yield of 0%, expected volatility of 46%, 84% and 86%, respectively; risk-free
interest rates of 5.75%, 5.50% and 6.70%, respectively; and expected life of the
option term of five years. The weighted average fair values of the options
granted in 1997, 1998 and 1999 with a stock price equal to the exercise price is
$6.18, $5.21 and $2.02, respectively. The weighted average fair value of options
granted in 1998 with a stock price greater than the exercise price is $7.36.
11. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
F-18
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES (CONTINUED)
Components of the Company's net deferred tax asset balance are as follows:
OCTOBER 31,
-------------------------
1998 1999
----------- -----------
Deferred tax asset:
Accrued expenses................................. $ 810,378 $ 280,100
Net operating loss carryforwards................. 970,689 5,569,085
Basis differences of acquired assets............. 939,468 411,334
Asset reserves................................... 1,106,423 1,294,156
----------- -----------
Total deferred asset............................... 3,826,958 7,554,675
----------- -----------
Deferred tax credit:
Acquisition of intangible assets................. (100,000) (100,000)
Depreciation..................................... (35,789) (205,674)
Valuation allowance.............................. (3,061,169) (5,966,306)
----------- -----------
Net deferred tax asset............................. $ 630,000 $ 1,282,695
=========== ===========
As of October 31, 1999, the Company had approximately $14.4 million in net
operating loss carryforwards which expire between 2012 and 2019. Approximately
$1.5 million of those net operating loss carryforwards relate to STMS and IDP
and may be significantly limited under Section 382 of the Internal Revenue
Service Code and the SRLY rules. The Company has recorded a valuation allowance
for a portion of the deferred tax assets because realizability of those assets
is uncertain. The Company expects to file claims for tax refunds using its net
operating loss carryback in fiscal 2000.
The components of the provision for income taxes are as follows:
YEARS ENDED OCTOBER 31,
---------------------------------
1997 1998 1999
-------- -------- -----------
Current tax expense (benefit):
Federal................................... $671,070 $411,709 $ (974,781)
State..................................... 125,900 91,144 (213,975)
-------- -------- -----------
796,970 502,853 (1,188,756)
Deferred tax expense:
Federal................................... (1,800) 155,675 535,500
State..................................... (300) 27,472 94,500
-------- -------- -----------
(2,100) 183,147 630,000
-------- -------- -----------
Total provision for (benefit from) income
taxes................................... $794,870 $686,000 $ (558,756)
======== ======== ===========
F-19
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES (CONTINUED)
The reconciliation of income tax from the Federal statutory rate of 34% is:
YEARS ENDED OCTOBER 31,
----------------------------------
1997 1998 1999
-------- -------- ------------
Tax at statutory rates:.................... $719,838 $566,413 $(11,536,368)
Non-deductible expenses.................... 8,291 35,480 7,277,936
Valuation allowance........................ -- -- 4,278,322
State income tax, net of federal benefit... 66,741 84,107 (578,646)
-------- -------- ------------
$794,870 $686,000 $ (558,756)
======== ======== ============
In September 1997 and in May 1998, respectively, the Company acquired the
stock of STMS and IDP in tax-free exchanges. The stock acquisitions were
accounted for using the purchase method. Included in the Company's deferred tax
assets at October 31, 1999 is approximately $3.8 million representing the
differences between the assigned values and tax bases of the assets and
liabilities acquired, as well as net operating loss carry forwards acquired.
These deferred tax assets were fully reserved at the dates of acquisition. To
the extent these deferred tax assets are subsequently realized, the resulting
tax benefit will be applied to reduce goodwill recorded in connection with the
acquisitions and there will be no impact on income tax expense.
12. RETIREMENT PLANS
401(K) PLANS
Effective April 1, 1995, the Company adopted a 401(k) plan (the "Former
Plan"). Employees are eligible to participate after completing six months of
services and attaining age 18. Employees can defer up to 15% of compensation.
Employee contributions are subject to Internal Revenue Service limitations. All
employees who contributed to the Former Plan are eligible to share in
discretionary Company matching contributions. During the years ended
October 31, 1997, 1998 and 1999, the Company contributed $11,855, $0 and $0,
respectively, to the Former Plan.
