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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NO. 000-23221
TEKGRAF, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 58-2033795
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification Number)
2979 Pacific Drive, Suite B, Norcross, Georgia 30071
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(770) 441-1107
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
CLASS A COMMON STOCK, $.001 PAR VALUE
AND
WARRANTS TO PURCHASE CLASS A COMMON STOCK, $8.40 EXERCISE PRICE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes: X No:
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the Class A Common Stock held by
non-affiliates of the registrant was $7,625,000 at March 27,1998. There were no
shares of the Class B Common Stock held by non-affiliates of the registrant at
March 27, 1998.
The number of shares of Class A and Class B Common Stock outstanding as
of March 27, 1998 was 2,100,000 and 3,333,333, respectively.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Definitive Proxy statement for the 1998
Annual Meeting of Stockholders of Tekgraf, Inc. are incorporated by reference
into Part III of this Annual Report on Form 10-K. Various exhibits to the
Registrant's Registration Statement on Form S-1, File Number 333-33449, are
incorporated by reference into the Exhibits to this Annual Report on Form 10-K.
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TEKGRAF, INC.
TABLE OF CONTENTS
ITEM PAGE
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PART I
1. Business...................................................................................... 3
2. Properties.................................................................................... 13
3. Legal Proceedings............................................................................. 14
4. Submission of Matters to a Vote of Security Holders........................................... 15
PART II
5. Market for the Company's Common Equity and Related
Shareholder Matters............................................................... 15
6. Selected Financial Data....................................................................... 18
7. Management's Discussion and Analysis of Results of
Operations and Financial Condition................................................ 19
8. Financial Statements and Supplementary Data................................................... 26
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................................... 26
PART III
10. Directors and Executive Officers of the Company.............................................. 26
11. Executive Compensation....................................................................... 26
12. Security Ownership of Certain Beneficial Owners and
Management........................................................................ 26
13. Certain Relationships and Related Transactions............................................... 26
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K......................................................................... 26
Signatures.................................................................................. 30
Index of Exhibits........................................................................... E-1
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PART I
ITEM 1. BUSINESS.
This report contains statements which constitute forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended (the "Securities Act"), and the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). See "Management's Discussion and Analysis of
Results of Operations and Financial Condition--Private Securities Litigation
Reform Act."
Overview
Tekgraf, Inc.("the Company") is engaged in the manufacture,
configuration, distribution and servicing of computers and computer peripherals,
hardware and software. The Company commenced operations in February 1993 for the
purpose of engaging in the manufacture of custom or "made-to order" premium
servers and network workstations under the brand name "Crescent Computer". In
December 1994, the Company acquired a controlling interest in Prisym
Technologies, Inc. of Georgia ("Prisym"), an authorized reseller of equipment
manufactured by Digital Equipment Corporation (a "DEC Reseller").
In June 1997, the Company completed the acquisition of all of the
outstanding capital stock of G&R Marketing, Inc., Microsouth, Inc., tekgraf,
inc., Computer Graphics Distributing Company, Intelligent Products Marketing,
Inc. and IG Distribution, Inc. (the "1997 Acquisitions")in exchange for
2,192,000 shares (giving effect to the .83333325-for-one stock split effected in
October 1997)of Class B Common Stock of the Company. All of the acquired
companies are regional distributors specializing in computer graphics
technologies. Subsequent to the 1997 Acquisitions, the Company reincorporated by
merger under the laws of the State of Delaware into a wholly owned Delaware
subsidiary (the "Merger") and changed its name to Tekgraf, Inc. In connection
therewith, the Company reorganized its operations into two divisions: the
Graphics Division, a wholesale distribution network of high-end computer
graphics products; and the Technology Division, which is engaged in the
manufacture, sale and support of the Crescent Computer and distribution of
related components and DEC Reseller activities.
On November 10, 1997, the Company completed the initial public
offering of its securities (the "Offering"). In the Offering, the Company
offered 2,100,000 units (the "Units") at a price of $6.00 per Unit, with each
unit consisting of one share of Class A Common Stock and one redeemable warrant
(a "Warrant"). Each Warrant entitles the holder to purchase one share of Class A
Common Stock at an exercise price of $8.40, subject to adjustment. See "Price
Range of Class A Common Stock and Warrants."
Strategy
The Company's overall business strategy is to become a nationally
recognized, vertically oriented provider of computer products and services. The
Company intends to accomplish this goal through internal growth of its operating
divisions, acquisitions of complementary businesses and expansion into selected
international markets.
Internal Growth. The Company anticipates that it will be able to
expand its operations through internal growth of each of its operating
divisions. The Company will seek to increase the customer base of the Technology
Division by utilizing the consolidated marketing and
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distribution structure of the Graphics Division achieved as a result of the
1997 Acquisitions, by increased marketing of the Crescent Computer to selected
markets, and through enhanced product and service offerings. The Company
believes that the increased technical personnel and capabilities will enable
Prisym to achieve higher certifications with DEC, thereby broadening the product
mix available to customers.
Acquisition Strategy and the 1998 Acquisitions
The Company intends to expand its operations through acquisitions of
complementary businesses. The Company intends to focus its acquisition
activities on profitable technology companies that can be integrated into the
Company's existing divisional structure, increase divisional revenues, expand
the geographic and technical scope of the Company's operations and offer a
greater range of products and services to existing and potential customers.
The Company continually explores acquisition possibilities and has
targeted certain computer graphics distributors. On March 23, 1998, the Company
entered into two agreements and plans of merger and on March 25, 1998 entered
into a third agreement and plan of merger (the "1998 Acquisitions") to acquire
three computer graphics wholesale companies. It is expected that each
acquisition will be accounted for as a purchase and will be treated as a
tax-free reorganization to the extent permissible. The agreement and plan of
merger (the "CGT Agreement") by and between the Company, Tekgraf Sub I, Inc., a
Georgia corporation ("Tekgraf Sub I"), Computer Graphics Technology, Inc., a
South Carolina corporation ("CGT"), and its shareholders (the "CGT
Shareholders") provides that CGT will merge with and into Tekgraf Sub I in
exchange for delivery to the CGT Shareholders of aggregate consideration of
330,000 unregistered shares of the Company's Class A Common Stock and $500,000
in cash. The consideration to be delivered to the CGT Shareholders is subject
to adjustment based on certain profitability and net asset value guarantees
made by CGT. To secure these guarantees, $100,000 of the cash and 20% of the
shares to be issued to the CGT Shareholders will be placed in escrow, and
another 20% of the shares to be issued to the CGT Shareholders will be placed
in escrow to secure various representations, warranties, and other provisions
contained in the CGT Agreement. The closing of the merger of CGT into Tekgraf
Sub I is scheduled for April 1, 1998, subject to the satisfactory completion of
due diligence, the receipt of regulatory approvals and consents, and other
conditions to closing. CGT, which is headquartered in Greenville, South
Carolina, is a computer graphics distribution company focused on the Southeast.
The agreement and plan of merger (the "MGD Agreement") by and between
the Company, Tekgraf Sub II, Inc., a Georgia corporation ("Tekgraf Sub II"),
Martec, Inc., a California corporation doing business as Media Graphics
Distribution and MGD ("MGD"), and its shareholders (the "MGD Shareholders"),
provides that MGD will merge with and into Tekgraf Sub II in exchange for
delivery to the MGD Shareholders of aggregate consideration of 300,000
unregistered shares of the Company's Class A Common Stock and $500,000 in cash.
The consideration to be received by the MGD Shareholders is subject to
adjustment based on certain profitability and net asset value guarantees made
by MGD. To secure these guarantees, $150,000 of the cash and 20% of the shares
to be issued to the MGD Shareholders will be placed in escrow, and another 20%
of the shares to be issued to the MGD Shareholders will be placed in escrow to
secure various representations, warranties, and other provisions contained in
the MGD Agreement. The closing of the merger of MGD into Tekgraf Sub II is
scheduled for April 30, 1998, subject to the satisfactory completion of due
diligence, the receipt of regulatory approvals and consents, and other
conditions to closing. MGD is a computer graphics distribution company
headquartered in Torrance, California.
The agreement and plan of merger, as amended (the "NECG Agreement"), by
and between the Company, Tekgraf Sub III, Inc., a Georgia corporation ("Tekgraf
Sub III"), New England Computer Graphics, Inc., a Massachusetts corporation
("NECG"), and its shareholders (the "NECG Shareholders"), provides that NECG
will merge with and into Tekgraf Sub III in exchange for delivery to the NECG
Shareholders of aggregate consideration of 265,000 unregistered shares of the
Company's Class A Common Stock and $415,000 in cash. The consideration to be
received by the NECG Shareholders is subject to adjustment based on certain
profitability and net asset value guarantees made by NECG. To secure these
guarantees, $75,000 of the cash and 25% of the shares to be issued to the NECG
Shareholders will be placed in escrow, and another 25% of the shares to be
issued to the NECG Shareholders will be placed in escrow to secure various
representations, warranties, and other provisions contained in the NECG
Agreement. The closing of the merger of NECG into Tekgraf Sub III is scheduled
for April 30, 1998, subject to the satisfactory completion of due diligence, the
receipt of regulatory approvals and consents, and other conditions to closing.
William M. Rychel, a director and shareholder of the Company, owns approximately
14% of the outstanding common stock of NECG, and Thomas Gust, a shareholder of
the Company, and Lowell Nerenberg, a shareholder and an employee of the Company,
own approximately 14% and 28%, respectively, of NECG. The acquisition of NECG
was approved by the unanimous vote of the disinterested directors of the
Company. NECG is headquartered in Westford, Massachusetts and also has offices
in Mississaugua, Ontario. It is engaged in selling computer graphics products
through a network of resellers focused on the pre-press, wideformat color
graphics, and electronic document management and storage markets in New England,
upper New York State and Canada.
The descriptions set forth herein of the terms and conditions of the
CGT, MGD and NECG Agreements (the "Agreements") are qualified in their entirety
by reference to the full texts of the Agreements and the exhibits thereto,
copies of which are filed as Exhibits to this Report on Form 10-K. There can be
no assurance that the Company's acquisition program will be successful, that the
acquisition of these or other companies will be completed or that, if completed,
any companies acquired will be profitable or will contribute revenues to the
Company.
International Expansion. The Company intends to market the Crescent
Computer and components, as well as products and services distributed by the
Graphics Division, to selected international markets such as Canada, the United
Kingdom, South Africa and Australia.
THE COMPANY'S DIVISIONS AND PRODUCTS
THE GRAPHICS DIVISION
General
The Graphics Division currently consists of five regional wholesale
distributor subsidiaries which specialize in computer graphics technologies.
These subsidiaries are G&R Marketing, Inc.("G&R"), Microsouth,
Inc.("Microsouth"), tekgraf, inc.("tekgraf"), Computer Graphics Distributing
Company("CGD"), and Intelligent Products Marketing, Inc.("IGD"), which includes
IG Distribution, Inc. The Graphics Division sells and supports products in the
digital prepress, presentation graphics, color desktop publishing, large format
display graphics, digital imaging, electronic drawing management, CAD and other
emerging computer graphics technologies markets. The Company provides
value-added sales, marketing, fulfillment, and logistics support for more than
30 manufacturers of a broad array of complex computer graphics hardware and
software. See "-- Products and Markets."
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Although initially comprised of six individual companies, central to
the business model of the Graphics Division and a core motivation for the 1997
Acquisitions and the resulting business combination were the pre-existing
relationships among such companies and their principals. The desire to provide
manufacturers with national sales and marketing programs fostered close
cooperation among these regional firms, ultimately leading to the formation of
two trade associations, the David Group and the Vision Group. The purpose of
these associations was to facilitate joint marketing and promotion, product line
acquisitions, the sharing of technical resources and sales strategies, and the
transfer of excess inventory. All of the companies that make up the Graphics
Division are current or former members of one or both of such trade
associations.
The goal of the Graphics Division is to build on the aforementioned
historic inter-company cooperation and function as a single entity with respect
to sales, marketing, advertising, public relations, technical support and
technology evaluation. With the current exception of the areas of Southern
California, Arizona, New Mexico and New England, the Graphics Division is in a
position to provide computer graphics manufacturers a national distribution
presence with the key benefit of local technical sales and support. See
"--Customers, Sales and Marketing." The Company intends to acquire additional
regional distributors of computer graphics technology in order to increase the
geographic scope of the operations of the Graphics Division. There can be no
assurance, however, that the Company will successfully complete any such
acquisitions.
During the years ended December 31, 1996 and 1997, the revenues of the
Graphics Division accounted for 80.5% and 78.4%, respectively, of the Company's
total revenues on a pro forma combined basis. The operating profit of the
Graphics Division for these same periods accounted for 78.0% and 76.7%,
respectively, of the Company's operating profit on a pro forma consolidated
basis. The identifiable assets of the Graphics Division accounted for 82.4% and
59.0%, respectively, of the Company's identifiable assets, on a consolidated
basis as of December 31, 1996 and 1997, respectively.
Products and Markets
The Company's Graphics Division distributes and supports products of
over 30 manufacturers, including Agfa Division of Bayer Corporation, Electronics
For Imaging (EFI) Encad, Inc., Epson America, Inc., Mitsubishi Electronics
America, Inc., Scitex America Corporation and Vidar Systems Corporation. Among
the products the Graphics Division distributes and sells are color scanners,
color digital film recorders, digital cameras, color laser printers,
color-calibrated monitors, audio-visual presentation systems, raster image
processors (RIPs), ink jet printers, plotters, pre-press software, image
setters, color proofers, mass storage devices and the consumable products used
in many of such products. Prices typically range from less than $100 to in
excess of $100,000.
The Company's agreements with manufacturers are generally
non-exclusive, provide for wholesale distribution to dealers and resellers in
specified geographic territories and are terminable by either party without
cause on either 30 or 60 days notice.
