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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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 July 31, 1998
OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File Number 0-21695
MANCHESTER EQUIPMENT CO., INC.
(Exact name of Registrant as specified in its charter)
New York 11-2312854
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) I. D. Number)
160 Oser Avenue 11788
Hauppauge, New York (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (516) 435-1199
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
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Indicate by check mark whether the Registrant (1) has filed all reports 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 _____
Indicate by check mark if the disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of October 2, 1998 was $8,621,988 (2,759,036 shares at a closing
sale price of $3.125).
As of October 2, 1998, 8,096,600 shares of Common Stock ($.01 par value) of the
Registrant were issued and outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
None
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MANCHESTER EQUIPMENT CO., INC.
FORM 10-K
YEAR ENDED JULY 31, 1998
TABLE OF CONTENTS
Part I
Page
Item 1. Business 3
Item 2. Properties 10
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
Part II
Item 5. Market for the Registrant's Common Stock and Related 11
Stockholder Matters
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis of Financial 13
Condition and Results of Operations
Item 8. Financial Statements and Supplementary Data 17
Item 9. Change In and Disagreements with Accountants on 17
Accounting and Financial Disclosures
Part III
Item 10. Directors and Executive Officers of the Registrant 18
Item 11. Executive Compensation 18
Item 12. Security Ownership of Certain Beneficial Owners and Management 21
Item 13. Certain Relationships and Related Transactions 22
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports 23
on Form 8-K
Signatures Chief Executive Officer, Chief Financial Officer, 42
and Directors
2
PART I
This Report contains certain forward-looking statements that are based on
current expectations. The actual results of Manchester Equipment Co., Inc. (the
"Company") may differ materially from the results discussed herein as a result
of a number of unknown factors. Such factors include, but are not limited to,
there being no assurance that the acquisitions of Electrograph Systems, Inc. and
Coastal Office Products, Inc. will continue to add to the Company's
profitability, that the Company will be successful in its efforts to focus on
value-added services, that the Company will be successful in attracting and
retaining highly skilled technical personnel and sales representatives necessary
to implement the Company's growth strategies, that the Company will not be
adversely affected by continued intense competition in the computer industry,
continued decreases in average selling prices of personal computers, a lack of
product availability or deterioration in relationships with manufacturers, or a
loss or decline in sales to any of its major customers. See "Products" and
"Competition" in Part I, Item 1 and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in Part II, Item 7 of this report
for a discussion of important factors that could affect the validity of any
forward looking statements.
ITEM 1. Business
General
Manchester Equipment Co., Inc. ("Manchester" or the "Company") is a
network integrator and reseller of computer hardware, software and networking
products, primarily for commercial customers. The Company offers its customers
single-source solutions customized to their information systems needs by
combining value-added services with hardware, software, networking products and
peripherals from leading vendors. Over the past 25 years, the Company has forged
long-standing relationships with both customers and suppliers and capitalized on
the rapid developments in the computer industry, including the shift toward
client/server-based platforms.
Manchester's marketing focus is on mid- to large-sized companies, which
have become increasingly dependent upon complex information systems in an effort
to gain competitive advantages. While many of these companies have the financial
resources to make the required capital investments in information systems, often
they do not have the necessary information technology personnel to design,
install or maintain complex systems or to incorporate the continuously evolving
technologies. As a result, these companies are turning to independent third
parties to procure, design, install, maintain and upgrade their information
systems.
The Company offers its customers a variety of value-added services,
such as consulting, integration and support services, together with a broad
range of computer and networking products from leading vendors. Consulting
services include systems design, performance analysis, and migration planning.
Integration services include product procurement, configuration, testing and
systems installation and implementation. Support services include network
management, "help-desk" support, and enhancement, maintenance and repair of
computer systems. Most of the Company's revenues are derived from sales to
customers located in the New York Metropolitan area, with approximately 71% of
the Company's revenues being generated from its Long Island and New York City
offices.
The Company was incorporated in New York in 1973 and has four active
wholly-owned subsidiaries; Manchester International, Ltd., a New York
corporation, which sells computer hardware, software and networking products to
resellers domestically and internationally; ManTech Computer Services, Inc. a
New York corporation which identifies and provides temporary information
technology positions and solutions for commercial customers; Electrograph
Systems, Inc. a New York corporation, which distributes microcomputer
peripherals throughout the United States; and Coastal Office Products, Inc. a
Maryland corporation that was acquired by the Company on January 2, 1998, which
is a network integrator and reseller of computer products in the Baltimore,
Maryland area.
Industry
Businesses have become increasingly dependent upon complex information
systems in an effort to gain competitive advantages or to maintain competitive
positions. Computer technology and related products are continuously evolving,
making predecessor technologies or products obsolete within a few years or, in
some cases, within months. The constant changes in hardware and software and the
competitive pressure to upgrade existing products create significant challenges
to companies.
Over the last several years, the increase in performance of personal
computers, the development of a variety of effective business productivity
software programs and the ability to interconnect personal computers in high
speed networks have led to an industry shift away from mainframe computer
systems to client/server systems based on personal computer technology. In such
systems, the client computer, in addition to its stand-alone capabilities, is
able to obtain resources from a central server or servers. Accordingly, personal
computers may share everything from data files to printers. Recently, networked
applications such as electronic mail and work group productivity software,
coupled with widespread acceptance of Internet technologies, have led companies
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to implement corporate intranets (networks that enable end-users (e.g.,
employees) to share information). The use of a corporate intranet allows a
company to warehouse valuable information, which may be "mined" or accessed by
employees or other authorized users through readily available Internet tools
such as Web browsers and other graphical user interfaces.
With these advances in information systems and networking, many
companies are reengineering their businesses using these technologies to enhance
their revenue and productivity. However, as the design of information systems
has become more complex to accommodate the proliferating network applications,
the configuration, selection and integration of the necessary hardware and
software products have become increasingly more difficult and complicated. While
many companies have the financial resources to make the required capital
investments, they often do not have the necessary information technology
personnel to design, install or maintain complex systems and may not be able to
provide appropriate or sufficient funding or internal management for the
maintenance of their information systems. As a result, such companies are
increasingly turning to independent third parties to procure, design, install,
maintain and upgrade their information systems. By utilizing the services of
such third parties, companies are able to acquire state-of-the-art equipment and
expertise on a cost-effective basis.
The Manchester Solution
Manchester offers its customers single-source solutions customized to
their information systems needs. The Manchester solution includes a variety of
value-added services, including consulting, integration, network management,
"help-desk" support, and enhancement, maintenance and repair of computer
systems, together with a broad range of computer and networking products from
leading vendors. Manchester believes it provides state-of-the-art,
cost-effective information systems designed to meet its customers' particular
needs.
As a result of the Company's long-standing relationships with certain
suppliers and its large volume purchases, the Company is often able to obtain
significant purchase discounts which can result in cost-savings for its
customers. Manchester's relationships with its suppliers, its inventory
management system and industry knowledge generally enable it to procure desired
products on a timely basis and therefore to offer its customers timely product
delivery.
Strategy
The key elements of the Company's strategy include:
Emphasizing Value-added Services. Value-added services, such as
consulting, integration and support services, generally provide higher profit
margins than computer hardware sales. The Company has increased its focus on
providing these services through a number of key strategies. The Company has
recruited additional technical personnel with broad-based knowledge in systems
design and specialized knowledge in different areas of systems integration,
including application software, inter-networking (including routers and
switches), database design and management.
Increasing Marketing Focus on Companies Outside the Fortune 500.
Manchester has decided to increase its marketing focus on those companies
outside the Fortune 500 in order to increase its value-added services revenue.
Manchester's experience is that those companies are increasingly looking to
third parties to provide a complete solution to their information systems needs
from both a service and product standpoint. Such companies often do not have the
necessary information technology personnel to procure, design, install or
maintain complex systems or to incorporate continuously evolving technologies.
Manchester believes that it can provide these companies with solutions to their
information systems requirements by providing a variety of value-added services
together with a broad range of computer and networking products.
Electronic Ordering System. Manchester has implemented an electronic
ordering system. This ordering system enables participating customers to access
the Company via the Internet, review various products, systems and services
offered by the Company and place their orders on-line. Customers are also able
to obtain immediate customized information regarding products, systems and
services that meet their specific requirements. The ordering system produces a
matrix of alternative fully compatible packages, together with their
availability and related costs, based on parameters indicated by the customer.
Customers are not granted access to this system without prior credit clearance.
Increasing Sales Force Productivity. Manchester is addressing a variety
of strategies to increase sales force productivity. The Company is implementing
an electronic sales information system that allows the Company's sales
representatives to obtain immediate customized information regarding products
and services that meet the specific system requirements of customers and the
availability and related costs of such products and services. The Company
believes that this system will increase the productivity of its sales
representatives by enabling them to offer rapid and comprehensive solutions to
their customers' needs.
The Company provides training of its sales representatives in matters
relating to value-added services, such as consulting and integration services.
To facilitate such training, the Company constructed dedicated training
facilities in one of its Long Island offices and in its New York City office.
Expanding New York Metropolitan Area Presence. The Company believes
that it has a strong presence and wide name recognition in the New York
Metropolitan area, where there is a growing corporate demand for computer
products and services. Manchester is seeking to expand its presence in this area
through its enlarged New York City office and increased sales and service
capabilities. The Company believes that these steps will enable it to capture a
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greater percentage of the New York Metropolitan area market. In fiscal
1998, the Company relocated its New York City office to space that is
approximately double the size of the previous space.
Expanding into Additional Business Centers. The Company has regional
offices in Newton, Massachusetts and Boca Raton and Tampa, Florida, from which
it derived approximately 10% of its revenues for the fiscal year ended July 31,
1998. During fiscal 1998, the Company expanded into Baltimore, Maryland through
the acquisition on January 2, 1998 of Coastal Office Products, Inc. (see
"Acquisitions").
Services and Products
The Company offers customized single-source solutions to its customers'
information systems requirements, including consulting, integration and support
services, together with a broad range of computer and networking products from a
variety of leading vendors. The Company provides its services through a skilled
staff of engineers who are trained and certified in leading products and
technology, including Microsoft Windows NT, Novell NetWare and Cisco Systems
routers and switches.
Services. The Company's services include consulting, integration and
support services.
Consulting. The Company's staff of senior systems engineers provides
consulting services consisting of systems design, performance and security
analysis, and migration planning services.
Systems design services include network, communications, applications
and custom solutions design. Network design services involve analysis of a
customer's overall network needs, including access to the Internet;
communications design services involve analysis and creation of enterprise-wide
networks, including corporate intranets; applications design services include
creation of relational databases meeting customers' specific business
requirements; and custom solutions design services include design of storage
systems, remote access systems and document retention through scanning
technology.
Performance analysis involves analyzing a customer's information
systems to assess potential points of failure, to determine where performance
could be increased and to prepare for change and growth. This service includes
the evaluation of applications and their interaction with the network in order
to maximize existing computer resources. Through this evaluation process, which
includes a detailed report to the end-user, a plan for the optimization of the
customer's existing system is created, as well as recommendations for
enhancements and future systems.
Security analysis involves working with customers to develop security
policies covering network security, as well as risk analysis. After a policy is
developed, a security strategy is planned and deployed using a variety of tools,
including physical firewalls, packet filtering, encryption and user
authentication.
Migration planning involves the performance of a detailed assessment of
existing mission critical systems, followed by an analysis of the end-user's
future requirements. Working closely with the customer, Manchester's consultants
develop a migration strategy using a defined project plan that encompasses
skills transfer and training, checking for data integrity, project management
and consolidation and reallocation of resources. The primary objective of this
service is to rapidly move the customer from a slow or expensive system to a
newer, more efficient and cost-effective solution.
Integration. Integration services include product procurement,
configuration, testing, installation and implementation.
The Company maintains a sophisticated systems build and test area,
adjacent to its warehousing facilities, where computer systems are configured
and tested through the use of automated systems. Manchester manages the
installation and implementation of its customers' information systems, and
provides critical path analysis, vendor management and facility management
services. Critical path analysis involves the management and coordination of the
various hardware and software networking components of a systems design project.
The Company's engineers prepare reports setting forth coordinated timetables
with respect to installing and integrating the customer's information systems.
Support. The Company offers support services for its customers'
existing information systems, including network management, "help-desk"
services, and enhancement, maintenance and repair.
Network management consists of managing the compatibility of, and
communication between, the various components comprising a customer's
information system. The increased expense associated with the ownership of
information systems has encouraged customers to outsource the management of
computer networks, including local area networks ("LANs") and wide area networks
("WANs"). Currently, the Company's engineers provide network management services
on site at customers' facilities.
"Help-desk" services consist of providing customers with telephone
support. In addition, the Company's service call management system, which the
Company is in the process of enhancing, will enable the Company's "help-desk"
technicians to access an archive of prior service calls concerning similar
problems and their solutions, resulting in a more efficient response to
customers' calls.
Enhancement, maintenance and repair services range from broad on-site
coverage to less expensive, basic maintenance and repair of itemized hardware or
5
software, as well as enhancements such as upgrades of existing systems.
Field representatives are equipped with notebook computers to facilitate the
exchange of information with both the information systems at the Company's
headquarters and with technical databases available on the Internet. The Company
maintains a laboratory at its Long Island facilities where the Company
prototypes customer problems for quicker solutions without jeopardizing
customers' information systems.