In connection with the IDP Acquisition, the Company assumed IDP's
tax-deferred savings plan under Section 401(k) of the Internal Revenue Code
which is offered to all employees who have attained the age of 21. The plan
provides for contributions by employees as well as matching and discretionary
contributions by the Company. The Company made contributions of approximately
$123,000 during the period from May 1, 1998 through October 31, 1998.
Effective May 1, 1999 the Company amended and terminated the existing plans.
Simultaneous to the termination, the Company adopted a new 401(k) (the "Plan")
for all current employees. Under the Plan, employees are eligible to participate
after completing 90 days of service and attaining the age of 18. Employees can
defer up to 15% of compensation. Employee contributions are subject to Internal
Revenue Service limitations. All employees who contributed to the Plan are
eligible to share in discretionary Company matching contributions. Company
contributions vest over 5 years. The Company did not contribute to the Plan in
1999.
F-20
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. RETIREMENT PLANS (CONTINUED)
DEFINED BENEFIT PLAN
The Company has a defined benefit plan (the "Pension Plan") covering
substantially all salaried employees. The Pension Plan benefits are based on
years of service and the employee's compensation. The Company's funding policy
is to annually contribute amounts sufficient to meet minimum funding
requirements set forth in the Employee Retirement Income Security Act of 1974
("ERISA"). Contributions are intended to provide not only for benefits
attributed to service to date, but also for those expected to be earned in the
future. The assets of the Pension Plan are invested in money market and
corporate debt and equity instruments. The Company contributed approximately
$63,777 for the Pension Plan year ending October 31, 1997. The Company has
accrued, but not yet paid, approximately $104,000, which amount represents its
minimum funding requirements under ERISA for fiscal years 1998 and 1999.
On January 6, 1997, the Company amended the Pension Plan to change the
benefits to be paid out after retirement from 100% to 40% of its initial
liability. This resulted in a reduction of the projected benefit obligation by
approximately $150,000.
On October 31, 1999, the Company amended and terminated the Defined Benefit
Plan. Under the termination, no additional benefits accrued to participants in
the Plan after that date. In addition, all existing participants in the Plan
became 100% vested in their accrued benefits in the Plan as of that date. No
gain or loss was recognized as a result of the termination of the Pension Plan.
The Company will distribute the vested benefits to the participants in fiscal
year 2000.
The following table sets forth the Pension Plan's funded status as reported
on activity, and amounts recognized in the Company's consolidated financial
statements:
OCTOBER 31,
--------------------
1998 1999
-------- ---------
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of year................ $321,559 $ 376,404
Service cost........................................... 48,195 48,195
Interest cost.......................................... 27,034 28,230
Actuarial gain (loss).................................. (20,384) 60,770
-------- ---------
Benefit obligation at end of year...................... 376,404 513,599
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of year......... 147,041 306,341
Actual return on plan assets........................... 95,523 81,840
Employer contributions................................. 63,777 --
-------- ---------
Fair value of plan assets at end of year............... 306,341 388,181
FUNDED STATUS:
Unrecognized actuarial loss............................ (70,063) (125,418)
Unrecognized transition asset.......................... (11,339) 3,028
Unrecognized prior service cost........................ 11,477
-------- ---------
Accrued benefit cost................................... $(69,925) $(122,390)
======== =========
F-21
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. RETIREMENT PLANS (CONTINUED)
Components of net periodic benefit cost
YEARS ENDED OCTOBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
Service cost................................... $ 44,140 $ 48,195 $ 48,195
Interest cost.................................. 19,355 27,034 28,230
Actual return on assets........................ 21,295 (95,523) (81,840)
Net amortization and deferral.................. (33,340) 90,219 57,880
-------- -------- --------
Total net periodic pension cost................ $ 51,540 $ 69,925 $ 52,465
======== ======== ========
Key assumptions used in the actuarial valuation were:
YEARS ENDED OCTOBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
Weighted average discount rate.......................... 7.5% 7.5% 6.5%