The Graphics Division intends to continue to operate in the following
four vertical markets:
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- Digital Pre-Press
- Computer-Aided Design (CAD)
- Electronic Drawing Management Systems (EDMS)
- Display Graphics
Digital Pre-Press. Over the last three years, there has been a dramatic
shift in the process printing industry from manual, analog production of printed
materials to the use of computers. Historically the production of a printed
brochure, magazine or catalog involved numerous manual steps using photographic
materials to produce the final press-ready copy.
With rapid advances in software and hardware, much of today's printed
materials are produced digitally. The print production process now allows a
printed piece to go from concept to imaged printing plate in a fully digital
environment. Copy writing, proofing and revisions all take place on a desktop
computer, increasing the speed and efficiency of the pre-press process, and
streamlining personnel requirements in the process. The Company believes this
market is in a period of rapid transition regarding the manner in which
electronics products are delivered to the traditional printing customer. When
digital pre-press systems sold for $200,000 per seat (user), most manufacturers
used a captive direct sales force to sell to the end-user. Today, the typical
seat sells for under $20,000, forcing manufacturers to utilize a reseller
channel to deliver their products.
The Graphics Division sells input, proofing, networking, color
management software and output devices, which are integral parts of a digital
pre-press system. These products are typically sold through two classes of
resellers: graphic arts dealers who have traditionally sold film, chemicals,
printing plates and other analog pre-press supplies, and graphics value added
resellers ("VARs") who have specialized in pre-press workflow technologies and
the automation of the pre-press process.
Computer Aided Design (CAD). Over the last ten years, traditional
drafting tables have given way to the desktop computer. Today, most
architectural and engineering design and drafting in the United States is done
using a desktop computer or workstation.
The CAD market is a more mature digital market than digital pre-press.
As a result, the delivery mechanism for products into this market has adapted to
the combination of less expensive products and more informed buyers. According
to industry sources, over 90% of all CAD software and peripherals are delivered
using a multi-tiered reseller channel.
The Graphics Division sells primarily processing and output products in
this market, with plotters, high-resolution graphics displays and optical
storage representing the majority of sales.
Electronic Drawing Management Systems (EDMS). The use of CAD systems in
the engineering and architectural community has created a workflow problem for
those firms that have embraced CAD - what to do with the archive of manually
drafted drawings.
EDMS allow these customers to capture (i.e., scan) paper drawings and
store them digitally. When needed, they can be retrieved, annotated, printed or
converted to CAD format for further revision. Since most of these functions can
be performed using existing CAD workstations or PC's, the cost of converting to
an EDMS systems is relatively low, and the demand for such systems is growing
dramatically.
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The Graphics Division sells all of the components necessary for the
installation of an EDMS system, including large format scanners, archiving and
manipulation software, optical storage systems and output devices.
Display Graphics. The most rapidly growing segment of the computer
graphics output market is display graphics. Display graphics, or large format
graphics, describes a process that allows computer-generated or captured images
to be printed in sizes up to 60 inches wide.
Historically, these images could only be printed on color electrostatic
printers costing over $120,000. However, over the last three years, significant
advances in ink-jet technology, software, specialty inks and media have placed
the cost of entry for display graphics systems starting at under $10,000, and
market acceptance has been rapid. End-users of this technology include a wide
range of industries and markets, such as:
- Trade-show graphics - production of booth and arcade
displays
- Point of Sale graphics - floor displays
- Sign Shops - traditional signage, fleet graphics
- Print-for-Pay (e.g., Kinkos, Sir Speedy)
- Package Design - package prototyping
- Graphic Arts - imposition proofing
Products sold to this market include large-format ink-jet printers
(ENCAD), faster image processing software (Amiable Technologies, EFI, Onyx
Graphics, PISA), lamination systems (Seal Products, a division of Hunt
Manufacturing) and a wide range of inks, papers and other specialty media.
Customers, Sales and Marketing
The Graphics Division's customers are principally value-added resellers
(VARs) and systems integrators (SIs), as well as, for certain products,
retailers, mass merchandisers and direct marketers. VARs typically focus on
sales to users in specific vertical markets where the selling organization has
unique knowledge and expertise concerning the prospective customer's
application. These customers purchase products from the Company and resell them
as an integrated solution bundled with installation services and post-sales
support. SIs typically purchase products from the Company for further
integration into a much larger solution comprised of components from many
sources. These solutions typically are very large in scale and may involve an
integration contract between the SI and the end-user customer. The Graphics
Division utilizes the retail, mass merchant and direct marketing sales channels
when product demand is firmly established and a lower cost mechanism of delivery
to the end user is warranted.
Currently, the Graphics Division has 21 outside and 18 inside sales
representatives and seven technical support representatives. The Company
believes that this constitutes the highest concentration of sales and technical
support professionals in the country devoted to the sales, marketing, and
support of high-end computer graphics products.
The Company's sales representatives receive commissions based on sales.
During each of the years ended December 31, 1995, 1996 and 1997,
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compensation paid to outside sales representatives amounted to less than 5% of
the Company's sales.
Each regional office of the Graphics Division maintains and has
training and demonstration facilities equipped with its manufacturers' hardware
and applications software. These resources are made available to prospects and
customers for product evaluations, product training, demonstrations, benchmark
testing and in-house and in-the-field seminars. In addition, the Graphics
Division's sales force and technical sales representatives are trained to
demonstrate the technology it distributes and the applications of such
technology. Inside and outside technical sales representatives are also trained
to understand their manufacturers' products, the competitors' products, related
applications, software and the relevant end-user markets.
The Company believes the service offered by the Graphics Division is
unique in providing face-to-face sales, marketing, and distribution of mid to
high-end computer graphics products sold through vertical reseller channels.
Typically, products carried by the Graphics Division are relatively complex,
requiring technical sales training, product demonstrations, product training,
pre-sale and post-sale technical support and immediate product availability.
Selling and supporting products in these markets require knowledge of many
distinct types of hardware and software as well as communications protocols,
networking architecture, file formats, compression techniques, and other systems
integration issues. Manufacturers of products with such a level of complexity
often need to leverage their own limited resources by selling and distributing
through reseller organizations. Similarly, reseller organizations are often
severely limited in the technical sales and marketing resources they can devote
to the sale of specific products. Accordingly, each regional office of the
Graphics Division augments both the manufacturer's and the reseller's staff,
capitalizing on its ongoing relationships with the local resellers and end user
community. Resellers are trained and assisted by Graphics Division staff in all
aspects of sales, marketing, distribution and installation of its products.
The Company believes that the consolidation of the operations of G&R,
Microsouth, tekgraf, CGD and IGD into the Graphics Division and the 1998
Acquisitions, if consummated, will enable it to establish a national
distribution network. In addition to economies of scale achieved, the Company
believes that it will be more cost-effective for certain manufacturers of
computer graphics technology and peripheral equipment to utilize the Company as
a distributor than to maintain their own extensive internal sales force.
THE TECHNOLOGY DIVISION
General
The operations of the Technology Division currently consist of the
manufacture of the Crescent Computer and the DEC Reseller activities of Prisym.
The Company custom designs, assembles and sells custom or "made-to-order"
premium servers or workstations (Crescent Computers) and related technology to
VARs, vertical solution providers ("VSPs"), corporations, universities and the
government. See "--Customers, Sales and Marketing." The Company also provides
services to its customers, including system architecture design, hardware
consulting and customer support.
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Products and Markets
The Crescent Computer is a PC that can be assembled in a number of
different configurations using standard component parts. Although many of the
Crescent Computers are based on standard configurations, customization enables
the Company to accommodate customer computer needs with respect to storage
capacity, speed, price, applications, size, configuration and a range of other
considerations that can be accommodated in whole or in part by the selection of
appropriate components. The Company works with SIs on network configuration. The
Company also provides customers with continuing technical support and assistance
in the maintenance and operations of Company purchased products.
Crescent Computers are currently being used to operate non-sterile heart
catheterization diagnostic equipment, as voice mail/auto-attendant controllers,
in informational kiosks and in other process-control applications. The Company
also sells servers and RAID storage systems to VARs and other companies seeking
to create Internet web sites, internal networks, graphics and CAD workstations
and application servers.
Through Prisym, the Company provides DEC's Alpha-based Workstations and
servers, mass storage, printers, components and computer peripherals and
supplies to the nationwide installed base of DEC customers. Prisym's customers
include Fortune 500 companies, governmental agencies and educational
institutions.
During the years ended December 31, 1996 and 1997, the revenues of the
Technology Division accounted for 19.5% and 21.6%, respectively, of the
Company's total revenues on a pro forma combined basis. The operating profit of
the Technology Division for these same periods accounted for 22.0% and 23.3%,
respectively, of the Company's operating profit on a pro forma consolidated
basis, and the identifiable assets of the Technology Division accounted for
17.6% and 41.0%, respectively, of the Company's identifiable assets, on a
consolidated basis as of December 31, 1996 and 1997, respectively.
Manufacturing and Suppliers
The Company's manufacturing operations consist of the assembly of Crescent
Computers at its facility in Norcross, Georgia and the testing of the electronic
and mechanical components incorporated into its products.
The Company has elected to assemble its products utilizing principally
off-the-shelf electronic component parts available from multiple sources. The
Company believes that this practice helps to ensure better quality control and
pricing by allowing the Company to select the best manufactured and best
performing components available on the market, rather than a proprietary product
that may fall behind the latest technology in terms of either such
characteristic, and to purchase such components from marketplace sources that
offer the best prices at the time the particular components are needed for
production, as opposed to having prices dictated by the limited sources able to
provide a proprietary component. The Company obtains component parts on a
purchase order basis and does not have long-term contracts with any suppliers.
To date, the Company has not experienced significant interruptions in the supply
of such component parts, and believes that numerous qualified suppliers are
available. The Company believes that the inability of any of its current
suppliers, except as specified below, to provide component parts to the Company
would not adversely
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affect the Company's operations and that alternate sources could be readily
established.
The Company currently obtains the motherboards (a primary component of
the PC) from two sources. Certain of the Company's file server products
incorporate a motherboard which is currently purchased from a sole supplier.
Historically the Company has been able to obtain adequate supplies of this
component and does not anticipate any related sourcing problems; the inability
in the future to obtain sufficient numbers of such components or to develop
alternative sources could result in delays in product introductions or
shipments. Such delays could have a material and adverse effect on the Company's
results of operations. The Company plans to attempt development of additional
alternative sources to limit any adverse impact on the Company's result of
operations.
The Company has established a comprehensive testing and qualification
program to ensure that all subassemblies meet the Company's specifications and
standards before final assembly and testing. The Company's quality control
program includes diagnostic tests, assembly, burn-in, final configuration and
final quality assurance tests and the employment of process controls at its
manufacturing facility. The Company has also implemented quality control
policies that are reviewed and accepted by the Company's major customers. The
Company believes that this procedure helps ensure a high-quality product.
The Company, through its Prisym subsidiary, is an authorized DEC
reseller. During the years ended December 31, 1996 and 1997, revenues derived
from the sale of DEC and DEC-related products accounted for 37.5% and 41.6%,
respectively, of the Technology Division's revenues. Prisym has no written
supply agreement with DEC.
The Company's own manufacturing facility totals approximately 4,000
square feet. The Company believes that additional manufacturing facilities, if
necessary, are available. The Company is currently operating at approximately
50% of capacity at this facility. See "Item 2 - Properties."
Customers, Sales and Marketing
Customers for the Crescent Computer include OEMs, other vertical market
computer resellers, computer dealers, universities, government entities and
corporations. The Technology Division does not market to individual end-users,
focusing instead on establishing relationships with entities which will
constitute repeat sales and have internal computer support personnel capable of
handling local issues prior to involvement of Company personnel.
Prisym markets to the current installed base of DEC customers. Such
customers primarily include Fortune 500 and other large corporations,
governmental agencies and educational institutions.
The Company currently distributes Technology Division products
principally through the efforts of its internal direct sales force. In the
future, the Company intends to offer Technology Division products through its
recently acquired Graphics Division sales force and to expand its marketing
efforts and seek to (i) expand the customer base for the Crescent Computer, (ii)
expand the geographic market serviced by the Graphics Division, and (iii)
increase both the number of products
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distributed and the number of manufacturers whose products are distributed by
the Graphics Division. Because the Technology Division typically sells large
amounts of equipment to a small number of customers, a large portion of the
Technology Division's sales may be derived from a limited number of customers.
During the year ended December 31, 1997, three customers accounted for an
aggregate of 9% of the Technology Division's sales.
Service and Support
The Company believes that customer service and support is a significant
competitive factor in the network systems market in which it sells the Crescent
Computer and will become more important as local area networks ("LANs") become
more complex and as more enterprises implement business-critical applications on
their networks. The Company supports its customers by providing rapid problem
resolutions both during and after the installation process. The Company
maintains a technical support organization that assists customers in
trouble-shooting problems and providing replacement parts. The Company provides
a toll-free telephone number to help diagnose and correct customer system
interruptions as they occur at customer sites and support staff is available
during normal business hours.
The Company warrants all of its Crescent Computer servers and
workstations against defects in materials and workmanship for two years. During
the warranty period, the Company will repair or replace any Crescent Computer,
or component thereof, which the Company identifies as defective. The Company
will, in certain circumstances, send replacement parts to the customer site
prior to the return of defective component in order to minimize down time. The
Company has contracted with a service provider to furnish on-site service of
Crescent Computers to customers which choose that option.
The Company's product warranties do not differ materially from those
generally available in the industry. In most instances, the Company receives
warranties on products from vendors which are at least equivalent to those it
provides to its customers. To date, the Company has not experienced significant
claims under its warranties.
Graphics and Technology
Backlog
The Company does not have significant backlog due to (i) the Technology
Division being able to manufacture and deliver products generally within a few
days of order receipt and long-term contracts to supply products have not been
entered into with customers (the Company manufactures and sells products on the
basis of individual purchase orders as and when received) and (ii) the fact that
the Graphics Division generally receives orders for shipment the same or next
day. Accordingly, backlog at the beginning of a quarter may not represent a
significant percentage of the products anticipated to be sold in that quarter.