Products. Manchester offers a wide variety of personal computer and
networking products and peripherals, including:
Desktop Computers Servers
Internet Access Products Software
Modems Storage Subsystems
Monitors Switches
Network Equipment Supplies and Accessories
Notebook Computers Teleconferencing Equipment
Printers Terminals
Routers Wireless Products
Scanners Workstations
The Company has long-standing relationships with many manufacturers,
which the Company believes assist it in procuring desired products on a timely
basis and on desirable financial terms. The Company sells products from most
major manufacturers, including:
Bay Networks, Inc. NEC Technologies, Inc.
Cisco Systems, Inc. Novell, Inc.
Compaq Computer Corporation Philips Electronics N.V.
Computer Associates International, Inc. Seagate Technology, Inc.
Epson America, Inc. 3Com Corp.
Hewlett-Packard Company Toshiba America Information
Intel Corporation Systems, Inc
Microsoft Corporation Viking Components, Inc.
For the fiscal year ended July 31, 1998, sales by the Company of
products manufactured by Compaq, Toshiba, and Hewlett-Packard collectively
comprised approximately 49% of the Company's revenues. For the fiscal years
ended July 31, 1997 and 1996, sales by the Company of products manufactured by
Compaq, Toshiba, Hewlett-Packard and NEC collectively comprised approximately
56% and 53%, respectively, of the Company's revenue. In fiscal years ended July
31, 1998, 1997 and 1996, sales of products manufactured by Toshiba accounted for
approximately 18%, 26%, and 23%, respectively, of the Company's revenue,
substantially all of which were sales of notebook computers and related
accessories. Also in these fiscal years, sales of products manufactured by
Compaq accounted for 21%, 13% and 13%, respectively, of the Company's revenue.
The total dollar volume of products purchased directly from manufacturers, as
opposed to distributors or resellers, was approximately $92 million, $103
million, and $117 million for the fiscal years ended July 31, 1998, 1997 and
1996, respectively, and as a percentage of total cost of products sold was
approximately 55%, 64%, and 72%, respectively.
The Company has entered into agreements with its principal suppliers
that include provisions providing for periodic renewals and permitting
termination by the vendor without cause, generally upon 30 to 90 days written
notice, depending upon the vendor. Toshiba, Hewlett-Packard, NEC and Compaq have
regularly renewed their respective agreements with the Company, although there
can be no assurance that the regular renewal of the Company's dealer agreements
will continue. The termination, or non-renewal, of any or all of these dealer
agreements would materially adversely affect the Company's business. The
Company, however, is not aware of any reason for the termination, or
non-renewal, of any of those dealer agreements and believes that its
relationships with Toshiba, Hewlett-Packard, NEC and Compaq are satisfactory.
The Company is dependent upon the continued supply of products from its
suppliers, particularly Toshiba, Hewlett-Packard, NEC and Compaq. Historically
certain suppliers occasionally experience shortages of select products that
render them unavailable or necessitate product allocations among resellers. Each
fiscal year, the Company has experienced product shortages, particularly related
to newer models. The Company believes that product availability issues are as a
result of the present dynamics of the personal computer industry as a whole,
which include high customer product demand, shortened product life cycles and
increased frequency of new product introductions into the marketplace. While
there can be no assurance that product unavailability or product allocation, or
both, will not increase in fiscal 1999, the impact of such an interruption is
not expected to be unduly troublesome due to the breadth of alternative product
lines available to the Company.
The Company seeks to obtain volume discounts for large customer orders
directly from manufacturers and through aggregators and distributors.
Most of the Company's major product manufacturers provide price
protection for a limited time period as well as stock balancing rights, by way
of credits or refunds, against price reductions by the supplier between the time
of the initial sale to the Company and the subsequent sale by the Company to its
customers. During fiscal 1998 certain manufacturers reduced the period for which
they provide price protection and stock balancing rights. There can be no
assurance that manufacturers will not further limit or eliminate price
protection and stock balancing rights in the future.
6
Customers
The Company grants credit to customers meeting specified criteria and
maintains a centralized credit department that reviews credit applications.
Accounts are regularly monitored for collectibility and appropriate action is
taken upon indication of risk.
The Company believes that it benefits from its long-standing
relationships with many of its customers, providing opportunities for continued
sales and services. Manchester believes that its broad range of capabilities
with respect to both products and services is attractive to companies of all
sizes. Although Manchester is planning to target companies outside the Fortune
500 as one part of its strategy, it has sold, and anticipates that it will
continue to sell, to some of the largest companies in the United States. For the
fiscal years ended July 31, 1998, 1997 and 1996, approximately 7%, 15% and 16%
of the Company's total revenues, respectively, were derived from United Parcel
Service of America, Inc. Some of the Company's other significant commercial
customers currently include Bysis Fund Services, Inc., Cabletron Systems Inc.,
National Broadcasting Company Inc., Sterling Doubleday Enterprises (New York
Mets), Reuters America Inc., Vytra Choice Care, Inc., United Nations
International Children's Emergency Fund and the United States Merchant Marine
Academy.
The Company's return policy generally allows customers to return
hardware and unopened software, without restocking charges, within 30 days of
the original invoice date, subject to advance approval and certain other
conditions. The Company is generally able to return defective merchandise
returned from customers to the vendor.
Sales and Marketing
The Company's sales are generated primarily by its 75 person sales
force. These sales representatives generally are responsible for meeting all of
their customers' product and service needs and are supervised by sales managers
with significant industry experience. The sales managers are responsible for
overseeing sales representative training, establishing sales objectives and
monitoring account management principles and procedures. Sales representatives
attend seminars conducted by manufacturers' representatives at the Company's
facilities, at which the Company's new and existing product and service
offerings are discussed.
The Company's sales representatives are assisted by technical personnel
who support and supplement the sales efforts. The responsibilities of technical
support personnel include answering preliminary inquiries from customers
regarding systems design, and on-site visits to customers' facilities. At
customers' facilities, the technical personnel gather information necessary to
assist customers in making informed decisions regarding their information
systems. Such data include the nature of the customer's current information
systems, the existing hardware and networking environment, the customer's level
of expertise and its applications needs.
Manchester believes that its name is widely recognized for high
quality, competitively priced products and services. Manchester recently adopted
a new logo that appears on all of the Company's marketing materials and other
corporate literature. The logo includes the phrase "Manchester, the Answer" to
emphasize our position as a knowledgeable resource for networking and computer
solutions for our customers. The Company promotes name recognition and the sale
of its products and services through regional business directories, trade
magazine advertisements, radio advertisements, direct mailings to customers and
participation in computer trade shows and special events. The Company advertises
at numerous sporting events in the New York metropolitan region, including full
page four-color advertisements in yearbooks and/or program guides for sports
teams such as the New York Mets, the New York Knicks and the New York Rangers.
The Company also promotes interest in its products and services through its
website on the Internet, and has expanded its website information to provide an
electronic catalog of its products and services. Several manufacturers offer
market development funds, cooperative advertising and other promotional
programs, on which the Company relies to partially fund many of its advertising
and promotional campaigns.
Sales force training is an integral part of the Company's strategy to
increase its focus on providing value-added services. As client/server-based
systems, applications and network capabilities grow in complexity, the need for
technically knowledgeable sales personnel becomes critical to the sale of
value-added services. Accordingly, the Company has expanded its training
capabilities at one of its Long Island facilities to conduct seminars for sales
representatives. The seminars address such topics as general developments in the
computer industry, systems integration services and the Company's management
information systems. The Company utilizes its technical personnel to conduct
such seminars and may hire additional dedicated trainers as needed.
Management Information Systems
The Company currently uses an IBM AS/400 integrated management
information system, which is an on-line system enabling instantaneous access.
The Company maintains a proprietary inventory management system on its computer
system pursuant to which product purchases and sales are continually tracked and
analyzed. The Company's computer system is also used for accounting, billing and
invoicing.
The Company's information system assists management in maintaining
controls over the Company's inventory and receivables. Manchester's average
inventory turnover was 17, 17 and 18 times for the fiscal years ended July 31,
1998, 1997 and 1996, respectively, and Manchester experienced bad debt expense
of less than .3% of revenues in each of these years.
7
During the fiscal year ended July 31, 1998, the Company invested in its
management information systems, including upgrading and expanding the IBM AS/400
system, implementing a client/server-based management system to track services
rendered for customers, and upgrading servers and network infrastructures for
its headquarters. The Company utilizes experienced in-house technical personnel,
assisted by the Company's senior engineers, to upgrade and integrate additional
functions into the Company's management information systems.
Competition
The computer industry is characterized by intense competition primarily
in the area of price, product availability and breadth of product line. The
Company directly competes with local, regional and national systems integrators,
value-added resellers and distributors as well as with certain computer
manufacturers that market through direct sales forces. While the Company's
competitors vary depending upon the particular market, some of the national and
regional competitors of the Company include Alphanet Solutions, Inc., CompuCom
Systems, Inc., Dell Computer Corporation, EnPointe Technologies, Inc., Entex
Information Services, Inc., Pomeroy Computer Resources, Inc., and Vanstar
Corporation. The computer industry has recently experienced a significant amount
of consolidation through mergers and acquisitions, and manufacturers of personal
computers may increase competition by offering a range of services in addition
to their current product and service offerings. In the future, the Company may
face further competition from new market entrants, possible alliances between
existing competitors, as well as competition from certain manufacturers who do
not currently market through direct sales forces. Some of the Company's
competitors have, or may have, greater financial, marketing and other resources,
and may offer a broader range of products and services, than the Company. As a
result, they may be able to respond more quickly to new or emerging technologies
or changes in customer requirements, benefit from greater purchasing economies,
offer more aggressive hardware and service pricing or devote greater resources
to the promotion of their products and services.
The Company's ability to compete successfully depends on a number of
factors such as breadth of product and service offerings, sales and marketing
efforts, product and service pricing, and quality and reliability of services.
In addition, product margins may decline due to pricing to win new business and
increasing pricing pressures from competition. The Company believes that gross
margins will continue to be reactive to industry-wide changes. Future
profitability will depend on the Company's ability to increase focus on
providing technical service and support to customers, competition, manufacturer
pricing strategies, as well as the Company's control of operating expenses,
product availability, and effective utilization of vendor programs. It will also
depend on the ability to attract and retain quality service personnel and sales
representatives while effectively managing the utilization of such personnel and
representatives. There can be no assurance that the Company will be able to
attract and retain such skilled personnel and representatives. The loss of a
significant number of the Company's existing technical personnel or sales
representatives or difficulty in hiring or retaining additional technical
personnel or sales representatives or reclassification of the Company's sales
representatives as employees could have a material adverse effect on the
Company's business, results of operations and financial condition.
Acquisitions
Electrograph Systems, Inc.
On April 25, 1997, the Company, through a newly formed wholly-owned
subsidiary, acquired substantially all of the assets and assumed certain
liabilities of Electrograph Systems, Inc. ("Electrograph"). Electrograph is a
specialized distributor of microcomputer peripherals, throughout the United
States. The purchase price and transaction costs aggregated approximately $2.6
million. The major categories of products presently distributed by Electrograph
include printers and monitors. Electrograph does not stock significant amounts
of inventory relative to the number of different products it carries. Most
products are stocked to provide a 30-day supply.
Electrograph provides technical assistance to customers through its
Hauppauge, New York office. Electrograph ships returns of defective products to
the manufacturer or to an authorized repair center. Returns have historically
been approximately 3% of Electrograph's revenue. The Company does not believe
that such a breakdown or the dollar amounts of product returns is material,
however, as substantially all of these costs are reimbursed to Electrograph by
its suppliers through credits or replacements. As a result, Electrograph's costs
charged to operations for such returns have been minimal.
Products are selected by Electrograph to minimize competition among
suppliers' products while maintaining some overlap to provide protection against
product shortages and discontinuations and to provide different price points for
certain items. Management believes Electrograph's relationships with its
suppliers are enhanced by providing feedback to suppliers on products, advising
suppliers of customer preferences, working with suppliers to develop marketing
programs, and offering suppliers the opportunity to provide seminars for
Electrograph's customers.
Like most of its competitors, Electrograph distributes products for
manufacturers throughout the United States on a non-exclusive basis without
geographic restrictions. Electrograph has supplier agreements with many of its
suppliers which it believes are in a form customarily used by each manufacturer.
These agreements usually contain provisions which allow termination without
cause, by the supplier generally upon 30 to 60 days notice.
None of Electrograph's material supplier agreements require the sale of
specified quantities of products or restrict Electrograph from selling similar
products manufactured by competitors. Electrograph, therefore, has the ability
to terminate or curtail sales of one product line in favor of another product
line as a result of technological change, pricing considerations, customer
demand or supplier distribution policy. Electrograph has never been terminated
by any of its suppliers.
8
Most of Electrograph's major suppliers provide price protection for a
limited time period, by way of credits, against price reductions by the supplier
between the time of the initial sale to Electrograph and the subsequent sale by
Electrograph to its customer. Additionally, most of Electrograph's suppliers
accept defective merchandise returned within 12 to 15 months after shipment to
Electrograph. Some suppliers permit Electrograph to rotate its inventory by
returning slow moving inventory for other inventory. Credits, refunds or other
payments to which Electrograph was entitled by reason of price protection,
advertising allowances, stock rotations and refunds for defective merchandise
totaled approximately 1% of revenue for fiscal 1998.
While Electrograph distributes products of more than 15 suppliers,
approximately 40% and 30% of Electrograph's revenue in fiscal 1998 was derived
from products manufactured by Fujitsu and Mitsubishi, Electrograph's largest
suppliers.
Electrograph's distribution operations are currently conducted from two
distribution centers in Hauppauge, New York and Long Beach, California.