Rate of return on assets:
Pre-retirement........................................ 8.0% 8.0% 8.0%
Post-retirement....................................... 8.0% 8.0% 8.0%
13. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per share:
YEARS ENDED OCTOBER 31,
--------------------------------------
1997 1998 1999
---------- ---------- ------------
Numerator:
Net income (loss)..................... $1,322,300 $ 979,921 $(33,607,145)
Denominator:
Denominator for basic earnings per
share-weighted-average shares......... 4,552,055 7,231,397 9,403,775
Effect of dilutive securities:
Employee stock options................ 124,906 251,132 --
Warrants.............................. 1,887 9,722 --
---------- ---------- ------------
Dilutive potential common shares...... 126,793 260,854 --
---------- ---------- ------------
Denominator for diluted earnings per
share--adjusted weighted-average
shares and assumed conversions........ 4,678,848 7,492,251 9,403,775
---------- ---------- ------------
Basic earnings per share.............. $ 0.29 $ 0.14 $ (3.57)
========== ========== ============
Diluted earnings per share............ $ 0.28 $ 0.13 $ (3.57)
========== ========== ============
F-22
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. CONTINGENCIES
EMPLOYEE TERMINATION
In November 1998, a former employee of the Company (who had previously been
an employee and stockholder of STMS) filed a demand for arbitration with the
American Arbitration Association, alleging a breach of his employment agreement
with the Company and seeking "in excess of $2,350,000" in damages from the
Company. The Company filed an answer denying the former employee's allegations
and a counterclaim for this former employee's breach of the employment agreement
and for conversion of certain of the Company's property. In August 1999, the
arbitrator entered a judgment in favor of the former employee for approximately
$1.7 million plus attorney's fees and costs. The decision was upheld on appeal
in September 1999. The Company has properly accrued for this claim. Included in
the loss accrual is an estimate of interest and legal costs included in the
award. Although the former employee has not submitted a claim for such costs,
the Company believes its estimated accrual for these costs is adequate. The
Company is currently reviewing whether a further appeal is warranted.
TEAMING PARTNERSHIP TERMINATION
In May 1999, a former contract teaming partner filed a demand for
arbitration with the American Arbitration Association, alleging breach of a
certain contract agreement with the Company. The issue relates to disputed
commissions due to the former teaming partner. The former teaming partner is
seeking damages of approximately $186,000. The matter is currently in
arbitration. Although the Company is aggressively defending this claim, it has
accrued this potential liability in the consolidated financial statements as of
October 31, 1999.
IDP ACQUISITION
In May 1997, the U.S. Air Force awarded a contract to IDP. Dynamic
Decisions, Inc. (DDI), a competitor for this contract, protested the contract
award to the Small Business Administration (SBA), which protest was denied. DDI
filed suit against the SBA and Air Force seeking review of the award decision.
IDP intervened in the litigation and the litigation was subsequently settled.
Based on the terms of the settlement, IDP agreed to pay DDI 1.8% of the first
$250 million of IDP's gross sales under the contract. On June 1, 1998, the
Company filed a Complaint for Declaratory Judgment in U.S. District Court for
the Eastern District of Virginia seeking a declaration that DDI is not entitled
to receive payments under the settlement agreement. This filing is based on the
Company's position that DDI breached the settlement agreement. DDI has
counter-claimed against the Company denying it breached the settlement agreement
and seeking the payments. The U.S. District Court has ruled in DDI's favor
awarding damages of $1,500. DDI is currently appealing this decision. The
Company is aggressively pursuing all avenues of defense against this appeal.
On July 31, 1998 the Company received notice from the SBA that it was
denying the request of the U.S. Air Force to waive the requirement to terminate
IDP's Desktop V contract for the convenience of the Government upon the change
in control of IDP to the Company. The Company appealed the denial by the SBA to
the SBA's Office of Hearings and Appeals. On August 31, 1999, the SBA denied the
appeal and ruled that the U.S. Air Force must terminate-for-convenience the
Desktop V contract. Under a termination-for-convenience, the Government shall
reimburse the Company for all costs incurred in the performance of the contract.
The Company expects to recover from the Government a portion or all of its
unreimbursed costs. The Company is currently in negotiations with the Government
regarding this matter.