Quarterly revenues and operating results depend on the volume and timing of
bookings received during the quarter. Therefore, management of the Company does
not consider order backlog a significant indicator of the Company's future
revenues.
Competition
The business of manufacturing and selling computers and computer
peripheral equipment is intensely competitive and rapidly changing. The Company
believes that the principal competitive factors in this industry
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include relative price and performance, product availability, technical
expertise, financial stability, service, support and reputation.
The Company's Graphics Division competes primarily with computer
equipment manufacturers that either utilize an in-house sales force to market
their products to resellers and end-users or utilize the services of large,
national fulfillment distributors. The Company believes that the primary
competition will come from national fulfillment distributors whose specialty is
order fulfillment. The Company believes that the key factors differentiating it
from such competitors lies in the ability to provide technical sales training,
product demonstrations, product training, pre- and post- sale technical support
and evaluation units.
The Company's Crescent Computers are constructed with standardized
parts which are available to others in the market. The Company's competitors
include established computer product manufacturers, some of which supply
products to the Company, computer resellers, distributors and service providers.
Some of the Company's current and potential competitors have substantially
greater financial, sales, marketing, technical and other competitive resources
than those of the Company. As a result, the Company's competitors may be able to
devote greater resources than the Company to the sales and service of their
computer products. As the computer market in which the Company competes has
matured, product price competition has intensified and is likely to continue to
intensify, which may make it too costly for the Company to continue the "made to
order" method of doing business. One of the results of this competition may be
to lower sales prices and decrease profit margins.
Technological competition from other and longer established computer
hardware manufacturers and software developers is significant and expected to
increase. The Company expects that hardware manufacturers and software
developers will continue to enter the market to provide and package integrated
information distribution solutions to the same customer base served by the
Company's Technology Division. All such market participants will compete
intensely to maintain or improve their market shares and revenues. Most of the
companies with which the Company's Technology Division competes have
substantially greater capital resources, research and development staffs,
marketing and distribution programs and facilities, and many of them have
substantially greater experience in the production and marketing of products.
In the development market for network servers and workstations, the
Company experiences competition from hundreds of small companies and a number of
significant competitors, including such major industry participants as IBM,
Novell, Inc. and Compaq Computers, Inc. Accordingly, there is no assurance that
the Crescent Computer will continue to achieve sufficient market acceptance to
assure the Company's future success and long range profitability in the face of
competition with such significantly larger and better capitalized companies.
With respect to the Technology Division's DEC reseller activities, the
Company faces competition from several national and regional companies, many of
which are substantially larger and more established than the Company and have
national sales forces.
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Intellectual Property
The Company has no patents and its success will depend, in part, on its
ability to preserve its trade secrets and proprietary know-how, and to operate
without infringing the proprietary rights of third parties.
The Company seeks to protect trade secrets and proprietary know-how, in
part, by confidentiality agreements with employees, consultants, advisors, and
others. There can be no assurance that such employees, consultants, advisors, or
others, will maintain the confidentiality of such trade secrets or proprietary
information, or that the trade secrets or proprietary know-how of the Company
will not otherwise become known or be independently developed by competitors in
such a manner that the Company will have no practical recourse.
Product Research and Market Development
The market for the Company's products is characterized by rapid
technological change and evolving industry standards, and it is highly
competitive with respect to timely product innovations. The introduction of
products embodying new technology and the emergence of new industry standards
can render existing products obsolete and unmarketable. The Company believes
that its future success will depend upon its ability to develop, manufacture and
market new products and enhancements to existing products on a cost-effective
and timely basis.
If the Company is unable for technological or other reasons to develop
products in a timely manner in response to changes in the industry, or if
products or product enhancements that the Company develops do not achieve market
acceptance, the Company's business will be materially and adversely affected.
The Company has in the past experienced delays in introducing certain of its
products and enhancements, and there can be no assurance that it will not
encounter technical or other difficulties that could in the future delay the
introduction of new products or enhancements. Such delays in the past have
generally resulted from the Company's need to obtain a requisite component from
a third-party vendor whose own development process has been delayed (e.g., the
RAID controller card for the Company's server products).
Employees
As of December 31, 1997, the Company had 27 full-time and 4 part-time
employees in the Technology Division and 66 full-time and 10 part-time employees
in the Graphics Division.
The Company intends to hire additional management, administrative,
technical and sales personnel. The Company's employees are not represented by a
labor union and the Company believes that relations with employees are
satisfactory.
Other Matters
The Company has been advised that D.H. Blair and Co., Inc. ("Blair &
Co.") intends to make a market in the Company's securities. The company is
unable to predict whether Blair & Co.'s settlement with NASD Regulation, Inc.
("NASDR") or any unfavorable resolution of the investigation of the Securities
and Exchange Commission (the "Commission") will have any effect on such firm's
ability to make a market in the Company's securities and, if so, whether the
liquidity or price of the Company's securities would be adversely affected.
ITEM 2. PROPERTIES.
Facilities and Administrative Functions
The Company's executive offices and the Technology Division's
manufacturing and warehousing facilities are located in approximately 7,600
square feet in Norcross, Georgia pursuant to a lease expiring October 31, 1998,
which provides for an annual rental of $30,600. Prisym has approximately 2,850
square feet in Norcross, Georgia pursuant to a lease expiring November 14, 1998,
which provides for an annual rental of $39,900.
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The table below sets forth certain information with respect to leased properties
of the Graphics Division, all of which are leased from non-affiliated lessors:
Lease Terms:
Approximate Square Expiration Annual
Location Footage Date Rental(1)
- --------- ------------------ ---------- ---------
980 Corporate Woods Parkway
Vernon Hills, Illinois 14,935 5/31/00 $159,058
645 Hembree Parkway
Roswell, Georgia 10,447 4/30/98 $ 47,012
620 East Diamond Avenue
Gaithersburg, Maryland 8,993 6/30/99 $ 91,368
7020 Koll Center Parkway
Pleasanton, California 7,892 12/8/01(2) $ 96,888
6721 Port West
Houston, Texas 5,495 2/28/99 $ 45,000
- ----------
(1) Certain of these leases provide for moderate annual rental increases.
(2) A portion of these premises is being subleased to a company affiliated with
IGD for an annual rental of approximately $39,000.
The Company will acquire additional office space by virtue of the 1998
Acquisitions, if consummated. The Company also maintains five regional
warehouses for the Graphics Division. As part of its ongoing consolidation, the
Company is examining the feasibility of reducing the number of warehouses to
three.
The Company has recently begun examining centralization of
administrative and marketing functions from the existing seven locations to its
executive offices in Georgia. Management is currently evaluating accounting
systems and integrated Management Information Systems ("MIS") that will provide
inventory management, billing and collection management, accounts receivable and
accounts payable management and streamlined consolidated financial reporting. In
addition, the MIS system being evaluated is intended to increase the Company's
customer service and sales capabilities by providing contact management,
customized management reports, facilitating order tracking and automating sales
projections.
The Company periodically reviews its space and is currently exploring
the possibility of relocating the Company's headquarters to another facility
during 1998.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in certain claims arising in the normal course
of business. In the opinion of management of the Company, although the outcomes
of the claims are uncertain, in the aggregate, they are not likely to have a
material adverse effect on the Company.
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ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders by the Company
during the quarter ended December 31, 1997.
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Price Range of Class A Common Stock and Warrants
The Company's Class A Common Stock and Warrants have been quoted on the
NASDAQ National Market under the symbols "TKGFA" and "TKGFW", respectively,
since November 10, 1997, when the Company completed the Offering. Each Warrant
entitles the holder thereof to purchase one share of Class A Common Stock of the
Company at an exercise price of $8.40 at any time until 5:00 p.m., New York City
time, on November 10, 2002. Beginning on November 10, 1998, the Warrants will be
redeemable by the Company, on 30 days' written notice, at a price of $0.05 per
Warrant, if the "closing price" of the Company's Class A Common Stock for any 30
consecutive trading days ending within 15 days of the notice of redemption
averages in excess of $11.75 per share. The "closing price" shall mean the
closing bid price if listed in the over-the-counter market on Nasdaq or
otherwise or the closing sale price if listed on the Nasdaq National Market or a
national securities exchange. The Company has agreed not to redeem the Warrants
unless a prospectus covering the shares of Class A Common Stock underlying the
Warrants is in effect throughout the date fixed for redemption. All Warrants
must be redeemed if any are redeemed.
The following table sets forth, for the period indicated, the high and
low closing prices per share of the Class A Common Stock and Warrants as
reported by the NASDAQ National Market.
For the period November 10, 1997 to
December 31, 1997 High Low
- ----------------------------------- ---- ---
Class A Common Stock $5 9/16 $2 5/16
Redeemable Warrants 1 7/8 9/16
Class B Common Stock
There is no active trading market for the Class B Common Stock,
however, each share of Class B common stock can be converted into one Class A
share. The Company issued 2,192,000 (giving effect to the .83333325-for-one
reverse stock split effected in October 1997) shares of Class B Common Stock,
as the consideration used in the 1997 Acquisitions on June 2, 1997. No
underwriter was employed by the Company in connection with the issuance and
sale of the Class B Common Stock described above. The Company believes that the
issuance and sale of all of the foregoing securities were exempt from
registration pursuant to Rule 701 under the Securities Act of 1933, as amended.
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All of the 3,333,333 outstanding shares of Class B Common Stock are
"restricted securities" within the meaning of Rule 144 under the Securities Act
and may not be sold publicly unless they are registered under the Securities Act
or are sold pursuant to Rule 144 or another exemption from registration.
1,141,333 of such shares are currently eligible for sale in the public market
pursuant to Rule 144 and the remainder will become so eligible commencing in
June 1998 (subject to the restrictions on transferability relating to those
shares placed in escrow pursuant to an Escrow Agreement(as defined below) with
American Stock Transfer & Trust Company, as escrow shares and subject to volume
limitations). However, all of the holders of the shares of Class B Common Stock
outstanding prior to the Offering have agreed not to sell or otherwise dispose
of any securities of the Company for a period of 13 months after the sale of the
Offering without the prior written consent of D. H. Blair Investment Banking
Corp. and for the ten months thereafter, not to sell more than 10% of their
holdings in any month on a cumulative basis without such consent.
Each share of Class B Common Stock of the Company is convertible into
one share of Class A Common Stock of the Company at any time at the option of
the holder, or automatically upon: (i) its sale, gift or transfer, except in the
case of transfer to a trust for which the original holder acts as sole trustee
or to any other holder of Class B Common Stock; (ii) the death of the original
holder thereof, including in the case of the original holder having transferred
the Class B Common Stock to a trust for which the original holder served as
trustee during his or her lifetime; or (iii) the conversion of an aggregate of
75% of the authorized shares of Class B Common Stock into Class A Common Stock.
In connection with the Offering, the holders of the Class B Common
Stock of the Company agreed to place an aggregate of 166,667 shares into escrow
pursuant to an escrow agreement (the "Escrow Agreement") with American Stock
Transfer & Title Company, as escrow agent. The Escrow Shares may be voted, but
are not transferable or assignable other than to a permitted transferee who
agrees to be bound by the Escrow Agreement. The Escrow Shares will be released
from escrow if, and only if, one or more of the following conditions are/is met:
(a) the Company's net income before provision for income taxes and
exclusive of any extraordinary earnings (all as audited by the
Company's independent public accountants) (the "Minimum Pretax
Income") amounts to at least $8,700,000 for the fiscal year ending
December 31, 1998;
(b) the Minimum Pretax Income amounts to at least $13,000,000 for the
fiscal year ending December 31, 1999;
(c) the Minimum Pretax Profit amounts to at least $17,900,000 for the
fiscal year ended December 31, 2000;
(d) the Closing Price (as defined in the Escrow Agreement)of the Class
A Common Stock averages in excess of $16.25 per share for 30
consecutive business days during the 18-month period commencing on
November 10, 1997;
(e) the Closing Price of the Class A Common Stock averages in excess of
$20.00 per share for 30 consecutive business days during the
18-month period commencing eighteen months from November 10, 1997.
The Minimum Pretax Profit amounts set forth above will be calculated
exclusive of any extraordinary earnings, including any charge to income
resulting from release of the Escrow Shares and any property distributed in
respect of such shares. Minimum Pretax Income will be calculated assuming
release of the Escrow Shares and conversion or exercise of all outstanding
equity securities of the Company convertible into or
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exchangeable for Common Stock, whether or not convertible or exchangeable at the
time of computation and after adjustment for any stock dividends, stock splits,
or similar events. The Closing Price amounts set forth above are subject to
adjustment in the event of any stock splits, reverse stock splits or other
similar events.
Any money, securities, rights or property distributed in respect of the
Escrow Shares, including any property distributed as dividends or pursuant to
any stock split, merger, recapitalization, dissolution, or total or partial
liquidation of the Company, shall be held in Escrow until the release of the
Escrow Shares. If none of the applicable Minimum Pretax Income or Closing Price
levels set forth above have been met by March 31, 2001, the Escrow Shares, as
well as any dividends or other distributions made with respect thereto will be
cancelled and contributed to the capital of the Company. The release of Escrow
Shares to officers, directors, employees and consultants of the Company will be
deemed compensatory and, accordingly, will result in a substantial change to
reportable earnings, which would equal the fair market value of such shares on
the date of release. Such charge could substantially reduce or eliminate the
Company's net income, if any, for financial reporting purposes for the period
during which such shares are, or become probable of being, released form escrow.
Although the amount of compensation expense recognized by the Company will not
effect the Company's total stockholder equity, it may have a negative effect on
the market price of the Company's securities.
The Minimum Pretax Income and Closing Price levels set forth above were
determined by negotiation between the Company and D.H. Blair Investment Banking
Corp. in connection with the Offering and should not be construed to imply or
predict any future earnings by the Company or any increase in the market price
of its securities.