Electrograph also maintains sales offices in Baltimore, Maryland, Northville,
New York and Long Beach, California.
Credit is extended in most circumstances, and is generally limited to
30-day payment terms.
Coastal Office Products, Inc.
On January 2, 1998, the Company acquired all of the outstanding shares
of Coastal Office Products, Inc. ("Coastal"), a reseller and provider of
microcomputer servers and peripherals in the greater Baltimore, Maryland area.
The acquisition, which has been accounted for as a purchase, consisted of a cash
payment of approximately $3.1 million plus future contingent payments.
Employees
At August 31, 1998, the Company had 322 full-time employees consisting
of 44 sales representatives, 38 management personnel, 84 technical personnel and
156 distribution and clerical personnel. In addition, at August 31, 1998, the
Company had 31 independent sales representatives. The Company is not a party to
any collective bargaining agreements and believes its relations with its
employees are good.
Intellectual Property
The Company owns one federally registered service mark with respect to
its name and logo. Most of the Company's various dealer agreements permit the
Company to refer to itself as an "authorized dealer" of the products of those
manufacturers and to use their trademarks and trade names for marketing
purposes. The Company considers the use of these trademarks and trade names in
its marketing to be important to its business.
9
ITEM 2. Properties
Properties
The Company currently has ten sales branches nationwide including the
corporate headquarters located in Hauppauge, New York. The following table
identifies the principal leased facilities.
Approximate
Square Footage Lease
Facility Location Office Warehouse Expiration Date
Corporate 160 Oser Avenue (1)
Headquarters Hauppauge, NY 30,000 - July 2000
Warehouse and 40 and 50 Marcus Blvd. (1) October 2005 (40)
Service Center Hauppauge, NY 20,000 43,000 January 2008 (50)
New York City 469 Seventh Avenue
Sales office New York, NY 13,000 - October 2007
Boca Raton 185 N.W. Spanish River Blvd.
Sales Office Boca Raton, FL 6,000 - November 2002
Boston 25-27 Christina Street 3,000 - October 2002
Sales office Newton, MA
Tampa 6304 Benjamin Road
Sales office Tampa, FL 1,200 - December 1998
Electrograph 175 Commerce Drive
Corporate HQ Hauppauge, NY 5,000 5,000 June 2002
Baltimore 57 W. Timonium Rd. 650 - Month to month
Sales Office Timonium, MD
Coastal 3832 Falls Rd. 8,000 2,000 January 2002
Corporate HQ Baltimore, MD
(1) Leased from entities controlled by or affiliated with certain of the
Company's executive officers, directors and principal shareholders. Effective
with the consummation of the Company's initial public offering in November 1996,
the leases with related parties were amended to provide terms comparable to
those that could be obtained from independent third parties.
10
ITEM 3. Legal Proceedings
On January 12, 1998, the Company announced that it had reached an
agreement in principle settling the Shareholder Securities Class Action
("Lawsuit") filed against the Company and certain of its officers in March 1997.
The settlement, which was approved by the Court on June 15, 1998, resulted in
the distribution of $1,350,000 minus approved attorney's fees and related
expenses, to purchasers of the Company's common stock in the Company's initial
public offering, and during the period of November 26, 1996 to February 13,
1997. The entire $1,350,000 cash settlement was paid by the Company's insurance
carrier.
The settlement included a release of all claims that were asserted or
that could have been asserted in the Lawsuit against the Company and its
officers and directors. The Company agreed to the settlement solely to avoid the
expense, burdens and uncertainties of further litigation and continues to deny
that it has any liability on account of the matters asserted in the litigation
or that the Plaintiffs' claims have merit.
The Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, based on advice
from its legal counsel, the ultimate disposition of these matters will not have
a material adverse effect.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the security holders during the fourth
quarter of the fiscal year ended July 31, 1998.
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company's Common Stock commenced trading on November 26, 1996 at $10.00 and
is traded on the NASDAQ National Market under the symbol MANC. The following
table sets forth the quarterly high and low sale prices for the Common Stock as
reported by the NASDAQ National Market.
Fiscal Year 1997 High Low
Second Quarter (starting November 26, 1996) 10-1/2 6-1/4
Third Quarter 7 3-1/4
Fourth Quarter 4-1/2 3-3/8
Fiscal Year 1998
First Quarter 5-1/4 4-1/8
Second Quarter 4-7/16 3-1/2
Third Quarter 4-1/8 3-1/4
Fourth Quarter 4-1/4 3-1/8
On October 2, 1998 the closing sale price for the Company's Common Stock was
$3-1/8 per share. As of October 2, 1998 there were 38 shareholders of record of
the Company's Common Stock. The Company believes that here are in excess of 500
beneficial holders of its common stock.
Manchester has never declared or paid any dividends to shareholders. At this
time the Company intends to continue its policy of retaining earnings for the
continued development and expansion of its business.
11
ITEM 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share amounts)
The selected consolidated financial data presented below are derived
from the audited consolidated financial statements of the Company. The
Consolidated Financial Statements as of July 31, 1998 and 1997 and for each of
the years in the three-year period ended July 31, 1998 and the report thereon of
KPMG Peat Marwick LLP, independent auditors, are included elsewhere in this
Report. The data should be read in conjunction with the Consolidated Financial
Statements and Notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included elsewhere in this
Report.
Fiscal Year Ended July 31,
1998 1997 1996 1995 1994
Income Statement Data:
Revenue $202,530 $187,801 $ 189,659 $ 170,818 $ 137,361
Cost of revenue 171,930 161,186 163,128 146,323 117,377
Gross profit 30,600 26,615 26,531 24,495 19,984
Selling, general and
administrative expenses 27,414 21,023 22,598 21,280 17,380
Income from operations 3,186 5,592 3,933 3,215 2,604
Interest and other income
(expenses), net 546 395 (365) (392) (172)
Provision for income taxes 1,560 2,450 1,430(1) 1,160 1,042
Cumulative effect of change in
accounting for income taxes - - - - 386
Net income $2,172 $3,537 $ 2,138(1) $ 1,663 $ 1,776
Net income per share:
Basic $0.26 $0.45 $ 0 .34(1) $ 0.27 $ 0.28
Diluted $0.26 $0.45 $ 0 .34(1) $ 0.27 $ 0.28
Weighted average shares of common stock outstanding:
Basic 8,494 7,779 6,247 6,263 6,263
Diluted 8,499 7,779 6,247 6,263 6,263
July 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Balance Sheet Data:
Working capital $26,112 $30,578 $ 9,841 $ 9,189 $ 7,701
Total assets 56,894 58,208 37,761 31,635 25,879
Short-term debt, including
current maturities of
capital lease obligation 82 1,637 6,952 5,600 5,400
Capital lease obligation, excluding
current maturities - 77 175 - -
Redeemable common stock(2) - - 4,739 5,210 5,210
Shareholders' equity 37,345 36,877 8,175 6,037 4,374
----------------
(1) Pro forma provision for income taxes, pro forma net income and pro
forma basic and diluted net income per share for the fiscal year ended
July 31, 1996 would have been $2,835, $4,246 and $.68 per share,
respectively, after giving effect to the assumed reduction of (i)
$3,209 in officers' compensation payable to the Company's Chief
Executive Officer, Executive Vice President and Chief Financial Officer
to an aggregate of $1,125, exclusive of fringe benefits, to reflect
adjustments commencing in fiscal 1997 to (A) the annual compensation
that the Company's Chief Executive Officer and Executive Vice President
have agreed to receive without any diminished duties or
responsibilities, and (B) the reduction from the amount of annual
compensation paid to the former Chief Financial Officer to the annual
compensation payable to the present Chief Financial Officer, net of
applicable income taxes, and (ii) $304 in rent paid to related parties
to amounts stipulated in leases, net of applicable income taxes. See
"Management" and "Certain Transactions."
(2) Represents the aggregate amounts payable by the Company to redeem
shares of common stock under the shareholder put right and
shareholders' agreements between the Company and certain shareholders.
See Note 12 of notes to the consolidated financial statements.
12
ITEM 7. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations
The following discussion and analysis of financial condition and
results of operations of the Company should be read in conjunction with the
Consolidated Financial Statements of the Company and Notes thereto appearing
elsewhere in this Report. The following discussion contains certain
forward-looking statements within the meaning of Securities Act of 1933 as
amended, and Section 21E of the Securities and Exchange Act of 1934, as amended,
which are not historical facts and involve risks and uncertainties that could
cause actual results to differ materially from the results anticipated in those
forward-looking statements. These risks and uncertainties include, but are not
limited to those set forth below and the risk factors described in the Company's
other filings from time to time with the Securities and Exchange Commission.
General
Manchester is a network integrator and reseller of computer hardware,
software and networking products, primarily for commercial customers. The
Company offers its customers single-source solutions customized to their
information systems needs by combining value-added services with hardware,
software, networking products and peripherals from leading vendors. To date,
most of the Company's revenues have been derived from product sales. The Company
generally does not develop or sell software products. However, certain computer
hardware products sold by the Company are loaded with pre-packaged software
products.
As a result of intense price competition within the computer industry
as well as other industry conditions, the Company has experienced increasing
pressure on per unit prices as well as on its gross profit and operating margins
with respect to the sale of products. Manchester's strategy includes increasing
its focus on providing value-added services with operating margins that are
higher than those obtained with respect to the sale of products. The Company has
experienced a significant increase in selling, general and administrative
expenses, primarily in the form of increased personnel costs, in connection with
the implementation of this strategy. The Company's future performance will
depend in part on its ability to manage successfully a continuing shift in its
operations towards value-added services.
The Company directly competes with local, regional and national systems
integrators, value-added resellers ("VARs") and distributors as well as with
certain computer manufacturers that market through direct sales forces. In the
future, the Company may face further competition from new market entrants and
possible alliances between existing competitors. In addition, certain suppliers
and manufacturers may choose to market products directly to end users through a
direct sales force rather than or in addition to channel distribution. Some of
the Company's competitors have, or may have, greater financial marketing and
other resources, and may offer a broader range of products and services, than
the Company. As a result, they may be able to respond more quickly to new or
emerging technologies or changes in customer requirements, benefit from greater
purchasing economies, offer more aggressive hardware and service pricing or
devote greater resources to the promotion of their products and services. There
can be no assurance that the Company will be able to compete successfully in the
future with these or other current or potential future competitors.
The Company's business is dependent upon its relationships with major
manufacturers in the computer industry. There can be no assurance that the
pricing and related terms offered by major manufacturers will not adversely
change in the future. The failure to obtain an adequate supply of products, the
loss of a major manufacturer, the deterioration of the Company's relationship
with a major manufacturer or the Company's inability in the future to develop
new relationships with other manufacturers could have a material adverse effect
on the Company's business, results of operations and financial condition.
The Company's largest customer accounted for approximately 7%, 15% and
16% of the Company's revenues for the fiscal years ended July 31, 1998, 1997 and
1996, respectively, substantially all of which revenues were derived from the
sale of hardware products. There can be no assurance that the Company will
continue to derive substantial revenues from this customer.
The Company's profitability has been enhanced by its ability to obtain
volume discounts from certain manufacturers, which has been dependent, in part,
upon Manchester's ability to sell large quantities of products to computer
resellers, including VARs. There can be no assurance that the Company will be
able to continue to sell products to resellers and thereby obtain the desired
discounts from manufacturers or that the Company will be able to increase sales
to end-users to offset the need to rely upon sales to resellers.
The markets for the Company's products and services are characterized
by rapidly changing technology and frequent introductions of new hardware and
software products and services, which render many existing products
noncompetitive, less profitable or obsolete. The Company believes that its
inventory controls have contributed to its ability to respond effectively to
these technological changes. As of July 31, 1998, 1997 and 1996, inventories
represented 16%, 17% and 24% of total assets, respectively. During these same
fiscal years, the Company's average inventory turnover was 17, 17 and 18 times,
respectively. The failure of the Company to anticipate technology trends or to
continue to effectively manage its inventory could have a material adverse
effect on the Company's business, results of operations and financial condition.
The Company believes its controls on accounts receivable have
contributed to its profitability. The Company's bad debt expense represented
.2%, .2% and .1% of total revenues for the fiscal years ended July 31, 1998,
1997 and 1996, respectively.
The Company's quarterly revenue and operating results have varied
significantly in the past and are expected to continue to do so in the future.
13
Quarterly revenues and operating results generally fluctuate as a result of the
demand for the Company's products and services, the introduction of new hardware
and software technologies with improved features, the introduction of new
services by the Company and its competitors, changes in the level of the
Company's operating expenses, competitive conditions and economic conditions. In
particular, the Company currently is increasing certain of its fixed operating
expenses, including a significant increase in personnel, as part of its strategy
to increase its focus on providing higher margin, value-added services.
Accordingly, the Company believes that period-to-period comparisons of its
operating results should not be relied upon as an indication of future
performance. In addition, the results of any quarterly period are not indicative
of results to be expected for a full fiscal year.
As a result of the rapid changes which are taking place in computer and
networking technologies, product life cycles are short. Accordingly, the
Company's product offerings change constantly. Prices of products change with
generally higher prices early in the life cycle of the product and lower prices
near the end of the product's life cycle. Recently, the computer industry has
experienced rapid declines in average selling prices of personal computers. In
some instances, the Company has been able to offset these price declines with
increases in units shipped. There can be no assurance that average selling
prices will not continue to decline or that the Company will be able to offset
declines in average selling prices with increases in units shipped.
Most of the personal computers shipped by the Company utilize operating
systems developed by Microsoft Corporation. The United States Department of
Justice has brought an antitrust action against Microsoft, which could delay the
introduction and distribution of Microsoft products. The potential
unavailability of Microsoft products could have a material adverse effect on the
Company's business, results of operations and financial condition.