F-23
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. CONTINGENCIES (CONTINUED)
MICROSOFT LICENSING AGREEMENT
IDP entered into a Government Integrator Agreement, as amended, with
Microsoft Corporation (Microsoft) in 1998 for the licensing of certain Microsoft
software. During 1999, Microsoft asserted that the Company owed approximately
$800,000 under this agreement due primarily to amended billings by Microsoft
concerning sales by the Company. The Company has accrued for amounts due
Microsoft based on the original billing terms. The Company believes that it has
meritorious defenses to Microsoft's allegations and intends to vigorously defend
itself if a suit is filed. The Company can't estimate at this time the amount of
the liability to be incurred, if any, but does not believe that this matter will
have a material adverse effect upon the Company's financial position or results
of operations and as such, the Company has not recorded any amount relating to
this matter, beyond amount accrued as noted above, in the accompanying financial
statements.
MONARCH TECHNOLOGY, INC.
In July 1999, Monarch Technology, Inc. ("Monarch") named the Company as a
cross-claim defendant in a legal action pending in Orange County, California in
which Worldnet Computers, Inc. has filed suit against Monarch. Monarch's cross
claims are that the Company is liable for actions of a former employee who
allegedly engaged in a scheme that resulted in Monarch paying $130,000 to the
employee and not receiving products which the employee allegedly stated that the
Company would sell to Monarch or its agent. Monarch claims that the Company is
liable for the $130,000 plus interest, attorneys fees and other consequential
damages totaling approximately $60,000. The Company can't estimate at this time
the amount of the liability to be incurred, if any, but does not believe that
this matter will have a material adverse effect upon the Company's financial
position or results of operations and as such, the Company has not recorded any
amount relating to this matter in the accompanying financial statements.
F-24
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors
Dunn Computer Corporation
We have audited the consolidated financial statements of Dunn Computer
Corporation (a Virginia corporation) as of October 31, 1998 and 1999, and for
each of the three years in the period ended October 31, 1999 and have issued our
report thereon dated February 1, 2000, except for Note 6 as to which the date is
February 11, 2000 (included elsewhere in this Form 10-K). Our audit also
included the consolidated financial statement schedule listed in Item 14 of this
Form 10-K. The schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion based on our audits.
In our opinion, the consolidated financial statement schedule referred to
above, when considered in relation to the basic consolidated financial
statements taken as a whole presents fairly, in all material respects, the
information set forth herein.
/s/ ERNST & YOUNG LLP
McLean, Virginia
February 1, 2000
S-1
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
DUNN COMPUTER CORPORATION
BALANCE AT BALANCE
BEGINNING OF AT END OF
CLASSIFICATION YEAR ADDITIONS DEDUCTIONS YEAR
- -------------- ------------ ---------- ---------- ----------
Allowance for doubtful accounts:
Year ended October 31, 1997.................. $ 15,000 $ 62,000 $ -- $ 77,000
Year ended October 31, 1998.................. $ 77,000 $ 59,000 $ 90,000(1) $ 46,000
Year ended October 31, 1999.................. $ 46,000 $1,400,000 $1,346,000(1) $ 100,000
Inventory reserve:
Year ended October 31, 1997.................. $ 20,000 $ 230,000 $ -- $ 250,000
Year ended October 31, 1998.................. $250,000 $ -- $ -- $ 250,000
Year ended October 31, 1999.................. $250,000 $2,241,000 $ 362,000(2) $2,129,000
- ------------------------
(1) Write-offs of accounts receivable
(2) Write-offs of inventory
S-2
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
on Form S-8 (No. 333-61557) pertaining to the Employee Stock Purchase Plan of
Dunn Computer Corporation (a Virginia corporation), with respect to the
consolidated financial statements and schedules of Dunn Computer Corporation
included in the Annual Report (Form 10-K) for the year ended October 31, 1999.
/s/ ERNST & YOUNG LLP
McLean, Virginia
February 15, 2000
EXHIBIT 23.2
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
on Form S-8 (No. 333-52419) pertaining to the 1997 Stock Option Plan of Dunn
Computer Corporation (a Virginia corporation), with respect to the consolidated
financial statements and schedules of Dunn Computer Corporation included in the
Annual Report (Form 10-K) for the year ended October 31, 1999.
/s/ ERNST & YOUNG LLP
McLean, Virginia
February 15, 2000