As of March 19, 1998, the approximate number of holders of record of
the Class A and Class B Common stock were 1,155 and 14, respectively.
As of March 19, 1998, the approximate number of holders of record of
the Warrants was 1,073.
Dividends
The Company has applied and intends to continue to apply, its retained
and current earnings toward the development of its business and to finance the
growth of the Company. Consequently, the Company currently does not anticipate
paying cash dividends in the foreseeable future. See "Management's Discussion
and Analysis of Results of Operations and Financial Condition--Liquidity and
Capital Resources."
Other Securities
As was stated above, in June 1997, the Company completed the
acquisitions of the outstanding capital stock of G&R, Microsouth, tekgraf, CGD,
and IGD in exchange for the issuance of an aggregate of 2,192,000 shares of its
Class B Common Stock (giving effect to the .83333325-for-one reverse stock split
effected in October 1997).
On November 1, 1997, the Company granted an employee stock options to
purchase shares of the Company's Class A Common Stock at an exercise price of
$6.00 per share. These options were terminated on March 1, 1998, pursuant to a
right granted to the Company in the option agreements. On March 1, 1998, the
Company granted options to purchase 45,000 shares of the Company's Class A
Common Stock to W.
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Jeffrey Camp, its Chief Financial Officer, with an exercise price of $3.00 per
share. 15,000 of these options became exercisable on March 1, 1998 15,000 of
these options will become exercisable on March 1, 1999, and 15,000 of these
options will become exercisable on March 1, 2000.
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED FINANCIAL AND OPERATING DATA
The financial information presented below represents selected
historical data for the Company. The following selected financial and operating
data presented by the Company should be read in conjunction with the historical
consolidated financial statements of the Company and the related notes thereto
and "Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition." Also note that effective June 2, 1997, the Company
acquired all of the outstanding common stock of G&R, Microsouth, tekgraf Texas,
CGD, and IGD. These acquisitions were accounted for as purchases and
accordingly, only included in the historical consolidated financial statements
from the acquisition date forward. All amounts are presented in thousands.
Historical
Years Ended
December 31
(in Thousands)
----------------------------------------------------------------
1993 1994 1995 1996 (1)1997
----------------------------------------------------------------
Statement of Operations Data:
Net sales $ 4,943 $ 6,340 $ 12,277 $13,414 $ 48,732
Cost of goods sold 4,214 5,228 10,368 10,952 41,250
------- ------- -------- ------- --------
Gross profit 729 1,111 1,910 2,463 7,483
Operating expenses:
Selling, general and
administrative 772 1,082 1,761 2,245 7,294
Depreciation and amortization 4 8 28 17 390
------- ------- -------- ------- --------
Operating income (loss) (47) 21 120 201 (201)
Other income 39 -- -- 15 68
Interest expenses 3 40 126 160 301
------- ------- -------- ------- --------
Income (loss) before taxes (11) (19) (5) 56 (434)
Provision (benefit) for income taxes (4) (4) (2) 13 (41)
------- ------- -------- ------- --------
Net income(loss) $ (15) $ (15) $ (4) $ 43 $ (393)
======= ======= ======== ======= ========
Net income(loss) per share $ -- $ .04 $ (.15)
======== ======= ========
Years Ended
December 31
(in Thousands)
-------------------------------------------------------
1993 1994 1995 1996 (1)1997
----- ------ ------ ----- ------
Balance Sheet Data:
Working capital $ (30) $ (39) $ (51) $ (104) $13,066
Total assets 833 1,725 2,264 3,007 29,952
Due to stockholders/related entities 723 1,424 1,616 2,211 517
Long-term obligations 13
Stockholders' equity (deficit) (11) (24) (33) 10 20,055
- ----------------------------
(1) On June 2, 1997, the Company acquired six computer graphics companies and
their operations are included in the Statement of Operations and Balance
Sheet data from this date forward. See "Item 1. Business-Overview".
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following discussion should be read in conjunction with the information
contained in the Consolidated Financial Statements, including the related notes.
Overview
The Company was incorporated in Georgia in February 1993 and in
December 1994, completed the acquisition of a 60% interest in Prisym. In June
1997, the Company completed the acquisition of a 100% interest in each of the
subsidiaries as shown in the table below. The acquisitions for each of the
subsidiaries have been accounted for using the purchase method of accounting.
Subsequent to the acquisitions, the Company completed a merger pursuant to which
it reincorporated in the State of Delaware and effected a recapitalization
pursuant to which each share of common stock of the Georgia entity was exchanged
for 400 shares of Class B Common Stock of the Delaware entity.
ACQUISITIONS
(in thousands)
Company Date 1996 Net
Name Acquired Net Sales Assets
- ---- -------- --------- ------
Microsouth June 2 $10,326 $ 484
tekgraf June 2 4,063 255
IGD June 2 9,104 407
G&R June 2 21,038 525
CGD June 2 11,003 639
------- ------
$55,534 $2,310
======= ======
In connection with the acquisitions listed above, a total of 2,192,000 shares of
Class B common stock of the Company were issued.
A principal part of Tekgraf's strategy is to acquire other companies in order to
increase the Company's market share by expanding to create a national
distribution network. This will allow the Company to become a nationally
recognized, vertically oriented provider of computer products and services, and
accordingly, to more efficiently absorb the Company's overhead and add
profitable lines of business.
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Tekgraf has also entered into agreements and plans of merger for the acquisition
of three additional computer graphics distribution companies, which it
anticipates consummating in the second quarter of 1998. See "Item 1. Business
Overview -- Acquisition Strategy and 1998 Acquisitions."
Results of Operations
Net sales reflect the sale of the Company's products, net of allowances
for returns and other adjustments and include minimal revenues related to
services performed at the Company's premises. Sales are generated from the sale
of products in both the domestic and international markets. No individual
customer accounted for more than 5% of sales during 1996 or 1997.
Cost of goods sold consists primarily of product costs (cost of
manufacture or acquisition) and freight charges. Cost of sales also includes
direct expenses, such as labor and inventory, obtaining FCC certification of
products where required, the cost of shipping and delivery charges to bring the
product to the Company's premises, as well as overhead allocated to direct
expenses, incurred in manufacturing products sold by the Company. The direct
costs associated with providing services performed by the Company for its
customers are also included in the cost of goods sold.
Sales and gross profits depend in part on the volume and mix of
components and finished goods contained in the Company's inventory from time to
time. Manufactured product sales have a higher gross profit margin with a
relatively lower volume of sales per customer, while component sales have a
comparably low gross profit with a relatively high volume of sales per customer.
A large portion of the Company's operating expenses is relatively
fixed. Since the Company does not obtain long-term purchase orders or
commitments from its customers, it must anticipate the future volume of orders
based upon historical purchasing practices of its customers as to their future
requirements. Cancellations, reductions or delays in orders by a customer or
group of customers could have a material adverse effect on the Company's
business, financial condition and results of operations.
Selling, general and administrative ("SG&A") expenses include costs
related to the Company's sales force, which are comprised of both direct
employees of the Company and independent sales representatives. Included are
direct labor costs for in-house sales representatives as well as commissions
paid to both in-house and independent sales personnel. Costs associated with
marketing and advertising of the Company's products are also included in SG&A
expenses, along with expenses relating to corporate and administrative functions
that serve to support the existing products and service business of the Company,
as well as to provide the infrastructure for future growth. Also reflected as
SG&A expenses are certain management, supervisory and staff salaries and
employee benefits, data processing, training, rent, and office supply costs.
Interest expense includes costs and expenses associated with working
capital indebtedness, as evidenced by prior outstanding balances on the
Company's principal credit facilities, and working capital advances made by
certain current and former stockholders.
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Year Ended December 31, 1997 Compared With Year Ended December 31,
1996.
Net sales. Net sales increased $35 million, or 263%, to $48.73 million
for the year ended December 31, 1997 compared to $13.4 million for the year
ended December 31, 1996. Of the increase, $33 million was attributable to the
acquisitions that occurred on June 2, 1997. The remaining $2 million increase
was due to increased market penetration and internal growth.
Gross Profit. Gross profit increased $5.02 million, or 204%, to $7.48
million for 1997 compared to $2.46 million for 1996. Gross margin decreased to
15.35% for 1997 compared to 18.36% for 1996. The decreases were primarily
attributable to the differing product mixes.
SG&A Expenses. SG&A expenses increased $5.05 million, or 225%, to $7.29
million for 1997 compared to $2.24 million for 1996. The acquisitions accounted
for $4.3 million of the increase and the remainder was primarily attributable to
the additional infrastructure costs associated with combining the companies and
the additional costs of operating as a public company.
Operating Income. Operating income(loss) decreased $402,000 to
$(201,000) for the 1997 year compared to $201,000 for the 1996 year. The
acquisitions increased operating income by $450,000 but were offset by a small
operating loss at the technology division and the increased infrastructure costs
discussed previously.
Year Ended December 31, 1996 Compared With Year Ended December 31,
1995.
Net sales. Net sales increased $1.14 million, or 9.3%, to $13.41
million for the year ended December 31, 1996 compared to $12.28 million for the
year ended December 31, 1995 ("1995"). The increase in net sales was primarily
attributable to strong sales in the OEM sector to both established and new OEM
customers as a result of a focus on systems sales and increased market
penetration by Prisym resulting from an expanded sales force.
Gross Profit. Gross profit increased $553,000, or 29%, to $2.46 million
for 1996 compared to $1.91 million for 1995. Gross margin increased to 18.4% for
1996 compared to 15.6% for 1995, primarily as a result of the growth in system
sales to specialized OEMs.
SG&A Expenses. SG&A expenses increased $484,000, or 27.5%, to $2.25
million for 1996 compared to $1.76 million for 1995. This increase was primarily
attributable to increased infrastructure costs and higher commissions. SG&A
expenses as a percentage of net sales increased to 16.7% for 1996 compared to
14.3% for 1995.
Operating Income. Operating income increased $81,000, or 68%, to
$201,000 for 1996 compared to $120,000 for 1995.
Year Ended December 31, 1995 Compared With Year Ended December 31,
1994.
Net Sales. Net sales increased $5.94 million, or 94%, to $12.28 million
for 1995 compared to $6.34 million for the year ended December
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31, 1994 ("1994"). The increase in net sales was primarily attributable to the
acquisition of Prisym in December 1994.
Gross Profit. Gross profit increased $799,000, or 72%, to $1.91 million
for 1995 compared to $1.11 million for 1994. Gross margin decreased to 15.6% for
1995 compared to 17.5% for 1994, primarily as a result of an increase in sales
by Prisym which operates at lower margins.
SG&A Expenses. SG&A expenses increased $679,000, or 62.8%, to $1.77
million for 1995 compared to $1.08 million for 1994. This increase was primarily
attributable to the addition of the costs of Prisym. SG&A expenses as a
percentage of net sales decreased to 14.3% for 1995 compared to 17.1% for 1994.
Operating Income. Operating income increased $99,000 to $120,000 for
1995 compared to $21,000 for 1994.
PRO FORMA COMBINED FINANCIAL INFORMATION
The Company is currently in the process of consolidating certain
general and administrative functions at the Company's headquarters in Atlanta,
Georgia, including human resources, public relations, accounting and legal
functions. Economies of scale and elimination of duplicate overhead and
administrative costs are expected to reduce future operating costs. The Company
does not believe that these savings can be accurately quantified. Offsetting
these anticipated benefits are anticipated increases in personnel costs and
expenses incurred and to be incurred in developing the Company's corporate
infrastructure and the costs associated with being a public company, such as the
cost of Directors' and Officers' insurance and increased accounting and legal
fees associated with complying with ongoing reporting requirements. The Company
does not believe these costs can be accurately quantified; however, the Company
has allocated $800,000 of the proceeds of the Offering to consolidation expenses
and estimates the costs associated with being a public company to be in the
range of $300,000 to $500,000 annually, although there can be no assurance that
actual costs will not significantly exceed such range. Accordingly, neither the
anticipated savings nor the anticipated costs have been included in the pro
forma combined financial information that is provided below.
The acquisitions described previously have had a significant impact on
the comparisons of operating results for 1997 and 1996, due to the fact that the
operating results are included only for the period June 2, 1997 through December
31, 1997. Therefore, in addition to the historical comparisons of the year ended
December 31, 1997 and the year ended December 31, 1996, the Company has included
the pro forma statements of income for these two years as if the acquisitions
had occurred at the beginning of 1996, giving effect to certain adjustments,
including the elimination of revenue and expenses related to affiliated entities
of the acquisitions which were not acquired by the Company, adjustments in
compensation levels that have been contractually agreed to, elimination of
amortization of negative goodwill, elimination of the pro rata interest expense
incurred on capital to be contributed by the pre-combination stockholders of the
Company, related income tax effects, elimination of transactions between the
acquisition companies, and amortization of the intangible assets. The year ended
December 31,
22
23
1997, includes a pro forma adjustment to eliminate the effect of certain
inventory purchase accounting adjustments.
The pro forma data below also gives no effect to any efficiencies or
additional costs that might have occurred, if any, had the companies actually
been combined for the entire period presented. Additionally, the pro forma data
does not take into account the additional interest that might have been earned
or interest expense that that might have been saved from the proceeds of the
Offering. The pro forma statement of operations data is not intended to be
indicative of future operations, but rather for a better understanding of the
Company on a comparative basis. A discussion and analysis of the pro forma
results, given the above qualifications, is not considered meaningful and is
therefore not presented. All amounts are presented in thousands.