The Company's Chief Executive Officer entered into an employment
agreement with the Company under which he received $550,000 in compensation,
exclusive of fringe benefits, for each of the fiscal years ending July 31, 1997
and 1998. In addition, the Company's Executive Vice President received base
compensation, exclusive of fringe benefits, of $450,000 for the fiscal years
ending July 31, 1997 and 1998. These officers agreed that they would not be
entitled to any bonuses for fiscal 1997 and that any bonus payable to either of
these officers in fiscal 1998 would require the approval of a majority of the
independent directors of the Company. No bonuses were paid to these officers in
fiscal 1997 or 1998. The Company leases certain warehouses and offices from
entities that are owned or controlled by the Company's majority shareholder.
Each of the leases with related parties has been amended effective with the
closing of the Company's initial public offering in December 1996 to reduce the
rent payable under that lease to then current market rates.
Year 2000 Issue
Many existing computer systems, including certain of the Company's
internal systems as well as those that the Company sells to customers, use only
the last two digits to identify years in the date field. As a result, those
systems may not accurately distinguish years in the 21st century from years in
the 20th century, or may not function properly when faced with years later than
1999. This problem is generally referred to as the "Year 2000 Issue." Computer
systems that are able to deal correctly with dates after 1999 are referred to as
"Year-2000-Compliant."
The Company has undertaken a complete and thorough review of all of its
operations to determine those aspects which involve or are dependent upon a
computer application. The Company is reviewing the software and operating
systems for each such application to determine if it is Year-2000-Compliant. Any
such system or application which is not Year-2000-Compliant is being modified or
upgraded to assure our continued ability to operate without interruption. This
process has been underway since before January 1, 1998 and is currently on
schedule for completion before January 1, 1999. The Company is in the process of
obtaining assurances regarding Year 2000 compliance from other companies upon
which we may rely for products or services.
The Company expects to implement successfully the systems and
programming changes necessary to address the Year 2000 Issue. Moreover, the
Company does not expect the costs associated with that implementation to be
material to the Company's financial position or results of operations.
With respect to products sold to customers, the Company does not
warrant any products sold as Year-2000-Compliant. Instead, the Company refers
customers to warrantees provided by the product's manufacturers.
The statements above describing the Company's plans and objectives for
handling the Year 2000 Issue and the expected impact of the Year 2000 Issue on
the Company are forward-looking statements. Those statements involve risks and
uncertainties that could cause actual results to differ materially from the
results discussed above. Factors that might cause such a difference include, but
are not limited to, delays in executing the plan outlined above and increased or
unforeseen costs associated with the implementation of the plan and any
necessary changes to the Company's systems. Any inability on the part of the
Company to implement necessary changes in a timely fashion could have an adverse
effect on future results of operations. Moreover, even if the Company
successfully implements the changes necessary to address the Year 2000 Issue,
there can be no assurance that the Company will not be adversely affected by the
failure of others to become Year-2000-Compliant.
Recent Acquisition
On January 2, 1998, the Company acquired all of the outstanding shares
of Coastal Office Products, Inc. ("Coastal"), a Maryland corporation and a
reseller and provider of microcomputer services and peripherals to companies in
14
the greater Baltimore, Maryland area. The acquisition, which has been
accounted for as a purchase, consisted of a cash payment of approximately $3.1
million plus potential future contingent payments. The cash payment was made
from the Company's cash balances. Contingent payments of up to $1,050,000 in
each of calendar 1998 and 1999 will be determined based upon achieving certain
agreed upon increases in revenues and pretax income for calendar 1998 and 1999
over calendar 1997 amounts. Contingent payments, if any, would be paid in cash
(or, under certain conditions, in Company common stock) on March 15, 1999 and
March 15, 2000. Operating results of Coastal are included in the Consolidated
Statements of Income from the date of acquisition. The acquisition resulted in
goodwill of $2,965,000 which is being amortized on the straight-line basis over
20 years.
Results of Operations
The following table sets forth, for the periods indicated, information
derived from the Company's consolidated statements of income expressed as a
percentage of related revenue or total revenue.
Percentage of Revenue
the Year Ended July 31,
-----------------------
1998 1997 1996
---- ---- ----
Revenue
Products 97.4% 98.7% 100.0
Services 2.6 1.3 -
--- --- -----
100.0% 100.0% 100.0%
----- ----- -----
Cost of revenue
Products 85.2 86.2 86.0
Services 72.1 54.4 -
---- ---- ----
84.9 85.8 86.0
---- ---- ----
Product gross profit 14.8 13.8 14.0
Services gross profit 27.9 45.6 -
---- ---- ----
Gross profit 15.1 14.2 14.0
Selling, general and administrative expenses 13.5 11.2 11.9
---- ---- ----
Income from operations 1.6 3.0 2.1
Interest and other income (expenses), net 0.3 0.2 (0.2)
--- --- ----
Income before income taxes 1.9 3.2 1.9
--- --- ---
Provision for income taxes 0.8 1.3 0.8
Net income 1.1% 1.9% 1.1%
=== === ===
Year Ended July 31, 1998 Compared to Year Ended July 31, 1997
Revenue. The Company's revenue increased $14.7 million or 7.8% from
$187.8 million in fiscal 1997 to $202.5 million for fiscal 1998. Revenue from
product sales increased by $11.8 million (6.4%) primarily due to revenue
generated from the Company's new wholly-owned subsidiaries, Electrograph
Systems, Inc. ("Electrograph") which was acquired on April 25, 1997 and Coastal
Office Products, Inc., which was acquired on January 2, 1998 as well as
increases in the number of personal computers shipped. These increases were
partially offset by lower revenue from the Company's major customer and lower
average selling prices for personal computers. Services revenue increased by
$2.9 million, or 122.0%, reflecting the Company's continued emphasis on
providing value-added services.
Gross Profit. Cost of revenue includes the direct costs of products
sold, freight and the personnel costs associated with providing technical
services, offset in part by certain market development funds provided by
manufacturers. All other operating costs are included in selling, general and
administrative expenses. Gross profit increased by $4.0 million or 15.0% from
$26.6 million for fiscal 1997 to $30.6 million for fiscal 1998. Gross profit
from the sale of products increased by $3.6 million or 14.1% due primarily to
increases in revenue as well as favorable changes in the mix of products sold.
Gross profit generated through service offerings increased by $394,000 or 36.0%
reflecting improved service revenue, as discussed above, partially offset by
greater expenditures in salaries and other personnel costs associated with
providing technical services. Fiscal 1998 costs of services reflect the costs of
technical and engineering personnel added during the year as a part of the
Company's strategy to grow higher margin service related business.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $6.4 million or 30.4% from $21.0 million in
fiscal 1997 to $27.4 million in fiscal 1998. This increase is principally a
result of higher salaries and personnel costs related to the Company's increased
emphasis on providing value added services as well as additional operating costs
associated with the Company's new subsidiaries, Electrograph and Coastal. In
addition, the Company incurred higher commission, depreciation and amortization,
training and professional costs.
Other Income (Expense). Interest expense decreased due to lower
borrowings by the Company. Interest income is generated by the investment of the
Company's excess cash balances.
Provision for Income Taxes. The Company's effective income tax rate
increased from 40.9% in fiscal 1997 to 41.8% in fiscal 1998 due to higher state
and local taxes in new and existing jurisdictions as well as non-deductible
amortization of goodwill associated with the Coastal acquisition.
Year Ended July 31, 1997 Compared to Year Ended July 31, 1996
Revenue. The Company's revenue decreased $1.9 million or 1.0% from
$189.7 million in fiscal 1996 to $187.8 in fiscal 1997. This decrease is due
primarily to lower shipments to the Company's major customer as well as
generally lower prices for personal computers, partially offset by increases in
units shipped and $5.1 million of revenue from the Company's Electrograph
subsidiary, which was acquired on April 25, 1997.
Gross Profit. Gross profit increased by $84,000 or 0.3% from $26.5
million in fiscal 1996 to $26.6 million in fiscal 1997. Gross profit as a
percentage of revenues increased from 14.0% in fiscal 1996 to 14.2% in fiscal
1997. The improvement in gross profit as a percentage of revenue reflects a more
favorable product mix. Competitive pressures, changes in the types of products
or services sold and product availability result in fluctuations in gross profit
from period to period.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $1.6 million or 7.0% from $22.6 million in
fiscal 1996 to $21.0 million in fiscal 1997. This decrease is primarily due to
lower officer salaries and rents paid to related parties due to agreements that
were entered into in connection with the Company's initial public offering,
partially offset by higher salaries, legal expenses, bad debts and depreciation
costs as well as additional operating expenses incurred as a result of the
acquisition of Electrograph Systems, Inc. on April 25, 1997. Giving pro forma
effect to the changes in officers' compensation and rents to related parties,
the pro forma selling, general and administrative expenses would have been
approximately $19.1 million or 10.1% of revenues for the year ended July 31,
1996.
Interest Income. Interest income increased significantly in 1997 due to
earnings on short term investments made with certain of the proceeds from the
Company's initial public offering.
Provision For Income Taxes. The effective tax rate increased slightly
from 40.1% in fiscal 1996 to 40.9% in fiscal 1997.
Liquidity and Capital Resources
The Company's primary sources of financing in fiscal 1998 have been
internally generated working capital from profitable operations and a line of
credit from a financial institution.
For the year ended July 31, 1998, cash provided by operating activities
was $2,340,000 consisting primarily of net income, decreased inventory and sales
of trading investments partially offset by increases in accounts receivable and
a decrease in accounts payable and accrued expenses. The Company's accounts
receivable and accounts payable and accrued expenses balances, as well as its
investment in inventory, can fluctuate significantly from one period to the next
due to the receipt of large customer orders or payments or variations in product
availability and vendor shipping patterns at any particular date. Generally, the
Company's experience is that increases in accounts receivable, inventory and
accounts payable and accrued expenses will coincide with growth in revenue and
increased operating levels. In addition, during the year ended July 31, 1998,
the Company used approximately $3.0 million for capital expenditures, $2.9
million (net of cash acquired) for the purchase of Coastal, $1.8 million for the
purchase of treasury stock and $1.9 million for the repayment of debt.
The Company and a subsidiary have available lines of credit with
financial institutions in the aggregate amount of $15.0 million. At July 31,
1998, no amounts are outstanding under this line.
On December 2, 1996, the Company completed the IPO of 2,325,000 shares of
its common stock resulting in net proceeds to the Company, after deducting
underwriting discount and expenses, of approximately $20.4 million. The Company
utilized $7.7 million of the proceeds from the IPO to repay the balance
outstanding at that date under its line of credit with a financial institution.
The Company believes that its current balances in cash and cash
equivalents and investments, expected cash flows from operations and available
borrowings under the lines of credit will be adequate to support current
operating levels for the foreseeable future, specifically through at least the
end of fiscal 1999. The Company has entered into commitments for the renovation
and expansion of certain of its sales and service facilities which is currently
underway and expected to be completed in the first quarter of the next fiscal
year. The aggregate commitment for these projects is approximately $500,000
which will be paid out of the Company's available cash balances. The Company
currently has no other material commitments for capital expenditures. Future
capital requirements of the Company include those for the growth of working
capital items such as accounts receivable and inventory, the purchase of
equipment and expansion of facilities, potential contingent acquisition payments
of $2,100,000, as well as the possible opening of new offices and potential
acquisitions.
16
New Accounting Standards
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 131, "Disclosure About Segments of an Enterprise and
Related Information," which is effective for fiscal years beginning after
December 15, 1997. This statement establishes standards for reporting
information about operating segments, and related disclosures about products and
services, geographic areas and major customers. The Company has not determined
the impact that the adoption of this new accounting standard will have on its
consolidated financial statement disclosures. The Company will adopt this
statement effective August 1, 1998, as required. Interim information is not
required until the second year of application, at which time comparative
information is required.
Inflation
The Company does not believe that inflation has had a material effect on
the Company's operations.
ITEM 8. Financial Statements and Supplementary Data
See Item 14.
ITEM 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
17
PART III
ITEM 10. Directors and Executive Officers of the Registrant
The following table sets forth information concerning each of the
directors and executive officers of the Company:
Name Age Position
- ---- --- --------
Barry R. Steinberg 56 Chairman of the Board, President,
Chief Executive Officer and Director
Joel G. Stemple, Ph.D 56 Executive Vice President, Secretary
and Director
Joseph Looney 41 Chief Financial Officer
Joel Rothlein, Esq. 69 Director
Bert Rudofsky 64 Director
Michael E. Russell 51 Director
Julian Sandler 54 Director
Barry R. Steinberg, the founder of the Company, has served as its Chairman
of the Board, President and Chief Executive Officer and as a director since
Manchester's formation in 1973. Mr. Steinberg previously served as a systems
analyst for Sleepwater, Inc. and Henry Glass and Co.
Joel G. Stemple, Ph.D. has served as Executive Vice President since
September 1996 and as Vice President and as a director since August 1982. Dr.
Stemple previously performed consulting services for the Company and, from 1966
to 1982, served as Assistant and Associate Professor of Mathematics at Queens
College, City University of New York.
Joseph Looney has served as the Company's Chief Financial Officer since May
1996. From 1984 until joining the Company, Mr. Looney served in various
positions with KPMG Peat Marwick LLP, including Senior Audit Manager at the end
of his tenure at such firm. Mr. Looney is a Certified Public Accountant, a
member of the AICPA, the New York State Society of Certified Public Accountants
and the Institute of Internal Auditors.
Joel Rothlein, Esq. has been a director of the Company since October 1996.
Mr. Rothlein is a partner in the law firm of Kressel Rothlein & Roth, Esqs.,
Massapequa, New York, where he has practiced law since 1955. Kressel Rothlein &
Roth, Esqs. and its predecessor firms have acted as outside general counsel to
the Company since the Company's inception.
Bert Rudofsky became a director on July 15, 1998. Mr. Rudofsky is the
founder and president of Bert Rudofsky and Associates, a management consulting
firm specializing in the computer industry. Mr. Rudofsky was a founder of MTI
Systems Corp., a leading edge, technical, value-added distribution company
specializing in computer and data communications products. Mr. Rudofsky was CEO
of MTI from 1968 until MTI was sold in 1990.
Michael E. Russell became a director on July 15, 1998. Mr. Russell is
presently a senior vice president at Prudential Securities Incorporated and has
held several distinguished positions as a member of the business community, as a
member of the New York State Metropolitan Transportation Authority (1997-1989),
as commissioner of the New York State Commission on Cable Television (1989-1991)
and as Special Assistant to the New York State Senate Majority Leader
(1991-1994).
Julian Sandler became a director on December 2, 1996. Mr. Sandler is Chief
Executive Officer of Rent-a-PC, Inc., a full-service provider of short-term
computer rentals, which Mr. Sandler founded in 1984. Mr. Sandler is also the
founder and was the President from 1974 to 1993 of Brookvale Associates, a
national organization specializing in the remarketing of hardware manufactured
by Digital Equipment Corporation. Mr. Sandler also co-founded and from 1970 to
1973 was Vice President of Periphonics Corporation, a developer and manufacturer
of voice response systems.
18
Section 16(a) Beneficial Reporting Compliance
Section 16 of the Securities Exchange Act of 1934, as amended, requires
that officers, directors and holders of more than 10% of the Common Stock
(collectively, "Reporting Persons") file reports of their trading in the
Company's equity securities with the Securities and Exchange Commission. Based
on a review of Section 16 forms filed by the Reporting Persons during the fiscal
year ended July 31, 1998, (a) Bert Rudofsky and Michael E. Russell, each
Reporting Persons, filed Form 3 approximately one and one-half months late; and
(b) Barry R. Steinberg, a Reporting Person, filed his Form 4 reporting the
acquisition of additional shares of the Common Stock approximately three months
late. Except as noted, the Company believes that the Reporting Persons timely
complied with all applicable Section 16 filing requirements.
ITEM 11. Summary Compensation.
The following table sets forth a summary of the compensation paid or
accrued by the Company during the fiscal years ended July 31, 1998, 1997 and
1996 to the Company's Chief Executive Officer and the other executive officers
whose compensation exceeded $100,000:
Summary Compensation Table
Annual Compensation
-------------------
Long Term
Compensation
------------
Common Stock
Name and Other Annual Underlying All Other
Principal Position Year Salary Bonus Compensation(5) Options(4) Compensation
- ------------------ ---- ------ ----- --------------- ---------- ------------
Barry R. Steinberg, 1998 $550,000 - $37,031(1) - -
President and Chief 1997 $550,000 - $59,252(1) - -
Executive Officer 1996 $271,800 $1,816,439 $59,210(1) - -
Joel G. Stemple, Executive 1998 $450,000 - $22,194(2) - -
Vice President and 1997 $450,000 - $33,050(2) - -
Secretary 1996 $251,800 $1,669,193 $29,000(2) - -
Joseph Looney, Chief 1998 $140,394 $40,000 $13,677 - -
Financial Officer(3) 1997 $125,489 $47,500 $7,610 70,000 -
1996 $ 31,250 $10,000 $1,275 - -
Other than set forth above, no restricted stock awards, stock appreciation
rights or long-term incentive plan awards (all as defined
in the proxy regulations promulgated by the Securities and Exchange Commission)
were awarded to, earned by, or paid to the Named Executive Officers during the
fiscal year ended July 31, 1998.
- ------------------
(1) Includes $32,081 in 1998 and $50,000 in each of 1997 and 1996 of premiums
paid by the Company for a whole life insurance policy in the name of Mr.
Steinberg having a face value of $2,600,000 and under which his daughters,
on the one hand, and the Company, on the other hand, are beneficiaries and
share equally in the death benefits payable under the policy.
(2) Includes $17,394 of premiums in 1998 and $25,000 in each of 1997 and 1996
paid by the Company for a whole life insurance policy in the name of the
executive officer having a face value of $1,300,000 and under which his
spouse and the Company are beneficiaries and are entitled to $600,000 and
$700,000, respectively, of the death benefits payable under the policy.
(3) Began employment with the Company on May 2, 1996.
(4) See Option Grant Table below for the exercise price and vesting of Mr.
Looney's options.
(5) Includes in fiscal 1998 employer matching contributions to the Company's
defined contribution plan of $4,950, $4,800 and $3,577 for Messrs.
Steinberg, Stemple, and Looney, respectively, and fiscal 1997 employer
matching contributions to the Company's defined contribution plan of
$6,252, $6,675 and $2,510 for Messrs. Steinberg, Stemple and Looney,
respectively.
19
Barry R. Steinberg has agreed with the Company that his annual base
salary for services rendered to the Company in his current positions as
President and Chief Executive Officer shall be $550,000 in each of the fiscal
years ending July 31, 1997 and 1998. Mr. Steinberg has agreed that he will not
be eligible to receive any bonus in fiscal 1997 and that any bonus payable for
fiscal 1998 will require the approval of a majority of the independent directors
of the Company. No bonus was paid for fiscal 1997 or 1998. The Company will
continue to make available to him the car allowance and deferred compensation
benefits that he is currently receiving. Mr. Steinberg will also be able to
participate in other benefits that the Company makes generally available to its
employees, such as medical and other insurance, and Mr. Steinberg will be able
to participate under the Company's stock option plan. In the event Mr.
Steinberg's employment with the Company were terminated, he would not be
precluded from competing with the Company.
The Company has an employment agreement with Joel G. Stemple, Ph.D.,
under which Dr. Stemple receives a base salary of $450,000 in each of the fiscal
years ending July 31, 1997 and 1998. Under the employment agreement, Dr. Stemple
is not eligible to receive any bonus in fiscal 1997 and any bonus payable to Dr.
Stemple for fiscal 1998 must be approved by a majority of the independent
directors of the Company. No bonus was paid for fiscal 1997 or 1998. Under the
employment agreement, the Company provides Dr. Stemple with an automobile and
certain deferred compensation benefits and provides Dr. Stemple with medical and
other benefits generally offered by the Company to its employees. Dr. Stemple
also is able to participate in the Company's stock option plan. The employment
agreement is terminable by either party on 90 days' prior notice. In the event
the Company so terminates Dr. Stemple's employment, or the Company elects not to
renew his employment agreement, he is entitled to severance equal to 12 months
of his then current base salary. This severance will be payable in accordance
with the Company's customary payroll practices. Under the employment agreement,
if Dr. Stemple terminates his employment, or the Company terminates his
employment for cause, Dr. Stemple is prohibited, for a two-year period from such
termination, from competing with the Company in the eastern half of the United
States.
The Compensation Committee of the Company's Board of Directors
determines compensation for the Company's executive officers. The Company's
objective is to provide a competitive compensation program that reflects both
the Company and individual performance.
Effective August 1, 1998, based upon the recommendation of the
Compensation Committee, the annual base salaries of Mr. Steinberg, Mr. Stemple
and Mr. Looney were set at $650,000, $450,000 and $200,000, respectively. In
addition, an incentive compensation program for fiscal 1999 has been adopted by
the Company whereby the executive officers would share in a predetermined bonus
pool in the event that the Company's operating earnings exceed fiscal 1998
amounts by 25% or more.
Option Grants in the Last Fiscal Year
The following table sets forth the information with respect to grants
of stock options to purchase the Company's common stock, par value $0.01 per
share (the "Common Stock"), pursuant to the Company's Amended and Restated 1996
Incentive and Non-Incentive Stock Option Plan (the "Plan") granted to the Named
Executive Officers during the fiscal year ended July 31, 1998 and all options
outstanding to the named Executive Officers as of July 31, 1998.
Individual Grants
-----------------
Number of Percent of Potential Realizable
Securities Total Options Value at Assumed
Underlying Granted to Annual Rates of Stock
Options Employees in Exercise Expiration Price Appreciation
Granted Fiscal year Price Date For Option Term(1)
------- ----------- ----- ---- ------------------
Name (#) ($/sh) 5% 10%
---- --- ------ -- ---
Joseph Looney 50,000(2) 6.3% $3.8125 2/03/2007 $105,000 $259,000
20,000(3) 2.5% $3.8125 3/26/2007 $42,000 $104,000
No options outstanding for all executive officers were exercised or
exercisable during the fiscal year ended July 31, 1998 or as of July 31, 1998.
There were no in-the-money exercisable or unexercisable options at July 31,
1998.
- --------------
(1) Amounts reported in this column represent hypothetical values that may be
realized upon exercise of the options immediately prior to the expiration of
their term, assuming the specified compounded rates of appreciation of the
Common Stock over the term of the options. These numbers are calculated
based on rules promulgated by the Securities and Exchange Commission. Actual
gains, if any, in option exercises are dependent on the time of such
exercise and the future performance of the Common Stock.
(2) Exercisable cumulatively at the rate of 20% per annum commencing February 3,
1999. (3) Exercisable cumulatively at the rate of 25% per annum commencing May
5, 1999.
20
Compensation Committee Interlocks and Insider Participation
The members of the Company's Compensation Committee are Joel Rothlein, Esq.
and Julian Sandler, and, effective July 15, 1998, Bert Rudofsky. George
Bagetakos was a member of the Compensation Committee until he resigned from the
Board of Directors in July, 1998. Mr. Rothlein is a partner of Kressel Rothlein
& Roth, Esqs., which, with its predecessor firms, has acted as outside general
counsel to the Company since the Company's inception. Kressel Rothlein & Roth,
Esqs. was paid approximately $217,000, $655,000 and $383,000 from the Company
for legal fees in the fiscal years ended July 31, 1998, 1997 and 1996,
respectively. Fiscal 1997 fees to Kressel Rothlein & Roth, Esqs. included fees
paid to special counsel of $286,000. In addition, during the years ended July
31, 1998 and 1997, the Company recorded revenue of approximately $177,000 and
$130,000, respectively, in connection with the sale of computer equipment to a
company controlled by Mr. Sandler.
The Company's Stock Option Plan is administered by the Board of
Directors. Barry R. Steinberg is President and Chief Executive Officer and Joel
G. Stemple is Executive Vice President of the Company and each of them is a
member of the Board. As members of the Board, they could vote on executive
compensation issues before the Board pertaining to the granting of stock
options. Although the issue has not arisen to date, each of Messrs. Steinberg
and Stemple has agreed to abstain from voting on the grant of stock options to
himself or to the other of them.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information as of October 2, 1998
(except as otherwise indicated) with respect to the number of shares of the
Company's common stock beneficially owned by each person who is known to the
Company to beneficially own more than 5% of the common stock, the number of
shares of common stock beneficially owned by each director of the Company and
each executive officer of the Company, and the number of shares of common stock
beneficially owned by all executive officers and directors of the Company as a
group. Except as otherwise indicated, each such shareholder has sole voting and
investment power with respect to the shares beneficially owned by such
shareholder.
Shares Beneficially Percent of Shares
Name and Address Owned Outstanding
---------------- ----- -----------
Barry R. Steinberg(1)(3) 4,674,101 57.7%
Joel G. Stemple(1) 626,263 7.7
Joseph Looney(1) 4,700 *
Joel Rothlein(2) 31,500 *
Bert Rudofsky(1) - -
Michael E. Russell(1) - -
Julian Sandler(1)(4) 3,500 *
Heartland Advisors 595,600 7.4
790 N. Milwaukee St., Milwaukee, WI 53202
Franklin Advisors, Inc. 417,100 5.2
777 Mariners Island Blvd., San Mateo, CA 94404
Capital Technology, Inc. 415,900 5.1
8314 Pineville-Mathews Rd., Suite 295,
Charlotte, NC 28226
All executive
officers and directors as a group
(5 persons) 5,340,064 65.9%
(1) Address is 160 Oser Avenue, Hauppauge, New York 11788.
(2) Address is 684 Broadway, Massapequa, New York 11758; consists of 3,300
shares held by Kressel, Rothlein & Roth, Esqs., in which Mr. Rothlein is a
partner, and 13,200 shares held by the Kressel, Rothlein & Roth Profit
Sharing Plan. Mr. Rothlein disclaims beneficial ownership of the Common
Stock owned by Kressel Rothlein & Roth, Esqs., except to the extent of his
equitable interest in the firm, and of the Common Stock owned by the
Kressel Rothlein & Roth Profit Sharing Plan, except to the extent of his
beneficial interest in such plan.
(3) Excludes 29,000 shares owned by Ilene Steinberg and 29,000 shares owned by
Sheryl Steinberg, daughters of Mr. Steinberg, which shares were purchased
with the proceeds of a loan from Mr. Steinberg. As reported on Schedule
13D filed on March 24, 1997, as amended, Mr. Steinberg, Ilene Steinberg,
and Sheryl Steinberg each disclaim beneficial ownership of the common
stock owned by the others.
(4) Includes option to purchase 2,500 shares that became exercisable on
December 18, 1997.
* Represents less than one tenth of one percent of outstanding shares.