Pro Forma Combined
Years Ended
December 31,
----------------------
1996 1997
------- -------
Statement of Income Data:
Net sales $68,902 $70,603
Cost of goods sold 57,643 59,066
------- -------
Gross profit 11,259 11,537
Operating expenses:
Selling, general and
Administrative 7,500 9,557
Depreciation and amortization 616 640
------- -------
Operating income 3,143 1,339
Other income 117 115
Interest expenses 430 316
------- -------
Income before taxes 2,830 1,139
Provision for income taxes 1,314 627
------- -------
Pro Forma Net income $ 1,516 $ 512
======= =======
LIQUIDITY AND CAPITAL RESOURCES
In November 1997, the Company consummated an initial public offering of
2,100,000 units consisting of 2,100,000 shares of Class A common stock and
2,100,000 Warrants at a combined price of $6 per unit. The net proceeds of the
sale, after deducting underwriter discounts, etc., were approximately $10.4
million. Additionally, certain stockholders of the Company contributed an
aggregate of $870,000 to the capital of the Company.
Proceeds from the initial public offering were also used to repay bank
debt of $2 million, debt to a related entity of $2 million and debt to a
stockholder of $125,000. In conjunction with the repayment of the bank debt, the
Company terminated the line of credit facilities with the related banks.
23
24
The Company expects to make purchase price adjustments during the first
quarter of 1998 for either excess net asset values contributed or for net asset
values that were less than originally estimated to the stockholders of the
acquisition companies. The gross amounts to be paid and received by the Company
are estimated to be approximately $300,000 and $200,000, respectively.
Since inception, the Company has financed its operations through a
combination of cash flow from operations, bank borrowings and equity capital and
the net proceeds from the Company's initial public offering. The Company's
capital requirements have arisen primarily in connection with acquisitions and
the purchase of fixed assets.
Additionally, from time to time, Alongal, a related entity, had made
advances to the Company for working capital purposes. At December 31, 1996 and
December 31, 1997, amounts owed to Alongal were $2,109,000 and $195,000,
respectively. Such advances bore interest at the annual rate of 8% and were
payable on demand.
The Company's cash used in operations was $170,000 and $199,000 for the
years ended December 31, 1995 and 1996, respectively. However, during 1997, cash
provided by operations was $1.6 million which was due primarily to an increase
in accounts payable arising from increased purchases of inventories and, to a
lesser extent, offset by an increase in accounts receivable and inventories due
to increased sales and sales demand. The increase in accounts receivable and
inventories is primarily attributable to the purchase of computer equipment
subject to firm purchase orders and then shipped to customers. The Company's
cash flow from operations has been and continues to be affected primarily by the
timing of collection of accounts receivable, which has increased as net sales
have increased. The Company's working capital was $(104,000) and $13.1 million
at December 31, 1996 and 1997, respectively, with the significant increase in
1997 due to the offering proceeds.
The Company invested $33,000, $69,000 and $59,000 in capital equipment
and leasehold improvements in 1995, 1996 and 1997, respectively. While the
capital expenditure amounts have been very minimal for the past three years, the
Company anticipates a significant increase in 1998 due primarily to purchases
and upgrades of computer equipment and software utilized in-house, development
of the services component of the Company's business and the enhancement of its
management information systems infrastructure. The Company has projected that
the total capital outlay for this project is approximately $800,000.
A key element of the Company's strategy is to continue to expand
through acquisitions of companies engaged in the distribution and/or marketing
of computers and/or computer hardware, software and peripherals. See "Item 1.
Business Strategy." Such acquisitions are expected to involve the issuance of
restricted stock, cash and debt or a combination thereof.
The Company believes that its available funds, together with the cash
flow expected to be generated from operations and anticipated credit facilities,
will be adequate to satisfy its current and planned operations for at least the
next 12 months.
24
25
FUTURE ADOPTION OF RECENTLY ISSUED ACCOUNTING STANDARDS
The Financial Accounting Standards Board has issued Statements of
Financial Accounting Standards No. 131, Disclosures About Segments of an
Enterprise and Related Information ("SFAS 131"), and No. 130, Reporting
Comprehensive Income ("SFAS 130"). SFAS 131 specifies revised guidelines for
determining an entity's operating segments and the type and level of financial
information to be disclosed. SFAS 130 establishes standards for reporting and
display of comprehensive income and its components revenues, expenses, gains,
and losses) in a full set of general-purpose financial statements. SFAS 129
consolidates the existing requirements to disclose certain information about an
entity's capital structure. These Standards are effective for periods ending
after December 31, 1997.
The Company believes that the impact of these Standards, when adopted,
will not have a material impact on the Company's financial statements and
financial statement presentation when presented on a comparable basis.
IMPACT OF INFLATION
Management believes that inflation has not had a material impact on the
Company's business, its net sales and revenues or its income from continuing
operations.
YEAR 2000
The Company has adopted a plan to facilitate a smooth transition of the
systems, products and vendors which Tekgraf relies on into the twentieth
century. Additionally, for the software products sold to customers, all products
are licensed from the suppliers, and while there is no guarantee, the suppliers
claim that where applicable, the software is Year 2000 compliant.
Substantially all of Tekgraf's software systems are licenses from
outside vendors or will be once the management information project is
completed(anticipated to be fourth quarter 1998). Tekgraf's primary exposure
emanates from the ability of its technology vendors to implement the necessary
changes for Year 2000 compliance. Management believes it will be successful in
the achievement of its plans and does not believe that the execution of the plan
will have a material adverse effect on future operating results.
PRIVATE SECURITIES LITIGATION REFORM ACT
Except for the historical information contained herein, the matters
discussed in this Annual Report on Form 10-K contain forward-looking statements
that involve a number of risks and uncertainties which could cause the Company's
future results of operations to differ materially, including the impact of
competitive products and pricing, business conditions and growth in the
industry, general economic and stock market conditions and other risks detailed
from time to time in this Annual Report on Form 10-K and in the Company's SEC
Reports, including the Prospectus included as part of the S-1 Registration
Statement (Sec File No. 333-33449) declared effective under the Securities Act
of 1933 on November 10, 1997. The words "may," "would," "could," "will,"
"increase," "expect," "estimate," "anticipate," "believes," "intends," "plans,"
and similar expressions and variations thereof are intended to identify
forward-looking statements. Investors are cautioned that such statements are
not guarantees of future performance and involve various risks and
uncertainties, many of which are beyond the Company's control.
25
26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See the Consolidated Financial Statements beginning on page F-1.
Consolidated condensed quarterly financial information on the Company is
included in Note 16 of Notes to the Consolidated Financial Statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
For the three year period ended December 31, 1997, there has been no
disagreement between Tekgraf, Inc. and any accountants on any matter of
accounting principles or practices or financial statement disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
The information relating to the Company's directors, nominees for
election as directors and executive officers under the headings "Election of
Directors" and "Executive Officers" in the Company's definitive proxy statement
for the 1998 Annual Meeting of Shareholders is incorporated herein by reference
to such proxy statement.
ITEM 11. EXECUTIVE COMPENSATION.
The information under the heading "Executive Compensation" in the
Company's definitive proxy statement for the 1998 Annual Meeting of Shareholders
is incorporated herein by reference to such proxy statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information under the heading "Security Ownership of Certain
Beneficial Owners and Management" in the Company's definitive proxy statement
for the 1998 Annual Meeting of Shareholders is incorporated herein by reference
to such proxy statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information under the heading "Certain Relationships and Related
Transactions" in the Company's definitive proxy statement for the 1998 Annual
Meeting of Shareholders is incorporated herein by reference to such proxy
statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) (1) Consolidated Financial Statements.
Report of Independent Accountants
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Changes in Stockholder's Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
26
27
(a) (2) Consolidated Financial Statement Schedule for the Period Ended
December 31, 1997.
Report of Independent Accountants on Schedule VIII Valuation and
Qualifying Accounts on page F-22.
Schedule VIII Valuation and Qualifying Accounts on page F-23.
All other financial statement schedules are omitted because the
information is not required, or is otherwise included in the Consolidated
Financial Statements or the notes thereto included in this Annual Report on Form
10-K.
Condensed quarterly financial information on the Company is included in
Note 16 of Notes to the Consolidated Financial Statements.
(a) (3) Exhibits.
The following exhibits are filed with or incorporated by reference into
this Annual Report on Form 10-K. Unless indicated otherwise, the exhibit number
corresponds to the exhibit number incorporated by reference.
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
------- ----------------------
2.1 Plan of Merger between Crescent Computers, Inc. and Tekgraf,
Inc., dated June 20, 1997 (Filed as Exhibit 2.1 to the Company's
Registration Statement on Form S-1, No. 333-33449, and
incorporated herein by reference(the "Registration Statement")) .
3.1 Certificate of Incorporation dated June 17, 1997 (Filed as
Exhibit 3.1 to the Registration Statement and incorporated herein
by reference).
3.2 Bylaws. (Filed as Exhibit 3.2 to the Registration Statement and
incorporated herein by reference).
4.1 Form of Warrant Agreement (Filed as Exhibit 4.1 to the Registration
Statement and incorporated herein by reference)
4.2 Form of Unit Purchase Option (Filed as Exhibit 4.2 to the Registration
Statement and incorporated herein by reference).
10.1 1997 Stock Option Plan of the Company (Filed as Exhibit 10.1 to the
Registration Statement and incorporated herein by reference).
27
28
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
------- ----------------------
10.2 Employment Agreement dated June 2, 1997 between Crescent
Computers, Inc. and Phillip C. Aginsky (Filed as Exhibit 10.2 to
the Registration Statement and incorporated herein by reference).
10.3 Employment Agreement dated June 2, 1997 between Crescent
Computers, Inc. and Dan I. Bailey (Filed as Exhibit 10.3 to the
Registration Statement and incorporated herein by reference).
10.4 Employment Agreement dated June 2, 1997 between Crescent
Computers, Inc. and William M. Rychel (Filed as Exhibit 10.4 to
the Registration Statement and incorporated herein by reference).
10.5 Form of Employment Agreement between Crescent Computers, Inc. and
Regional Sales Directors (Filed as Exhibit 10.5 to the
Registration Statement and incorporated herein by reference).
10.6 Employment Agreement dated February 26, 1998, between Tekgraf,
Inc. and W. Jeffrey Camp.
10.7 Stock Purchase Agreement dated May 1, 1997, by and among
Crescent Computers, Inc. and its shareholders and Microsouth, Inc.
and its shareholders, as amended (Filed as Exhibit 10.6 to the
Registration Statement and incorporated herein by reference).
10.8 Stock Purchase Agreement dated May 1, 1997 by and among Crescent
Computers, Inc. and its shareholders and tekgraf, inc. and its
shareholders, as amended (Filed as Exhibit 10.7 to the Registration
Statement and incorporated herein by reference).
10.9 Stock Purchase Agreement dated May 1, 1997 by and among Crescent
Computers, Inc. and its shareholders and G&R Marketing, Inc. and
its shareholders, as amended (Filed as Exhibit 10.8 to the
Registration Statement and incorporated herein by reference).
10.10 Stock Purchase Agreement dated May 1, 1997 by and among Crescent
Computers, Inc. and its shareholders and Computer Graphics
Distributing Company and its shareholders, as amended (Filed as
Exhibit 10.9 to the Registration Statement and incorporated
herein by reference).
10.11 Stock Purchase Agreement dated May 1, 1997 by and among Crescent
Computers, Inc. and its shareholders and Intelligent Products
Marketing, Inc. and its shareholders and IG Distributing, Inc.
and its shareholders, as amended (Filed as Exhibit 10.10 to the
Registration Statement and incorporated herein by reference).
10.12 Escrow Agreement dated August 1997 (Filed as Exhibit 10.11 to the
Registration Statement and incorporated herein by reference).
10.13 Indemnification Agreement dated 1997 (Filed as Exhibit 10.12 to
the Registration Statement and incorporated herein by reference).
10.14 [Intentionally omitted]
10.15 Lease Agreement dated September 4, 1993 between Crescent
Computers, Inc. and TCW Realty Fund II (Filed as Exhibit 10.14 to
the Registration Statement and incorporated herein by reference).
10.16 Leases for property located at 7020 Koll Center Parkway by and
between Patrician Associates, Inc. Koll Bernal Avenue Associates
and Intelligent Products Marketing, Inc., as amended (Filed as
Exhibit 10.15 to the Registration Statement and incorporated
herein by reference)
10.17 Industrial Space Lease dated November 13, 1991 between G&R
Technologies and American National Bank and Trust Company of
Chicago (Filed as Exhibit 10.16 to the Registration Statement and
incorporated herein by reference).
28
29
10.18 Commercial Lease Agreement dated March 29 , 1991 between Computer
Graphics Distributing Company and Girard Associates II Limited
Partnership (Filed as Exhibit 10.17 to the Registration Statement
and incorporated herein by reference).
10.19 Lease Agreement dated May 1, 1992 between Microsouth, Inc. and
ASC North Fulton Associates Joint Venture (Filed as Exhibit 10.18
to the Registration Statement and incorporated herein by
reference).
10.20 Lease Agreement dated March 1998 between Tekgraf, Inc. a Texas
corporation and Connecticut General Life Insurance Company,
(Filed as Exhibit 10.19 to the Registration Statement and
incorporated herein by reference), as amended (amendment
attached as Exhibit 10.20a).
10.21 Voting Agreement dated as of August 7, 1997 between Tekgraf, Inc.
and A. Lowell Nerenberg and Edward H. L. Mason (Filed as Exhibit
10.20 to the Registration Statement and incorporated herein by
reference).
10.22 Agreement and Plan of Merger by and among Tekgraf,
Inc., a Delaware corporation, Tekgraf Sub I, Inc., a Georgia
corporation, and Computer Graphics Technology, Inc., a South
Carolina corporation, and its Shareholders, dated March 23, 1998.
10.23 Agreement and Plan of Merger by and among Tekgraf, Inc., a
Delaware corporation, Tekgraf Sub II, Inc., a Georgia
corporation, and Martec, Inc., a California corporation, and its
Shareholders, dated March 23, 1998.