21
ITEM 13. Certain Relationships and Related Transactions
Until August 1994, the Company was affiliated with Electrograph
Systems, Inc. ("Electrograph"). Barry R. Steinberg, the Company's President and
Chief Executive Officer and its majority shareholder, served as Electrograph's
Chairman of the Board and Chief Financial Officer and had beneficial ownership
(directly and through shares held by his spouse and certain trusts, of which his
children are beneficiaries) of 35.5% of the outstanding shares of common stock
of Electrograph. During the fiscal years ended July 31, 1993 and 1994, the
Company paid approximately $322,000 and $385,000, respectively, to Electrograph
for the purchase of products. In August 1994, Bitwise Designs, Inc. ("Bitwise"),
a publicly-traded company engaged in the manufacture and distribution of
document imaging systems, personal and industrial computers and related
peripherals, acquired Electrograph through a stock-for-stock merger; Mr.
Steinberg acquired beneficial ownership of less than 1% of the outstanding
capital stock of Bitwise for the common stock of Electrograph in which he had a
direct or indirect beneficial interest. Mr. Steinberg served as a director of,
and provided consulting services to, Bitwise from August 1994 through September
17, 1996. On April 25, 1997, the Company purchased substantially all of the
assets of Electrograph Systems, Inc. See Item 1 - Business "Acquisitions".
Three of the Company's four Hauppauge, New York facilities are leased
from entities affiliated with certain of the Company's executive officers,
directors or principal shareholders. The property located at 40 Marcus
Boulevard, Hauppauge, New York is leased from a limited liability company owned
70% by Mr. Steinberg and his relatives, 20% by Joel G. Stemple, Ph.D., the
Company's Executive Vice President and a principal shareholder, and 10% by
Michael Bivona, a shareholder of the Company. For the fiscal years ended July
31, 1998, 1997 and 1996, the Company made lease payments of $179,000, $174,000
and $216,000, respectively, to such entity. The Company's offices at 160 Oser
Avenue, Hauppauge, New York are leased from a limited liability company owned
65% by Mr. Steinberg, 17.5% by Dr. Stemple and 17.5% by Mr. Bivona. For the
fiscal years ended July 31, 1998, 1997, and 1996, the Company made lease
payments of $263,000, $259,000 and $360,000, respectively, to such entity. The
property located at 50 Marcus Boulevard, Hauppauge, New York is leased from Mr.
Steinberg doing business in the name of Marcus Realty. For the fiscal years
ended July 31, 1998, 1997 and 1996, the Company made lease payments of $340,000,
$329,000, and $435,000, respectively, to such entity. See
"Business--Properties."
Joel Rothlein, Esq., a director of the Company, is a partner of Kressel
Rothlein & Roth, Esqs., which, with its predecessor firms, has acted as outside
general counsel to the Company since the Company's inception. Kressel Rothlein &
Roth, Esqs. was paid approximately $89,000 (exclusive of disbursements) from the
Company for legal fees in the fiscal year ended July 31, 1996 and received fees
of approximately $655,000 from the Company in the fiscal year ended July 31,
1997, which sum includes fees paid to special counsel ($286,000). During fiscal
1998, $217,000 was paid to such firm for legal fees.
During the year ended July 31, 1998 and 1997, the Company recorded
revenue of $177,000 and $130,000 in connection with the sale of computer
equipment to a company controlled by Julian Sandler, a director of the Company.
22
PART IV
ITEM 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K
(a) (1) Financial Statements
The financial statements included herein are filed as a part
of this Report.
Manchester Equipment Co., Inc.
INDEX TO FINANCIAL STATEMENTS
Page
Independent Auditors' Report 24
Consolidated Financial Statements:
Balance Sheets as of July 31, 1998 and 1997 25
Statements of Income for the years ended July 31, 1998,
1997 and 1996 26
Statements of Shareholders' Equity for the years ended
July 31, 1998, 1997 and 1996 27
Statements of Cash Flows for the years ended July 31, 1998,
1997 and 1996 28
Notes to Consolidated Financial Statements 29
23
Independent Auditors' Report
The Board of Directors and Shareholders
Manchester Equipment Co., Inc.:
We have audited the accompanying consolidated balance sheets of Manchester
Equipment Co., Inc. and subsidiaries as of July 31, 1998 and 1997 and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the years in the three-year period ended July 31, 1998. In
connection with our audits of the consolidated financial statements, we have
also audited the financial statement schedule as listed in the accompanying
index. These consolidated financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Manchester Equipment
Co., Inc. and subsidiaries at July 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended July 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
KPMG PEAT MARWICK LLP
Melville, New York
September 18, 1998
24
Manchester Equipment Company, Inc. and Subsidiaries
Consolidated Balance Sheets
July 31, 1998 and 1997
Assets 1998 1997
------ ---- ----
(in thousands)
Current assets:
Cash and cash equivalents $7,816 $15,049
Investments 1,501 4,408
Accounts receivable, net of allowance for doubtful
accounts of $1,150 and $1,051, respectively 26,296 21,473
Inventory 9,167 10,127
Deferred income taxes 482 440
Prepaid expenses and other current assets 290 248
--- ---
Total current assets 45,552 51,745
Property and equipment, net 5,975 4,073
Goodwill, net 4,325 1,524
Deferred income taxes 475 379
Other assets 567 487
--- ---
$56,894 $58,208
======= =======
Liabilities and Shareholders' Equity
------------------------------------
Current liabilities:
Current maturities of long-term debt $ 82 $ 99
Notes payable-bank - 1,274
Notes payable - other - 264
Accounts payable and accrued expenses 18,358 19,283
Deferred service contract revenue 775 247
Income taxes payable 225 -
--- ------
Total current liabilities 19,440 21,167
Long-term debt, less current maturities - 77
Deferred compensation payable 109 87
Commitments and contingencies (note 8)
Shareholders' equity:
Preferred stock, $.01 par value, 5,000 shares
authorized, none issued - -
Common stock, $.01 par value; 25,000 shares
authorized, 8,097 and 8,525 shares issued
and outstanding 81 85
Additional paid-in capital 18,767 20,403
Deferred compensation (64) -
Retained earnings 18,561 16,389
------ ------
Total shareholders' equity 37,345 36,877
------ ------
$56,894 $58,208
======= =======
See accompanying notes to consolidated financial statements.
25
Manchester Equipment Company, Inc. and Subsidiaries
Consolidated Statements of Income
Years ended July 31, 1998, 1997 and 1996
1998 1997 1996
---- ---- ----
(in thousands except per share amounts)
Revenue
Products $197,194 $185,397 $189,659
Services 5,336 2,404 -
----- ----- ------
202,530 187,801 189,659
------- ------- -------
Cost of revenue
Products 168,083 159,877 163,128
Services 3,847 1,309 -
----- ----- ------
171,930 161,186 163,128
------- ------- -------
Gross profit 30,600 26,615 26,531
Selling, general and administrative expenses 27,414 21,023 22,598
------ ------ ------
Income from operations 3,186 5,592 3,933
Other income (expense):
Interest expense (41) (225) (399)
Investment income 587 560 25
Other - 60 9
---- -- -
Income before provision for income taxes 3,732 5,987 3,568
Provision for income taxes 1,560 2,450 1,430
----- ----- -----
Net income $2,172 $3,537 $2,138
====== ====== ======
Net income per share
Basic $0.26 $0.45 $0.34
===== ===== =====
Diluted $0.26 $0.45 $0.34
===== ===== =====
Weighted average shares of common
stock and equivalents outstanding
Basic 8,494 7,779 6,247
===== ===== =====
Diluted 8,499 7,779 6,247
===== ===== =====
See accompanying notes to consolidated financial statements.
26
Manchester Equipment Company, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
Years ended July 31, 1998, 1997 and 1996
Additional
Common Par Paid-in Deferred Retained
Shares Value Capital Compensation Earnings Total
------ ----- ------- ------------ -------- -----
(in thousands)
Balance July 31, 1995 6,263 $63 $ - $ - $5,974 $6,037
Purchase and retirement of
stock (63) (1) - - 1 -
Net income - - - - 2,138 2,138
-- -- -- -- ----- -----
Balance July 31, 1996 6,200 62 - - 8,113 8,175
Issuance of common stock 2,325 23 20,391 - - 20,414
Stock option commission
expense - - 12 - - 12
Transfer of redeemable
common stock - - - - 4,739 4,739
Net income - - - - 3,537 3,537
-- -- -- -- ----- -----
Balance July 31, 1997 8,525 85 20,403 - 16,389 36,877
Deferred compensation 20 - 80 (80) - -
Purchase and retirement of stock (448) (4) (1,781) - - (1,785)
Stock option commission expense - - 65 - - 65
Stock award compensation
expense - - - 16 - 16
Net income - - - - 2,172 2,172
-- -- -- -- ----- -----
Balance July 31, 1998 8,097 $81 $18,767 $(64) $18,561 $37,345
===== === ======= ==== ======= =======
See accompanying notes to consolidated financial statements.
27
Manchester Equipment Company, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended July 31, 1998, 1997 and 1996
1998 1997 1996
---- ---- ----
(in thousands)
Cash flows from operating activities:
Net income $2,172 $3,537 $2,138
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation and amortization 1,340 720 473
Allowance for doubtful accounts 75 210 132
Non-cash compensation and commission expense 81 12 -
Deferred income taxes (138) (90) (86)
Gain on disposition of assets - (37) (9)
Change in assets and liabilities; net of the effects
of acquisitions:
Increase in accounts receivable (4,430) (545) (1,700)
Decrease in inventory 1,882 515 548
(Increase) decrease in prepaid expenses and
other current assets (12) (44) 41
(Increase) decrease in other assets - 342 (307)
(Decrease) increase in accounts payable and
accrued expenses (1,997) 221 2,715
Increase in deferred service contract revenue 213 118 27
Increase (decrease) in income taxes payable 225 (295) 205
Increase (decrease) in deferred compensation payable 22 (96) (15)
(Purchase) sale of investments 2,907 (4,408) -
----- ------
Net cash provided by operating activities 2,340 160 4,162
----- --- -----
Cash flows from investing activities:
Capital expenditures (2,972) (2,439) (1,028)
Proceeds from the sale of assets - - 55
Payment for acquisitions, net of cash acquired (2,921) (1,886) __-
------ ------
Net cash used in investing activities (5,893) (4,325) (973)
------ ------ ----
Cash flows from financing activities:
Net repayments or borrowings from bank (1,274) (6,490) 900
Payments on note payable shareholder - (353) (118)
Payments on capitalized lease obligations (140) (98) (31)
Payments on notes payable - other (481) (33) -
Net proceeds from initial public offering - 20,414 -
Purchase and retirement of common stock (1,785) - -
------ ---- ---
Net cash provided by (used in) financing activities (3,680) 13,440 751
------ ------ ---
Net increase (decrease) in cash and cash equivalents (7,233) 9,275 3,940
Cash and cash equivalents at beginning of year 15,049 5,774 1,834
------ ----- -----
Cash and cash equivalents at end of year $7,816 $15,049 $5,774
====== ======= ======
Cash paid during the year for:
Interest $41 $225 $399
=== ==== ====
Income taxes $1,428 $2,868 $1,290
====== ====== ======
Other noncash transactions:
Capitalized lease obligation $ - $ - $305
=== == ====
Purchase of stock for notes payable-shareholder $ - $ - $471
=== === ====
See accompanying notes to consolidated financial statements.
28
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
(1) Operations and Summary of Significant Accounting Policies
---------------------------------------------------------
(a) The Company
-----------
Manchester Equipment Company, Inc. ("the Company") is a network
integrator and reseller of computer hardware, software and networking
products, primarily for commercial customers. The Company offers its
customers single-source solutions customized to their information systems
needs by combining value-added services with hardware, software,
networking products and peripherals from leading vendors.
Sales of hardware, software and networking products comprise the
majority of the Company's revenues. The Company has entered into
agreements with certain suppliers and manufacturers which provide the
Company favorable pricing and price protection in the event the vendor
reduces its prices.
(b) Principles of Consolidation
---------------------------
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All material intercompany
transactions and balances are eliminated in consolidation.
(c) Cash Equivalents
----------------
The Company considers all highly liquid investments with original
maturities at the date of purchase of three months or less to be cash
equivalents.
(d) Investments
-----------
The Company classifies its marketable debt securities in one of three
categories: trading, available for sale, or held to maturity and its
marketable equity securities as trading, or available for sale. Trading
securities are bought and held principally for the purpose of selling them
in the near term. Held-to-maturity securities are those debt securities in
which the Company has the ability and intent to hold the security until
maturity. All other securities not included in trading or held-to-maturity
are classified as available-for-sale.
Trading and available-for-sale securities are recorded at fair value.
Held-to-maturity securities are recorded at amortized cost, adjusted for
the amortization or accretion of premiums or discounts. Unrealized holding
gains and losses on trading securities are included in earnings.
Unrealized holding gains and losses, net of the related tax effect, on
available-for-sale securities are excluded from earnings and are reported
as a separate component of shareholders' equity until realized. Transfers
of securities between categories are recorded at fair value at the date of
transfer. Unrealized holding gains and losses are recognized in earnings
for transfers into trading securities.
Dividend and interest income are recognized when earned. Cost is
maintained on a specific identification basis for purposes of determining
realized gains and losses on sales of investments.
(e) Revenue Recognition
-------------------
Revenue from product sales is recognized at the time of shipment to the
customer. Revenue for services is recognized when the related services are
performed. When product sales and services are bundled, revenue is
recognized upon delivery of the product and completion of the services.
Service contract fees are recognized as revenue ratably over the period of
the applicable contract. Deferred service contract revenue represents
29
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
the unearned portion of service contract fees. The Company generally does
not develop or sell software products. However, certain computer hardware
products sold by the Company are loaded with prepackaged software
products. The net impact on the Company's financial statements of product
returns, primarily for defective products has been insignificant.
(f) Market Development Funds
------------------------
The Company receives various market development funds including
cooperative advertising funds from certain vendors, principally based on
volume purchases of products. The Company records such amounts related to
volume purchases as purchase discounts which reduce cost of revenue and
other incentives that require specific incremental action on the part of
the Company, such as training, advertising or other pre-approved market
development activities as an offset to the related costs included in
selling, general and administrative expenses. Total market development
funds amounted to $623, $521 and $943 for the years ended July 31, 1998,
1997 and 1996, respectively.
(g) Inventory
---------
Inventory, consisting of computer hardware, software and related
supplies, is valued at the lower of cost (first-in first-out) or market
value.
(h) Property and Equipment
----------------------
Property and equipment are stated at cost. Depreciation is provided
using the straight-line and accelerated methods over the economic lives of
the assets, generally from five to seven years. Leasehold improvements are
amortized over the shorter of the underlying lease term or asset life.
(i) Goodwill
--------
Goodwill related to acquisitions represents the excess of cost over the
fair value of net assets acquired. Goodwill is amortized on a
straight-line basis over twenty years. The Company reviews the significant
assumptions that underlie the twenty-year amortization period on a
quarterly basis and will shorten the amortization period if considered
necessary. The Company assesses the recoverability of this intangible
asset by determining whether the amortization of the goodwill balance over
its remaining life can be recovered through projected undiscounted future
cash flows. Accumulated amortization was approximately $183 and $19 at
July 31, 1998 and 1997, respectively. Amortization expense of $164 and $19
for the years ended July 31, 1998 and 1997 is included in selling general
and administrative expenses in the consolidated statements of income.
(j) Income Taxes
------------
Deferred taxes are recognized for the future tax consequences
attributable to temporary differences between the carrying amounts of
assets and liabilities for financial statement purposes and income tax
purposes using enacted rates expected to be in effect when such amounts
are realized or settled. The effect on deferred taxes of a change in tax
rates is recognized in income in the period that includes the enactment
date.
(k) Net Income Per Share
--------------------
In fiscal 1998, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" ("EPS"). It replaces the
presentation of primary EPS with the presentation of basic EPS and
replaces fully diluted EPS with diluted EPS. It also requires a dual
presentation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures and requires a
reconciliation of the numerators and denominators of the basic EPS
computation to the numerator and denominator of the diluted EPS
computation. Prior periods' EPS data have been restated to conform with
Statement No. 128.
30
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
Basic net income per share has been computed by dividing net income by
the weighted average number of common shares outstanding. Diluted net
income per share has been computed by dividing net income by the weighted
average number of common shares outstanding, plus the assumed exercise of
dilutive stock options and warrants, less the number of treasury shares
assumed to be purchased from the proceeds of such exercises using the
average market price of the Company's common stock during each respective
period. Options and warrants representing 380 and 1,052 shares for the
years ended July 31, 1998 and 1997, respectively, were not included in the
computation of diluted EPS because to do so would have been antidilutive.
The following table reconciles the denominators of the basic and diluted
per share computations. For each year, the numerator is the net income as
reported.
1998 1997 1996
---- ---- ----
Per Share Per Share Per Share
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------
Basic EPS 8,494,000 $0.26 7,779,000 $0.45 6,247,000 $0.34
===== ===== =====
Effect of dilutive
options 5,000 - -
----- ---- ----
Diluted EPS 8,499,000 $0.26 7,779,000 $0.45 6,247,000 $0.34
========= ===== ========= ===== ========= =====
(l) Impairment of Long-Lived Assets
-------------------------------
The Company evaluates its long-lived assets, certain intangibles, and
goodwill related to those assets to be held and used, and long-lived
assets and certain identifiable intangibles to be disposed of and
recognizes an impairment if it is probable that the recorded amounts are
in excess of anticipated undiscounted future cash flows. If the sum of the
expected cash flows, undiscounted and without interest, is less than the
carrying amount of the assets, an impairment loss is recognized as the
amount by which the carrying amount of the asset exceeds the fair value.
(m) Accounting for Stock-Based Compensation
---------------------------------------
The Company records compensation expense for employee stock options if
the current market price of the underlying stock exceeds the exercise
price on the date of the grant. On August 1, 1996, the Company adopted
SFAS No. 123, "Accounting for Stock-Based Compensation." The Company has
elected not to implement the fair value based accounting method for
employee stock options, but has elected to disclose the pro forma net
income and net income per share for employee stock option grants made
beginning in fiscal 1996 as if such method had been used to account for
stock-based compensation cost as described in SFAS No.
123.
(n) Use of Estimates
----------------
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period to prepare these financial statements in
conformity with generally accepted accounting principles. Actual results
could differ from those estimates.
(o) Fair Value of Financial Instruments
-----------------------------------
The fair values of cash equivalents, accounts receivable, prepaid
expenses, accounts payable and accrued expenses, and long-term debt are
estimated to be the carrying values at July 31, 1998 due to the short
maturity of such instruments.
31
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
(p) Reclassifications
-----------------
Certain prior year information has been reclassified to conform with
the 1998 presentation format.
(2) Investments
-----------
The Company classified all its investments at July 31, 1998 and 1997 as
trading securities. Fair value of U.S. government obligations and other
securities are based on quoted market prices. The gross unrealized holding gains
and fair values of investments by major type at July 31, 1998 and 1997 were as
follows:
Gross Unrealized Fair Value
Holding Gain of Investment
------------ -------------
At July 31, 1998
U.S. government obligation $ 1 $ 501
Corporate commercial instruments - 1,000
-- -----
$ 1 $1,501
=== ======
At July 31, 1997
U.S. government obligation $ 2 $1,007
Corporate commercial instruments - 3,401
-- -----
$ 2 $4,408
=== ======
At July 31, 1998 and 1997 all investments had maturities of less than one
year.
(3) Property and Equipment
----------------------
Property and equipment at July 31, consist of the following:
1998 1997
---- ----
Furniture and fixtures $2,327 $2,096
Machinery and equipment 4,289 3,401
Transportation equipment 426 281
Leasehold improvements 2,284 2,168
----- -----
9,326 7,946
Less accumulated depreciation and amortization 3,351 3,873
----- -----
$5,975 $4,073
====== ======
Depreciation and amortization expense amounted to $1,176, $701, and
$473 for the years ended July 31, 1998, 1997 and 1996, respectively.
(4) Acquisitions
------------
Electrograph Systems. Inc.
- --------------------------
On April 25, 1997, the Company, through a newly formed wholly-owned
subsidiary, acquired substantially all of the assets and assumed certain
liabilities of Electrograph Systems, Inc. ("Electrograph"). Electrograph is a
specialized distributor of microcomputer peripherals, primarily in the eastern
United States. The purchase price and transaction costs aggregated approximately
$2,600, plus liabilities assumed. Included in the liabilities assumed were notes
payable-bank and notes payable-other with balances of $1,274 and $264,
respectively, at July 31, 1997 which were repaid in fiscal 1998.
32
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
The acquisition has been accounted for as a purchase and the operating
results of Electrograph are included in the consolidated statements of income
from the date of acquisition. The acquisition resulted in goodwill of $1,543,
which is being amortized on the straight-line basis over 20 years.
Coastal Office Products, Inc.
- -----------------------------
On January 2, 1998, the Company acquired all of the outstanding shares
of Coastal Office Products, Inc. ("Coastal"), a value added reseller and
provider of microcomputer services and peripherals to companies in the greater
Baltimore, Maryland area. The acquisition, which has been accounted for as a
purchase, consisted of a cash payment of approximately $3,100 plus potential
future contingent payments. Contingent payments of up to $1,050 in each of
calendar 1998 and 1999 will be determined based upon achieving certain agreed
upon increases in revenues and pretax income for calendar 1998 and 1999 over
calendar 1997 amounts. The cash payment was made from the Company's cash
balances. Contingent payments, if any, would be paid in cash (or, under certain
conditions, in Company common stock) on March 15, 1999 and March 15, 2000. The
selling shareholders received employment agreements that also provided for the
issuance of 20,000 shares of common stock. The fair value of the common stock,
amounting to $80 was recorded as deferred compensation and is being expensed
over the three year vesting period.
Operating results of Coastal are included in the consolidated
statements of income from the date of acquisition. The acquisition resulted in
goodwill of $2,965, which is being amortized on the straight-line basis over 20
years.
The following unaudited pro forma consolidated results of operations
for the years ended July 31, 1998 and 1997 assume that the Coastal and
Electrograph acquisitions occurred on August 1, 1996 and reflect the historical
operations of the purchased businesses adjusted for lower interest on invested
funds, contractually revised officer compensation and rent (for Coastal) and
increased amortization, net of applicable income taxes, resulting from the
acquisitions:
Year ended July 31,
1998 1997
---- ----
Revenue $206,105 $216,118
Net income $2,186 $3,749
Diluted net income per share $0.26 $0.48
The pro forma results of operations are not necessarily indicative of the
actual results that would have occurred had the acquisitions been made at the
beginning of the period, or of results which may occur in the future.
(5) Accounts Payable and Accrued Expenses
-------------------------------------
Accounts payable and accrued expenses consist of the following:
July 31,
--------
1998 1997
---- ----
Accounts payable, trade $14,659 $15,783
Accrued salaries and wages 2,462 1,630
Customer deposits 494 740
Other accrued expenses 743 1,130
--- -----
$18,358 $19,283
======= =======
33
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
The Company has entered into financing agreements for the purchase
of inventory. These agreements are secured by the related inventory and/or
accounts receivables. In each of the years in the three-year period ended
July 31, 1998, the Company has repaid all balances outstanding under these
agreements within the 30 day non-interest bearing payment period.
Accordingly, amounts outstanding under such agreements of $2,372 and $5,184
at July 31, 1998 and 1997, respectively, are included in accounts payable
and accrued expenses. Prior to December 1996, pursuant to certain
intercreditor agreements, these financing agreements were subordinated to
the Company's line of credit agreement except as to specific inventory
purchased under these financing agreements. In August 1997, the Company
entered into a new financing agreement for the purchase of inventory. The
agreement provides a maximum of $10,000 in credit for purchases of
inventory from certain specified manufacturers. The new agreement is
unsecured, allows for a 30 day non-interest bearing payment period and
requires the Company to maintain, among other things, a certain minimum
tangible net worth. As of July 31, 1998, retained earnings available for
dividends amounts to approximately $8,400.
(6) Long-Term Debt
--------------
In January 1996, the Company entered into a capitalized lease
obligation for certain computer equipment. Future minimum payments required
under such lease are $85 (including interest of $3) in fiscal 1999.
(7) Employee Benefit Plans
----------------------
The Company maintains a qualified defined contribution plan with a
salary deferral provision, commonly referred to as a 401(k) plan. The
Company matches 50% of employee contributions up to three percent of the
employees' compensation. The Company's contribution amounted to $205, $161
and $124 for the years ended July 31, 1998, 1997 and 1996, respectively.
The Company also has a deferred compensation plan which is available to
certain eligible key employees. The plan consists of life insurance
policies purchased by the Company for the participants. Upon vesting, which
occurs at various times from three to ten years, the participant becomes
entitled to have ownership of the policy transferred to him or her at
termination of employment with the Company. As of July 31, 1998 and 1997
the Company has recorded an asset (included with other assets) of $109 and
$87, respectively, representing the cash surrender value of policies owned
by the Company and a liability of the same amount relating to the unvested
portion of benefits due under this plan. For the years ended July 31, 1998,
1997 and 1996, the Company recorded an expense of $105, $110 and $72 in
connection with this plan.
(8) Commitments and Contingencies
-----------------------------
Leases
------
The Company leases most of its executive offices and warehouse
facilities primarily from related parties (Note 11). In addition, the
Company is obligated under lease agreements for sales offices and
additional warehouse space. Aggregate rent expense under all these leases
amounted to $1,255, $1,073 and $1,212 for the years ended July 31, 1998,
1997 and 1996.
The following represents the Company's commitment under operating
leases for the next five years ended July 31:
1999 $1,460
2000 $1,489
2001 $1,221
2002 $1,272
2003 $975
34
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
Litigation
----------
The Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, based on
advice from its legal counsel, the ultimate disposition of these matters
will not have a material adverse effect.
On January 12, 1998, the Company announced that it had reached an
agreement in principle settling the Shareholder Securities Class Action
("Lawsuit") filed against the Company and certain of its officers in March
1997. The settlement resulted in the distribution of $1,350 minus approved
attorney's fees and related expenses, to purchasers of the Company's common
stock in the Company's initial public offering, and during the period of
November 26, 1996 to February 13, 1997. The entire $1,350 cash settlement
was paid by the Company's insurance carrier.
The settlement included a release of all claims that were asserted or
that could have been asserted in the Lawsuit against the Company and its
officers and directors. The Company agreed to the settlement solely to
avoid the expense, burdens and uncertainties of further litigation and
continues to deny that it has any liability on account of the matters
asserted in the litigation or that the Plaintiffs' claims had merit.