10.24 Agreement and Plan of Merger by and among Tekgraf, Inc., a
Delaware corporation, Tekgraf Sub III, Inc., a Georgia
corporation, and New England Computer Graphics, Inc., a
Massachusetts corporation, and its Shareholders, dated
March 25, 1998.
10.25 First Amendment to Agreement and Plan of Merger, dated March 30,
1998, by and among Tekgraf, Inc., Tekgraf Sub III, Inc., New
England Computer Graphics, Inc. and its Shareholders.
11.1 Computation of Earnings Per Share.
21.1 Subsidiaries of the Registrant.
27.1 Financial Data Schedule (for SEC use only).
The Registrant agrees to furnish supplementally a copy of any omitted
schedule or exhibit to Exhibit 10.22, 10.23 or 10.24 to the Securities and
Exchange Commission upon request, as provided in Item 601(b)(2) of Regulation
S-K.
(b) Reports on Form 8-K.
None.
29
30
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 THIS 31st DAY OF MARCH,
1998.
Tekgraf, Inc.
(Registrant) By: /s/ Phillip C. Aginsky
-------------------------------------
Phillip C. Aginsky
Principal Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT
HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND
IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE Title Date
--------- ----- ----
/s/ Phillip C. Aginsky Chairman of the Board, President March 31, 1998
- ------------------------- and Chief Executive Officer
Phillip C. Aginsky (Principal Executive Officer)
/s/ Dan I. Bailey Co-President-Technology Division March 31, 1998
- ------------------------- and Director
Dan I. Bailey
/s/ William M. Rychel Co-President-Graphics Division March 31, 1998
- ------------------------ and Director
William M. Rychel
/s/ Martyn L. Cooper Chief Operating Officer and March 31, 1998
- ------------------------- Director
Martyn L. Cooper
/s/ J. Thomas Woolsey Director March 31, 1998
- -------------------------
J. Thomas Woolsey
/s/ Albert E. Sisto Director March 31, 1998
- -------------------------
Albert E. Sisto
/s/ Frank X. Dalton, Jr. Director March 31, 1998
- -------------------------
Frank X. Dalton, Jr.
/s/ W. Jeffrey Camp Chief Financial Officer March 31, 1998
- ------------------------- (duly authorized principal
W. Jeffrey Camp financial and accounting
officer)
30
31
Tekgraf, Inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements of Tekgraf, Inc.
Report of Independent Accountants.................................. F-2
Consolidated Balance Sheets........................................ F-3
Consolidated Statements of Operations.............................. F-4
Consolidated Statements of Changes in Stockholder's Equity......... F-5
Consolidated Statements of Cash Flows.............................. F-6
Notes to Consolidated Financial Statements......................... F-8
F-1
32
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders
Tekgraf, Inc.
We have audited the accompanying consolidated balance sheets of Tekgraf, Inc. as
of December 31, 1996 and 1997, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1997. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the 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
consolidated 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
Tekgraf, Inc. as of December 31, 1996 and 1997, and the results of their
consolidated operations and their cash flows for each of the three years in the
period ended December 31, 1997 in conformity with generally accepted accounting
principles.
Atlanta, Georgia
March 20, 1998 Coopers & Lybrand, L.L.P.
F-2
33
TEKGRAF, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------------------
1996 1997
ASSETS
Current assets:
Cash and cash equivalents $ 633,027 $ 8,600,339
Accounts receivable, less allowance for doubtful accounts of $35,000
and $100,000 at December 31, 1996 and 1997, respectively 1,621,180 9,217,843
Inventories, net 636,019 4,700,615
Prepaid expenses and other assets 368,770
Deferred income taxes 1,500 62,832
---------------- ---------------
Total current assets 2,891,726 22,950,399
---------------- ---------------
Property and equipment:
Furniture and fixtures 83,294 188,132
Computer equipment 36,225 343,790
---------------- ---------------
119,519 531,922
Less accumulated depreciation (62,765) (187,219)
---------------- ---------------
56,754 344,703
Goodwill, net 6,555,773
Other assets 58,629 52,633
Deferred income taxes 48,840
---------------- ---------------
Total assets $ 3,007,109 $ 29,952,348
================ ===============
LIABILITIES
Current liabilities:
Current debt $ 23,474
Due to acquisition stockholders 180,289
Notes payable, stockholders 90,000
Due to stockholders and related entities $ 2,211,164 246,956
Accounts payable 711,125 8,345,388
Accrued expenses 69,408 928,121
Income taxes payable 4,100 70,100
---------------- ---------------
Total current liabilities 2,995,797 9,884,328
---------------- ---------------
Debt, less current maturities 12,788
Deferred income taxes 1,200
Commitments and contingencies
STOCKHOLDERS' EQUITY
Class A Common Stock $.001 par value, 31,666,667 shares authorized; no shares
issued and outstanding at December 31, 1996;
2,100,000 shares issued and outstanding at December 31, 1997 2,100
Class B Common Stock, $.001 par value, 3,333,333 shares authorized;
1,141,333 shares issued and outstanding at December 31, 1996 and
3,333,333 issued and outstanding at December 31, 1997 1,141 3,333
Preferred Stock, $.001 par value, 5,000,000 shares authorized; no shares
issued and outstanding at December 31, 1996 and 1997
Due from acquisition stockholders (149,863)
Additional paid-in capital 20,584,028
Retained earnings (deficit) 8,971 (384,366)
---------------- ---------------
Total stockholders' equity 10,112 20,055,232
---------------- ---------------
Total liabilities and stockholders' equity $ 3,007,109 $ 29,952,348
================ ===============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
34
TEKGRAF, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1995 1996 1997
Net sales $ 12,277,340 $ 13,414,131 $ 48,732,391
Cost of goods sold 10,367,789 10,951,551 41,249,611
---------------- ----------------- ----------------
Gross profit 1,909,551 2,462,580 7,482,780
Operating expenses:
Selling, general and administrative 1,760,957 2,244,924 7,294,267
Depreciation 28,349 16,999 124,453
Amortization 265,263
---------------- ----------------- ----------------
Income (loss) from operations 120,245 200,657 (201,203)
Other income 14,916 68,333
Interest expense 125,566 159,500 301,453
---------------- ----------------- ----------------
Income (loss) before provision (benefit) for
income taxes (5,321) 56,073 (434,323)
Provision (benefit) for income taxes (1,600) 13,000 (40,986)
---------------- ----------------- ----------------
Net income (loss) $ (3,721) $ 43,073 $ (393,337)
================ ================= ================
Basic and diluted weighted average shares outstanding 1,084,266 1,084,266 2,581,441
================ ================= ================
Basic and diluted net income (loss) per share $ - $ .04 $ (.15)
================ ================= ================
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
35
TEKGRAF, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY
NUMBER CLASS A NUMBER CLASS B
OF SHARES COMMON OF SHARES COMMON DUE FROM
CLASS A STOCK CLASS B STOCK STOCKHOLDERS
Balances, January 1,1995 1,141,333 $ 1,141
Net loss
----------- ------------- ---------- ------------ -------------
Balances, December 31, 1995 1,141,333 1,141
Net income
----------- ------------- ---------- ------------ -------------
Balances, December 31, 1996 1,141,333 1,141
Issuance of stock for acquisitions 2,192,000 2,192
Due from acquisition stockholders $ (149,863)
Contribution from pre-acquisition
stockholders
Common stock issued 2,100,000 $ 2,100
Net loss
----------- ------------- ---------- ------------ -------------
Balances, December 31, 1997 2,100,000 $ 2,100 3,333,333 $ 3,333 $ (149,863)
=========== ============= ========== ============ =============
ADDITIONAL RETAINED
PAID-IN EARNINGS
CAPITAL (DEFICIT) TOTAL
Balances, January 1,1995 $ (30,381) $ (29,240)
Net loss (3,721) (3,721)
--------------- ------------ ---------------
Balances, December 31, 1995 (34,102) (32,961)
Net income 43,073 43,073
--------------- ------------ ---------------
Balances, December 31, 1996 8,971 10,112
Issuance of stock for acquisitions $ 9,170,866 9,173,058
Due from acquisition stockholders 149,863 -
Contribution from pre-acquisition
stockholders 870,000 870,000
Common stock issued 10,393,299 10,395,399
Net loss (393,337) (393,337)
--------------- ------------ ---------------
Balances, December 31, 1997 $ 20,584,028 $ (384,366) $ 20,055,232
=============== ============ ===============
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
36
TEKGRAF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------------------------
1995 1996 1997
Cash flows from operating activities:
Net income (loss) $ (3,721) $ 43,073 $ (393,337)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation 28,349 16,999 124,454
Provision/writedown of inventory 237,275
Amortization 265,263
Provision for doubtful accounts receivable 2,800 18,000 149,170
Deferred income taxes (1,600) 8,900 (111,372)
Changes in net assets and liabilities, net of
the effects of the acquisitions:
Receivables (417,787) (256,507) (956,268)
Inventories (137,289) (86,745) (501,897)
Other assets 1,456 (45,897) 114,455
Accounts payable and accrued expenses 357,377 99,025 2,591,941
Income taxes payable 4,100 66,000
--------- ----------- ------------
Net cash provided (used) by operating
activities (170,415) (199,052) 1,585,684
--------- ----------- ------------
Cash flows from investing activities:
Cash acquired from acquisitions, net of acquisition
costs of $88,677 371,585
Payments for purchase of property and equipment (33,060) (69,042) (59,082)
--------- ----------- ------------
Net cash provided (used) by investing
activities (33,060) (69,042) 312,503
--------- ----------- ------------
Cash flows from financing activities:
Advance from stockholders and related entities 472,272 1,115,957 37,862
Repayment of advance from stockholders and
related entities (520,657) (2,039,000)
Repayment of stockholder notes payable (125,000)
Repayments on lines of credit, net (280,130) (2,018,036)
Payment to stockholders for excess net asset values (1,050,000)
Capital contribution from stockholders 870,000
Payment of stock issuance costs (923,701)
Proceeds from issuance of common stock, net of
underwriting discounts 11,317,000
--------- ----------- ------------
Net cash provided by financing activities 192,142 595,300 6,069,125
--------- ----------- ------------
Increase (decrease) in cash and cash equivalents (11,333) 327,206 7,967,312
Cash and cash equivalents, beginning of year 317,154 305,821 633,027
--------- ----------- ------------
Cash and cash equivalents, end of year $ 305,821 $ 633,027 $ 8,600,339
========= =========== ============
F-6
37
TEKGRAF, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1995 1996 1997
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 120,109 $ 159,500 $ 301,453
================ =============== ===============
Cash paid during the year for income taxes $ - $ - $ 4,386
================ =============== ===============
Supplemental noncash investing and financing activities:
During June 1997, the Company issued 2,192,000 shares of Class B Common Stock
for the outstanding common stock of six companies
Fair value of stock issued $ 9,485,537
Other acquisition costs 88,677
Fair value of liabilities assumed 9,240,106
Fair value of assets acquired (11,993,284)
----------------
Goodwill $ 6,821,036
================
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
38
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION, BASIS OF PRESENTATION, AND NATURE OF OPERATIONS:
ORGANIZATION
The consolidated financial statements of Tekgraf, Inc. (the "Company") as
of December 31, 1996 include the accounts of Prisym Technologies, Inc. of
Georgia ("Prisym"), a 60% owned subsidiary. The consolidated financial
statements of the Company as of December 31, 1997 and for the year then
ended include the accounts of Prisym and six computer graphics distributing
companies which were acquired on June 2, 1997. These acquisitions were
recorded under the purchase method of accounting, and accordingly their
results of operations are included in the consolidated statements of
operations since their date of acquisition. Minority interest, if any,
represents the minority stockholder's proportionate share of the equity in
Prisym. All significant intercompany balances, transactions, and profits
have been eliminated in consolidation.
BASIS OF PRESENTATION
The consolidated financial statements are prepared on the basis of
generally accepted accounting principles. The preparation of financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at December 31, 1996 and 1997
and reported amounts of revenues and expenses for each of the three years
in the period ended December 31, 1997. Significant estimates include
primarily those made for the allowance for doubtful accounts, reserves for
obsolete and slow-moving inventory and the useful life of goodwill. Actual
results could differ from those estimates made by management.
NATURE OF OPERATIONS
The Company is a manufacturer, integrator and distributor of premium
personal computers, workstations, and internet/intranet servers. Products
are sold either directly or through distributors. Prisym markets
workstations, printers, mass storage, components and peripherals of a major
U.S. manufacturer.
The computer graphic distributing companies acquired during 1997 are
located in five separate regions of the U.S. and distribute and market a
broad array of complex computer graphics hardware and software. Products
are sole primarily to value added resellers and vertical solutions
providers.
F-8
39
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
NATURE OF OPERATIONS, CONTINUED:
Inherent in the accompanying consolidated financial statements are certain
risks and uncertainties. These risks and uncertainties include, but are not
limited to: the impact of competitive products, competition, available
sources of supply and various technology related risks.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a remaining
maturity of three months or less when purchased to be cash equivalents.
INVENTORIES
Inventories are stated at the lower of cost (determined principally by the
first-in, first-out, and average costs methods) or market. The Company
maintains a reserve for its estimate of excess, obsolete and damaged goods.
In most instances, the Company receives warranties on its products from its
vendors which are at least equivalent to those it provides to its
customers.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Property and equipment are
depreciated on a straight-line basis over their estimated useful lives
which generally range from 3 to 7 years. Amounts expended for maintenance
and repairs are charged to expense as incurred. Upon disposition, both the
related cost and accumulated depreciation accounts are relieved and the
related gain or loss is credited or charged to operations.
GOODWILL
Goodwill is amortized over its estimated economic life or period of future
benefit. The Company is currently amortizing goodwill, on a straight-line
basis of 15 years. This estimated life is a composite of many factors which
are subject to change because of the nature of the Company's operations.
This is particularly true because goodwill reflects value attributable to
the going concern nature of acquired businesses, the stability of their
operations, market presence and reputation. Accordingly, at each reporting
period, the Company evaluates the continued appropriateness of this life
and recoverability of the carrying value of the goodwill based upon current
and future levels of income and undiscounted cash flows as well as the
latest available economic factors and circumstances. Impairment of value,
if any, is recognized in the period in which it is determined. The Company
does not believe that there are facts or circumstances to indicate
impairment of goodwill at December 31, 1997.
F-9
40
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
REVENUE
Sales are recognized upon the shipment of products to the customer or
distributor.
Concentration of credit risk with respect to trade accounts receivable is
generally diversified due to the number of entities comprising the
Company's customer base. The Company performs ongoing credit evaluations
and provides an allowance for potential credit losses against the portion
of accounts receivable which is estimated to be uncollectible. Such losses
have historically been within management's expectations.
INCOME TAXES
The provision for income taxes and corresponding balance sheet accounts are
determined in accordance with SFAS No. 109, "Accounting for Income Taxes"
("SFAS 109"). Under SFAS 109, deferred tax liabilities and assets are
determined based on temporary differences between the bases of certain
assets and liabilities for income tax and financial reporting purposes. The
deferred tax assets and liabilities are classified according to the
financial statement classification of the assets and liabilities generating
the differences. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments include its debt obligations.
Management believes that these instruments bear interest at rates which
approximate prevailing market rates for instruments with similar
characteristics and, accordingly, that the carrying values for these
instruments are reasonable estimates of fair value.
3. ACQUISITIONS:
Effective June 2, 1997, the Company completed the acquisition of 100% of
the outstanding common stock of six regional computer graphics distributors
(collectively the "Subsidiaries") in exchange for the issuance of 2,192,000
shares of Class B Common Stock. Each stockholder deposited 40% of his
shares in escrow to cover potential claims for indemnification under the
stock purchase agreements (the "Agreement") for liabilities resulting from
the breach of any representation, warranty, covenant or agreement contained
in the Agreements.
F-10
41
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
3. ACQUISITIONS, CONTINUED:
Pursuant to the terms of the Agreements, the Subsidiaries were required to
deliver a defined guaranteed net asset value ("NAV"). For certain of the
Subsidiaries the estimated excess net book value over the NAV was
approximately $1,230,000. During December 1997, $1,050,000 of this estimate
was distributed to certain stockholders of subsidiaries. It is anticipated
that the remaining excess NAV will be distributed during 1998. For certain
of the Subsidiaries the preliminary deficit NAV over the net book value of
approximately $150,000 will be collected from the former stockholders of
the Subsidiaries. It is anticipated that these amounts will be collected
after the final calculation is completed during 1998.
Pursuant to the terms of the Agreements, pre-acquisition Tekgraf
stockholders were required to contribute approximately $870,000 to capital.
This contribution was made during November 1997.
The acquisitions were recorded under the purchase method of accounting. The
purchase prices have been allocated to assets acquired and liabilities
assumed based on the fair market value of the Company's common stock at the
date of acquisition. The fair market value of the Company's stock was
estimated based on the initial public offering price of the Company's
Units, a discount for lack of marketability, a premium for the voting
rights of the Class B Common Stock issued in connection with the
acquisitions, and the value of the warrants contained in the Units using
the Black Scholes model. The fair value of assets acquired and liabilities
assumed, after giving effect to the excess and deficit NAV, is as follows:
Fair value of stock issued and other acquisition cost $ 9,574,214
Fair value of liabilities assumed 9,240,106
Fair value of tangible and identifiable assets acquired (11,993,284)
----------------
Goodwill $ 6,821,036
================
F-11
42
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
3. ACQUISITIONS, CONTINUED:
The following unaudited pro forma summary combines the consolidated results
of the Company and the Subsidiaries as if the acquisitions had occurred at
the beginning of the earliest period presented, after giving effect to
certain adjustments, including the elimination of expenses related to
affiliated entities of the Subsidiaries which were not acquired by the
Company, adjustments in compensation levels that have been contractually
agreed to, elimination of amortization related to negative goodwill,
elimination of the pro rata interest expense incurred on capital to be
contributed by the pre-acquisition stockholders of the Company, related
income tax effects, elimination of transactions between the Subsidiaries,
and amortization of intangible assets. The year ended December 31, 1997
amounts include a pro forma adjustment to eliminate the effect of certain
inventory purchase accounting adjustments. In addition, the earnings per
share amounts give effect to the acquisitions, subsequent recapitalization
and the weighted average shares outstanding exclude 166,667 of escrow
shares. The pro forma summary does not purport to represent what the
Company's results of operations would actually have been if such
transaction in fact had occurred at the beginning of the earliest period
presented or to project the Company's results of operations for any future
period.
FOR THE YEAR ENDED
DECEMBER 31,
--------------------------------
1996 1997
Net sales $ 68,902,291 $ 70,603,136
Gross profit 11,259,485 11,536,984
Income from operations 3,143,383 1,339,482
Income before taxes 2,829,594 1,138,943
Net income 1,515,862 512,304
Basic and diluted income per share .48 .15
Weighted average shares outstanding 3,166,666 3,454,337
4. INVENTORIES:
Inventories, net of reserves, at December 31, 1996 and 1997 consist of the
following:
1996 1997
Component materials $ 562,526 $ 661,770
Finished goods 73,493 4,038,845
--------------- ---------------
$ 636,019 $ 4,700,615
=============== ===============
F-12
43
5. GOODWILL:
Goodwill at December 31, 1997 consists of the following:
Goodwill associated with the 1997 acquisition $ 6,821,036
Accumulated amortization (265,263)
---------------
$ 6,555,773
===============
6. DEBT:
Long-term debt at December 31, 1997 consists of various installment notes
payable with banks bearing interest at rates ranging from 7.5% to 8.5%.
These notes are payable in monthly principal and interest installments
through 1999 and are collateralized by certain equipment with an
approximate net book value of $50,000.
7. INCOME TAXES:
The provision (benefit) for income taxes for the years ended 1995, 1996 and
1997 is as follows:
1995 FEDERAL STATE TOTAL
Current $ - $ - $ -
Deferred (1,200) 400 (1,600)
--------------- --------------- ---------------
$ (1,200) $ 400 $ (1,600)
=============== =============== ===============
1996 FEDERAL STATE TOTAL
Current $ 3,567 $ 533 $ 4,100
Deferred 7,654 1,246 8,900
--------------- --------------- ---------------
$ 11,221 $ 1,779 $ 13,000
=============== =============== ===============
1997 FEDERAL STATE TOTAL
Current $ 59,261 $ 11,125 $ 70,386
Deferred (108,030) (3,341) (111,372)
--------------- --------------- ---------------
$ (48,770) $ 7,784 $ (40,985)
=============== =============== ===============
F-13
44
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
7. INCOME TAXES, CONTINUED:
A reconciliation of federal statutory and effective income tax rates is as
follows:
1995 1996 1997
Statutory U.S. federal income tax rate 15.0% 15.0% (34.0)%
Effect of:
State income taxes, net of federal benefit 5.0 5.0 2.4
Nondeductible meals and entertainment 8.0 1.5 3.9
Nondeductible goodwill amortization 20.8
Other, net 2.0 1.5 (2.5)
---------- ---------- ----------
Effective rate 30.0% 23.0% (9.4)%
========== ========== ==========
Benefits of approximately $8,400 and $15,000 were recognized due to
operating loss carryforwards during 1996 and 1997, respectively.
An analysis of the deferred income tax assets and liabilities is as
follows:
1996 1997
Current deferred income tax assets:
Net operating loss carryforward $ 1,500
Accounts receivable $ 36,885
Inventory 25,947
---------- ---------
Total current deferred income tax assets $ 1,500 $ 62,832
========== =========
Noncurrent deferred income tax assets:
Other $ 48,840
Net operating loss carryforwards $ 800 -
---------- ---------
Total noncurrent deferred income tax assets $ 800 $ 48,840
========== =========
Noncurrent deferred income tax liabilities:
Property and equipment $ (1,200) $ -
---------- ---------
Total noncurrent deferred income tax liabilities $ (1,200) $ -
========== =========
F-14
45
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
7. INCOME TAXES, CONTINUED:
Management believes that realization of the deferred tax assets are more
likely than not due primarily to anticipated future taxable income and
taxable income available in carryback periods.
8. COMMITMENTS AND CONTINGENCIES:
OPERATING LEASE
The Company leases office space under various operating leases expiring
through 2001. At December 31, 1997 minimum rentals due under these leases
were as follows:
1998 $ 464,655
1999 309,265
2000 163,162
2001 96,888
----------
$1,033,970
==========
Rent expense for the years ended December 31, 1995, 1996 and 1997 was
approximately $60,000, $60,000 and $323,000, respectively.
LITIGATION
The Company is involved from time to time in litigation on matters which
are routine to the conduct of its business. Although the outcome of any
litigation cannot be predicted with certainty, the Company does not believe
that any outstanding litigation will have a material adverse effect on the
Company's consolidated financial position, results of operations, or cash
flows.
EMPLOYMENT AGREEMENTS
Certain stockholders of the Company have entered into employment agreements
which provide for a set base salary, participation in future incentive
bonus plans, stock option plans, certain other benefits, and a covenant not
to compete following termination of such person's employment.
F-15
46
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
9. CAPITAL STRUCTURE:
On November 11, 1997, in connection with the initial public offering of the
Company's securities, 2,100,000 units were issued. Each unit consisted of
one share of Class A Common Stock and one Redeemable Warrant. The Class A
Common Stock and Redeemable Warrant were transferable separately
immediately upon issuance.
CLASS A COMMON STOCK
On June 2, 1997, the Company authorized 31,666,667 shares of Class A Common
Stock, $.001 par value. Holders of Class A Common Stock have the right to
cast one vote for each share held of record on all matters submitted to a
vote of holders of Class A Common Stock.
REDEEMABLE WARRANTS
Each Redeemable Warrant entitles the registered holder to purchase one
share of Class A Common Stock at an exercise price of $8.40 at any time
until the fifth anniversary of the date of issue. Beginning on the first
anniversary of the date of issue, the Redeemable Warrants are redeemable by
the Company on 30 days written notice and at a redemption price of $.05 per
Redeemable Warrant if the closing price of the Class A Common Stock for any
30 consecutive trading days ending within 15 days of the notice of
redemption averages in excess of $11.75 per share. All Redeemable Warrants
must be redeemable if any are redeemed. The Company has reserved from its
authorized but unissued shares a sufficient number of shares of Class A
Common Stock for issuance upon the exercise of the Redeemable Warrants. The
Redeemable Warrants do not contain any voting or other rights of a
stockholder of the Company.
CLASS B COMMON STOCK
On May 1, 1997 the Company increased the outstanding shares from 100 to
3,424 by declaring a 34.24-for-1 stock split of the Company's common stock
(par value of $1.00). On June 2, 1997, the Company declared a 400-for-1
stock split of the Company's common stock pursuant to which all of the
Company's outstanding common stock were exchanged for 4,000,000 shares of
Class B Common Stock with a par value of $.001. During October 1997, the
Company effected a .83333325-for-1 reverse stock split pursuant to which
the outstanding shares of Class B Common Stock were exchanged for 3,333,333
shares of Class B Common Stock. Each share of Class B Common Stock is
entitled to five votes on all matters on which stockholders may vote,
including the election of directors. Each share of Class B Common Stock is
automatically converted into one share of Class A Common Stock upon (i) its
sale, gift of transfer, except in the case of a transfer to a trust for
which the original holder acts as sole trustee or to any other holder of
Class B Common Stock, (ii) the death of the original holder thereof,
including in the case of the original holder having transferred the Class B
common Stock to a trust for which the original holder served as trustee
during his or her lifetime, or (iii) the conversion of an aggregate of 75%
of the authorized shares of Class B Common Stock.
F-16
47
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
9. CAPITAL STRUCTURE, CONTINUED:
ESCROW SHARES
In connection with the Company's initial public offering of its securities,
the holders of the Company's Class B Common Stock agreed to place an
aggregate of 166,667 shares into escrow. These shares may be voted, but are
not transferable or assignable. These shares will be released if, and only
if, certain predetermined thresholds of pre-tax income or market value of
the Company's Class A Common stock are exceeded. In the event any shares
are released from escrow to the holders who are employees or directors of
the Company, compensation expense equal to the fair value of the escrow
shares will be recognized in the consolidated statement of operations.
PREFERRED STOCK
On June 2, 1997, the Company authorized 5,000,000 shares of preferred
stock. The Board of Directors will have the authority to issue the
preferred stock in one or more series and to fix the number of shares and
the relative rights, conversion rights, voting rights and terms of
redemption and liquidation preferences, without further vote or action by
the stockholders.
The consolidated balance sheets as of December 31, 1996 and 1997 have been
retroactively adjusted for these events. As part of the recapitalization,
the Company changed its name from Crescent Computers, Inc. to Tekgraf, Inc.
10. STOCK OPTION PLAN:
During August 1997, the Company's Board of Directors and stockholders
approved the 1997 Stock Option Plan (the "Plan") covering 300,000 shares of
the Company's Class A Common Stock which may be granted to employees,
officers, directors, and consultants or advisers to the Company. Options
granted under the Plan may be either (i) options intended to qualify as
incentive stock options under Section 422 of the Internal Revenue Code or
(ii) non-qualified stock options. Incentive options granted under the Plan
are exercisable for a period of up to ten years from the date of grant at
an exercise price which is not less than the fair market value of the stock
on the date of grant, except that the term of an incentive option granted
under the Plan to a stockholder owning more than 10% of the outstanding
voting power may not exceed five years and its exercise price may not be
less than 110% of the fair market value of the stock on the date of grant.
In addition, to the extent that the aggregate fair market value, as of the
date of grant, of the stock for which incentive options become exercisable
for the first time by an optionee during the calendar year exceeds $100,000
the portion of such option which is in excess of $100,000 limitation will
be treated as a non-qualified option. The Plan, which expires in August
2007, is administered by the Company's Board of Directors.
F-17
48
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
10. STOCK OPTION PLAN, CONTINUED:
The Company granted 15,000 options during November 1997, at an exercise
price of $6.00 per share. The Company did not grant any options prior to
November 1997 and at December 31, 1997 no options were exercisable.
The Company has 285,000 shares available for future grant at December 31,
1997.
The Company applies APB Opinion No. 25 ("APB 25") and related
Interpretations in accounting for the Plan. During 1995, the Financial
Accounting Standards Board issued Statement No. 123, "Accounting for
Stock-Based Compensation" ("FAS 123") changing the methods for recognition
of cost on plans similar to those of the Company. Adoption of the
accounting provisions of FAS 123 is optional; however, pro forma
disclosures as if the Company adopted the cost recognition requirements
under FAS 123 are required, but approximate the amounts recognized by
applying APB 25. This is not indicative of future amounts as additional
awards in future years are anticipated.
11. NET INCOME (LOSS) PER COMMON SHARE:
In February 1997, the Financial Accounting Standard Board issued Statement
No. 128 ("FAS 128"). This statement establishes standards for computing and
presenting earnings per share ("EPS"). Basic EPS excludes dilution and is
computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into
common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. FAS 128 requires restatement of all
prior-period EPS data.
Potential common stock is in the form of stock options and warrants which
do not have an effect on the 1997 diluted net income (loss) per common
share calculations. The following table presents information necessary to
calculate basic and diluted EPS for the years ended December 31, 1995, 1996
and 1997:
1995 1996 1997
Weighted average shares outstanding 1,141,333 1,141,333 2,702,166
Escrow shares (57,067) (57,067) (120,725)
------------- ------------- -------------
1,084,266 1,084,266 2,581,441
============= ============= =============
F-18
49
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
12. RELATED PARTY TRANSACTIONS:
Included in the due to stockholder and related parties balance at December
31, 1996 and 1997 are advances from the Company's majority stockholder of
$2,109,325 and $137,314, respectively, and advances from other stockholders
of $101,840 and $109,642, respectively. During each of the three years in
the period ended December 31, 1997, the Company recognized interest expense
on the advances from the majority stockholder of approximately $126,000,
$160,000, and $177,000, respectively. The advances from the majority
stockholders bear interest at 8%. The advances from other stockholder do
not bear interest. All advances from stockholders are due on demand.
During the year ended December 31, 1996, the Company paid management fees
to the majority stockholder of $135,000.
At December 31, 1997, the Company has a note payable with a stockholder of
the Company for $90,000. The note bears interest at 12% and has no stated
maturity date.
13. FUTURE ADOPTION OF RECENTLY ISSUED ACCOUNTING STANDARDS:
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 131, Disclosures About Segments of an Enterprise
and Related Information ("SFAS 131"), and No. 130, Reporting Comprehensive
Income ("SFAS 130"). SFAS 131 specifies revised guidelines for determining
an entity's operating segments and the type and level of financial
information to be disclosed. SFAS 130 establishes standards for reporting
and display of comprehensive income and its components (revenues, expenses,
gains and losses) in a full set of general-purpose financial statements.
These Standards are effective for years beginning after December 15, 1997.
The Company believes that the impact of these Standards, when adopted, will
not have a material impact on the Company's consolidated financial
statements.
F-19
50
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
14. SEGMENT INFORMATION:
The Company's operations are classified into two business units: graphics
and technology. These business units are revenue producing components of
the Company about which separate financial information is produced
internally and operating decisions are made.
1995 1996 1997
Net sales:
Graphics $ - $ - $ 33,511,680
Technology 12,277,340 13,414,131 15,220,711
--------------- --------------- --------------
Total net sales $ 12,277,340 $ 13,414,131 $ 48,732,391
=============== =============== ==============
Operating income (loss):
Graphics $ - $ - $ 449,446
Technology 120,245 200,657 (225,862)
Corporate (424,787)
--------------- --------------- --------------
Total operating income (loss) $ 120,245 $ 200,657 $ (201,203)
=============== =============== ==============
Identifiable assets:
Graphics $ - $ - $ 17,668,748
Technology 2,264,411 3,007,109 2,096,920
Corporate - - 10,186,680
--------------- --------------- --------------
Total identifiable assets $ 2,264,411 $ 3,007,109 $ 29,952,348
=============== =============== ==============
Corporate operating income (loss) includes overhead and special charges
related to the consolidated Company.
15. SUBSEQUENT EVENT:
In March 1998, the Company entered into three agreements and plans of
merger, each of which is by and among the Company, a subsidiary of the
Company formed for purposes of effectuating each merger, and a computer
graphics wholesale company. The agreements provide for the issuance of an
aggregate of 895,000 unregistered Class A common stock shares of the
Company and payment of $1,415,000 in cash, in connection with these
acquisitions, subject to adjustment in the event that warranted earnings
levels and warranted net asset values are either not met or exceeded.
These acquisitions will be accounted for under the purchase method of
accounting and are subject to the satisfactory completion of due
diligence, the receipt of regulatory approvals and consents, and other
conditions to closing.
F-20
51
TEKGRAF, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
16. CONSOLIDATED CONDENSED QUARTERLY INFORMATION (UNAUDITED):
Selected financial information for each of the four quarters in the years
ended December 31, 1996 and 1997 are as follows:
NET INCOME WEIGHTED
NET (LOSS) AVERAGE SHARES
NET GROSS INCOME PER SHARE OUTSTANDING
1996 SALES PROFIT (LOSS) BASIC AND DILUTED BASIC AND
DILUTED
First $ 3,415,851 $ 585,817 $ 139,230 $ 0.13 1,084,266
Second 3,434,479 566,137 23,672 0.02 1,084,266
Third 3,282,468 658,078 (32,266) (0.03) 1,084,266
Fourth 3,281,333 652,548 (87,563) (0.08) 1,084,266
------------- ------------- ------------
Total $ 13,414,131 $ 2,462,580 $ 43,073 $ 0.04 1,084,266
============= ============= ============
1997
First $ 3,130,610 $ 611,138 $ 109,610 $ 0.10 1,084,266
Second 9,321,271 1,234,430 28,245 0.02 1,725,004
Third 18,536,085 3,009,566 191,966 0.06 3,166,666
Fourth 17,744,425 2,627,646 (723,158)(1) (0.17) 4,307,970
------------- ------------- ------------
Total $ 48,732,391 $ 7,482,780 $ (393,337) $ (0.15) 2,581,441
============= ============= ============
(1) Net loss in the fourth quarter was primarily attributable to decreased
sales and additional selling, general and administrative expenses incurred
in the fourth quarter, including costs associated with operating as a
public company.
Basic income (loss) per shared was the same as diluted income (loss) per
share in each period presented above.
F-21
52
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Our report on the consolidated financial statements of Tekgraf, Inc. is included
on page F-2 of this Form 10-K. In connection with our audits of such
consolidated financial statements, we have also audited the related consolidated
financial statement schedule included on page F-23 of this Form 10-K.
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 required
to be included therein.
Coopers & Lybrand, L.L.P.
Atlanta, Georgia
March 20, 1998
F-22
53
SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO DEDUCTIONS BALANCE
BEGINNING COSTS AND AND AT END
DESCRIPTION OF PERIOD EXPENSES RECLASSIFICATIONS OF PERIOD
Allowance for doubtful accounts $ 35,000 $ 149,170 $ (84,170) $ 100,000
================ ================ ===================== ===============
F-23
54
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
------- ----------------------
2.1 Plan of Merger between Crescent Computers, Inc. and Tekgraf,
Inc., dated June 20, 1997 (Filed as Exhibit 2.1 to the Company's
Registration Statement on Form S-1, No. 333-33449, and
incorporated herein by reference(the "Registration Statement")) .
3.1 Certificate of Incorporation dated June 17, 1997 (Filed as
Exhibit 3.1 to the Registration Statement and incorporated herein
by reference).
3.2 Bylaws. (Filed as Exhibit 3.2 to the Registration Statement and
incorporated herein by reference).
4.1 Form of Warrant Agreement (Filed as Exhibit 4.1 to the Registration
Statement and incorporated herein by reference)
4.2 Form of Unit Purchase Option (Filed as Exhibit 4.2 to the Registration
Statement and incorporated herein by reference).
10.1 1997 Stock Option Plan of the Company (Filed as Exhibit 10.1 to the
Registration Statement and incorporated herein by reference).
10.2 Employment Agreement dated June 2, 1997 between Crescent
Computers, Inc. and Phillip C. Aginsky (Filed as Exhibit 10.2 to
the Registration Statement and incorporated herein by reference).
10.3 Employment Agreement dated June 2, 1997 between Crescent
Computers, Inc. and Dan I. Bailey (Filed as Exhibit 10.3 to the
Registration Statement and incorporated herein by reference).
10.4 Employment Agreement dated June 2, 1997 between Crescent
Computers, Inc. and William M. Rychel (Filed as Exhibit 10.4 to
the Registration Statement and incorporated herein by reference).
10.5 Form of Employment Agreement between Crescent Computers, Inc. and
Regional Sales Directors (Filed as Exhibit 10.5 to the
Registration Statement and incorporated herein by reference).
10.6 Employment Agreement dated February 26, 1998, between Tekgraf,
Inc. and W. Jeffrey Camp.
10.7 Stock Purchase Agreement dated May 1, 1997, by and among
Crescent Computers, Inc. and its shareholders and Microsouth, Inc.
and its shareholders, as amended (Filed as Exhibit 10.6 to the
Registration Statement and incorporated herein by reference).
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EXHIBIT
NO. DESCRIPTION OF EXHIBIT
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10.8 Stock Purchase Agreement dated May 1, 1997 by and among Crescent
Computers, Inc. and its shareholders and tekgraf, inc. and its
shareholders, as amended (Filed as Exhibit 10.7 to the Registration
Statement and incorporated herein by reference).
10.9 Stock Purchase Agreement dated May 1, 1997 by and among Crescent
Computers, Inc. and its shareholders and G&R Marketing, Inc. and
its shareholders, as amended (Filed as Exhibit 10.8 to the
Registration Statement and incorporated herein by reference).
10.10 Stock Purchase Agreement dated May 1, 1997 by and among Crescent
Computers, Inc. and its shareholders and Computer Graphics
Distributing Company and its shareholders, as amended (Filed as
Exhibit 10.9 to the Registration Statement and incorporated
herein by reference).
10.11 Stock Purchase Agreement dated May 1, 1997 by and among Crescent
Computers, Inc. and its shareholders and Intelligent Products
Marketing, Inc. and its shareholders and IG Distributing, Inc.
and its shareholders, as amended (Filed as Exhibit 10.10 to the
Registration Statement and incorporated herein by reference).
10.12 Escrow Agreement dated August 1997 (Filed as Exhibit 10.11 to the
Registration Statement and incorporated herein by reference).
10.13 Indemnification Agreement dated 1997 (Filed as Exhibit 10.12 to
the Registration Statement and incorporated herein by reference).
10.14 [Intentionally omitted]
10.15 Lease Agreement dated September 4, 1993 between Crescent
Computers, Inc. and TCW Realty Fund II (Filed as Exhibit 10.14 to
the Registration Statement and incorporated herein by reference).
10.16 Leases for property located at 7020 Koll Center Parkway by and
between Patrician Associates, Inc. Koll Bernal Avenue Associates
and Intelligent Products Marketing, Inc., as amended (Filed as
Exhibit 10.15 to the Registration Statement and incorporated
herein by reference)
10.17 Industrial Space Lease dated November 13, 1991 between G&R
Technologies and American National Bank and Trust Company of
Chicago (Filed as Exhibit 10.16 to the Registration Statement and
incorporated herein by reference).
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56
10.18 Commercial Lease Agreement dated March 29 , 1991 between Computer
Graphics Distributing Company and Girard Associates II Limited
Partnership (Filed as Exhibit 10.17 to the Registration Statement
and incorporated herein by reference).
10.19 Lease Agreement dated May 1, 1992 between Microsouth, Inc. and
ASC North Fulton Associates Joint Venture (Filed as Exhibit 10.18
to the Registration Statement and incorporated herein by
reference).
10.20 Lease Agreement dated March 1998 between Tekgraf, Inc. a Texas
corporation and Connecticut General Life Insurance Company,
(Filed as Exhibit 10.19 to the Registration Statement and
incorporated herein by reference), as amended (amendment
attached as Exhibit 10.20a).
10.21 Voting Agreement dated as of August 7, 1997 between Tekgraf, Inc.
and A. Lowell Nerenberg and Edward H. L. Mason (Filed as Exhibit
10.20 to the Registration Statement and incorporated herein by
reference).
10.22 Agreement and Plan of Merger by and among Tekgraf,
Inc., a Delaware corporation, Tekgraf Sub I, Inc., a Georgia
corporation, and Computer Graphics Technology, Inc., a South
Carolina corporation, and its Shareholders, dated March 23, 1998.
10.23 Agreement and Plan of Merger by and among Tekgraf, Inc., a
Delaware corporation, Tekgraf Sub II, Inc., a Georgia
corporation, and Martec, Inc., a California corporation, and its
Shareholders, dated March 23, 1998.
10.24 Agreement and Plan of Merger by and among Tekgraf, Inc., a
Delaware corporation, Tekgraf Sub III, Inc., a Georgia
corporation, and New England Computer Graphics, Inc., a
Massachusetts corporation, and its Shareholders, dated
March 25, 1998.
10.25 First Amendment to Agreement and Plan of Merger, dated March 30,
1998, by and among Tekgraf, Inc., Tekgraf Sub III, Inc., New
England Computer Graphics, Inc. and its Shareholders.
11.1 Computation of Earnings Per Share.
21.1 Subsidiaries of the Registrant.
27.1 Financial Data Schedule (for SEC use only).
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