(9) Line of Credit
--------------
In July 1998, the Company entered into a revolving credit facility with
its banks. Under the terms of the facility, the Company may borrow up to a
maximum of $15,000. The maximum borrowings are reduced to $12,500 at April
1, 2000 and $10,000 on April 1, 2001. Borrowings under the facility bear
interest at variable interest rates based upon several options available to
the Company. The facility requires the Company to maintain certain
financial ratios and covenants. As of July 31, 1998, there was no balance
outstanding under this agreement, which expires on March 31, 2002.
35
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
(10) Income Taxes
------------
The provision for income taxes for the years ended July 31, 1998, 1997 and
1996 consists of the following:
1998 1997 1996
---- ---- ----
Current
Federal $1,300 $1,938 $1,166
State 398 602 350
--- --- ---
1,698 2,540 1,516
----- ----- -----
Deferred
Federal (105) (68) (73)
State (33) (22) (13)
--- --- ---
(138) (90) (86)
---- --- ---
$1,560 $2,450 $1,430
====== ====== ======
The difference between the Company's effective income tax rate and the
statutory rate is as follows, for the years ended July 31, 1998, 1997 and
1996:
1998 1997 1996
---- ---- ----
Income taxes at statutory rate $1,269 $2,036 $1,213
State taxes, net of
federal benefit 241 383 222
Other 50 31 (5)
-- -- --
$1,560 $2,450 $1,430
====== ====== ======
The tax effects of temporary differences that give rise to significant
portions of the net deferred tax asset at July 31, 1998 and 1997 were as
follows:
1998 1997
---- ----
Deferred tax assets:
Allowance for doubtful accounts $450 $410
Deferred compensation 315 270
Other 192 139
--- ---
Deferred tax asset $957 $819
==== ====
A valuation allowance has not been provided in connection with the
deferred tax assets since the Company believes that it is more likely than
not that such deferred tax assets will be realized.
36
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
(11) Related Party Transactions
--------------------------
The Company leases its warehouse and distribution center as well as its
corporate offices and certain sales facilities from entities owned or
controlled by shareholders, officers, or directors of the Company. The
leases generally cover a period of ten years and expire at various times
from 1998 through 2005. Lease terms generally include annual increases of
five percent. Rent expense for these facilities aggregated $782, $771, and
$1,022 for the years ended July 31, 1998, 1997 and 1996, respectively.
The Company paid legal fees to a law firm in which a director of the
Company is a partner. Such fees amounted to $217, $655, and $383,
including disbursements, in the fiscal years ended July 31, 1998, 1997,
and 1996 respectively.
During fiscal year ended July 31, 1998 and 1997 the Company received
approximately $177 and $130, respectively, in revenue from a company
controlled by a director of the Company.
(12) Shareholders' Equity
--------------------
Initial Public Offering
-----------------------
On December 2, 1996, the Company completed an initial public offering
(IPO) of 2,325,000 shares of its common stock at an initial public
offering price of $10 per share. Net proceeds to the Company were $20,414
after deducting the underwriting discounts and commissions and other costs
associated with the IPO. In connection with the IPO, the Company issued to
the underwriter warrants to purchase an aggregate of 250,000 shares of
common stock. The warrants are exercisable at a price of $12 per share and
expire in December, 2001.
Redeemable Common Stock
-----------------------
Prior to the IPO, the Company was a party to an agreement among its
shareholders whereby each of the Company's two minority shareholders had
the right to demand that upon termination, retirement, or death, the
Company redeem his interest at differing values stated in the agreement.
The Company maintains term life insurance with a face value of $1,500 to
be used towards the purchase of the shares in the event of the death of
each shareholder. One of the minority shareholders retired in fiscal 1996
and based upon the terms of the agreement and a subsequent agreement
entered into in May 1996, payment was fixed at $4,710 for the
shareholder's interest in the Company (626,263 shares at the time of the
agreement). The shareholder had an annual option to redeem one-tenth of
his shares commencing in fiscal 1996, at an annual price of $471 to be
paid in equal quarterly installments over the following year. In
connection with such agreements, in May 1996 the Company purchased 62,626
shares of common stock from the retired minority shareholder. The purchase
price was $471, which was paid in four non-interest bearing equal
quarterly installments beginning on May 1, 1996. Such shares were
subsequently retired.
In September 1996, among other provisions, the retired minority
shareholder agreed to terminate his put options to sell his remaining
shares to the Company upon the effective date of the Company's IPO. In
addition, the shareholders' agreement terminated upon the effective date
of the Company's IPO. As a result of the successful completion of the IPO,
the amounts which would have been due under the agreements were
reclassified from redeemable common stock to retained earnings.
37
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
Stock Option Plan
-----------------
Under the Company's Amended and Restated 1996 Incentive and
Non-Incentive Stock Option Plan (the "Plan"), which was approved by the
Company's shareholders in October 1996, an aggregate of 1,100,000 shares of
common stock are reserved for issuance upon exercise of options thereunder.
Under the Plan, incentive stock options, as defined in section 422 of the
Internal Revenue Code of 1986, as amended, may be granted to employees and
non-incentive stock options may be granted to employees, directors and such
other persons as the Board of Directors may determine, at exercise prices
equal to at least 100% (with respect to incentive stock options) and at
least 85% (with respect to non-incentive stock options) of the fair market
value of the Common Stock on the date of grant. In addition to selecting
the optionees, the Board of Directors will determine the number of shares
of Common Stock subject to each option, the term of each stock option up to
a maximum of ten years (five years for certain employees for incentive
stock options), the time or times when the stock option becomes
exercisable, and otherwise administer the Plan. Incentive stock options
expire three months from the date of the holder's termination of employment
with the Company other than by reason of death or disability. Options may
be exercised with cash or common stock previously owned for in excess of
six months. During fiscal 1997, 742,350 and 60,000 options were granted at
$10 and $5, respectively, per share. Such exercise prices were greater than
or equal to the market value on the date of grant. Vesting commences one or
two years from the date of grant and ranges from one to seven years. On
December 22, 1997, the exercise price of all then outstanding options was
reduced to $3.8125 per share, which was the closing market price of the
Company's common stock on that date. The following table summarizes stock
option activity to date:
Average
Exercise
Balance Price
------- -----
Balance August 1, 1996 - -
Granted 802,350 $9.63
------- -----
Balance July 31, 1997 802,350 $9.63
Granted 220,000 $4.24
Cancelled (172,750) $3.8125
-------- -------
Balance July 31, 1998 849,600 $3.92
======= =====
At July 31, 1998, 2,500 options exercisable at $3.8125 per share were
exercisable and all options granted expire ten years from the date of
grant. The range of exercise prices for options outstanding at July 31,
1998 was $3,8125 - $5.00 with a remaining life of approximately nine years.
The Company has adopted the pro forma disclosure provision of SFAS No.
123, "Accounting for Stock Based Compensation". Accordingly, the Company
does not record compensation cost in the financial statements for its stock
options which have an exercise price equal to or greater than the fair
value of the underlying stock on the date of grant. The Company has
recognized $108 in deferred commission expense representing the value of
stock options granted to non-employee sales representatives. Such cost is
expensed over the vesting period, amounting to $65 and $12 in fiscal 1998
and 1997, respectively. Had compensation cost for the Company's stock
option grants been determined based on the fair value at the grant date
under SFAS No. 123, the Company's net income and net income per share for
the years ended July 31, 1998 and 1997 would approximate the pro forma
amounts below:
1998 1997
---- ----
Net Income:
As reported $2,172 $3,537
Pro forma 1,992 $3,464
Diluted net income per share:
As reported $0.26 $0.45
Pro forma $0.23 $0.45
38
Manchester Equipment Company, Inc. and Subsidiaries
Notes to Financial Statements
July 31, 1998, 1997 and 1996
(in thousands, except share and per share data)
The pro forma effects on net income and diluted net income per share for
1998 and 1997 may not be representative of the pro forma effects in future
years.
The fair value of options granted was estimated using the Black-Scholes
option pricing model with the following weighted average assumptions:
1998 1997
---- ----
Expected dividend yield 0% 0%
Expected stock volatility 27% 29%
Risk free interest rate 5% 5%
Expected option term until exercise (years) 4.70 4.27
The per share weighted average fair value of stock options granted during fiscal
1998 and 1997 was $1.09 and $1.05, respectively.
Repurchase of Common Stock
- --------------------------
During the year ended July 31, 1998, the Company repurchased 448,400 shares
of its common stock at an aggregate purchase price of $1,785. Such shares were
subsequently retired.
(13) Major Customer and Vendors and Concentration of Credit Risk
-----------------------------------------------------------
The Company sells and services customers that are located primarily in
the eastern United States. One customer accounted for approximately 7%, 15% and
16% of total revenues for the years ended July 31, 1998, 1997 and 1996,
respectively.
The Company's top three vendors accounted for approximately 24%, 13% and 11% of
total product purchases for the year ended July 31, 1998. The Company's top two
vendors accounted for approximately 17% and 15% of total product purchases for
the year ended July 31, 1997. The Company's top four vendors accounted for 20%,
12%, 11% and 10% of total product purchases for the year ended July 31, 1996.
One customer accounted for 5% of the Company's accounts receivable at
July 31, 1998.
39
ITEM 14. Exhibits, Financial Statements, Schedules, and Reports on Form 8-K
(Continued)
(2) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts and Reserves
All other schedules are omitted because they are not
applicable or the required information is shown in the
financial statements or notes thereto.
(3) Exhibits:
3.1.a(1) Certificate of Incorporation of Registrant filed August 21, 1973.
3.1.b(1) Certificate of Amendment of Certificate of Incorporation filed
January 29, 1985.
3.1.c(1) Restated Certificate of Incorporation filed October 1, 1996.
3.2(1) Bylaws of Registrant.
4.2(1) Form of Representative's Warrants.
10.1(1) 1996 Incentive and Non-Incentive Stock Option Plan of Registrant.
10.2(1) Agreement dated September 24, 1996 between Registrant and Michael
Bivona.
10.3(1) * Compensation Agreement dated November 6, 1996 between Registrant and
Joel G. Stemple.
10.4(1) * Agreement of Employment dated September 30, 1996 between Registrant
and Barry Steinberg
10.4.a(1)* Amendment dated November 6, 1996 to Agreement of Employment dated
September 30, 1996 between Registrant and Joel G. Stemple.
10.5.a(1) Lease dated October 1995 between Registrant and 40 Marcus Realty, LLC
- f/k/a 40 Marcus Realty Associates, as amended.
10.5.b(1) Lease dated January 1988 between Registrant and Marcus Realty, as
amended.
10.5.c(1) Lease dated June 1995 between Registrant and Facilities Management.
10.5.d(1) Lease dated July 31, 1995 between Registrant and Boatman's Equities,
LLC - f/k/a 160 Oser Avenue Associates, as amended.
10.5.e(1) Lease dated January 15, 1992 between Registrant and 352 Seventh Avenue
Associates.
10.5.f(1) Lease dated April 16, 1990 between Registrant and Regent Holding
Corporation, as successor to Crow-Childress-Donner, Limited, as
amended.
10.5.g(1) Business Lease dated December 4, 1992 between Registrant and TRA
Limited, as amended.
10.5.h(5) Lease dated June 23, 1997 between Registrant and First Willow, LLC.
10.5.i(5) Lease dated June 30, 1997 between Registrant and Angela C. Maffeo,
Trustee Under the Will of John Capobianco.
10.5.j(6) Lease dated October 1, 1997 between Registrant and Spanish River
Executive Plaza, Ltd. A/k/a Century Financial Plaza.
40
10.5.k(4) Lease dated January 2, 1998 between Coastal Office Products, Inc. and
BC & HC Properties, LLC
10.6.2 Promissory Note dated October 15, 1996 between Registrant and The
Bank of New York
10.7.a(1) Letter Agreement Regarding Inventory Financing dated December 7, 1993
between ITT Commercial Finance Corp. and Registrant.
10.7.b(1) Agreement for Wholesale Financing dated November 11, 1993 between ITT
Commercial Finance Corp. and Registrant.
10.7.c(1) Intercreditor Agreement dated May 18, 1994 between ITT Commercial
Finance Corp. and The Bank of New York.
10.8.(1) Letter Agreement Regarding Inventory Financing dated April 22, 1996
between AT&T Capital Corporation and Registrant.
10.8.b(1) Intercreditor Agreement dated May 18, 1994 between AT&T Commercial
Finance Corporation and The Bank of New York.
10.9(1) Reseller Agreement dated May 1, 1990 between Toshiba America
Information Systems, Inc. and Registrant.
10.10(1) Agreement for Authorized Resellers dated March 1, 1996 between
Hewlett-Packard Company and Registrant.
10.11(3) Asset Purchase Agreement dated April 15, 1997 among Electrograph
Systems, Inc., Bitwise Designs, Inc., Electrograph Acquisition,
Inc. and Registrant.
10.12(4) Definitive Purchase Agreement and Indemnity Agreement dated January 2,
1998 between Registrant and Coastal Office Products, Inc.
10.13 $15,000,000 Revolving Credit Facility Agreement dated July 21, 1998
between Registrant and Bank of New York, as Agent.
27 Financial Data Schedule.
(b) Reports on Form 8-K
The Registrant did not file any reports on Form 8-K during the last
quarter of the period covered by this report, and none were required.
- -----------------------
* Denotes management contract or compensatory plan or arrangement required to
be filed as an Exhibit to this Annual Report on Form 10-K.
1 Filed as the same numbered Exhibit to the Company's Registration Statement on
Form S-1 (File No. 333- 13345) and incorporated herein by reference thereto.
2 Filed as the same numbered Exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended October 31, 1996 (Commission File No. 0-21695) and
incorporated herein by reference thereto.
3 Filed as the same numbered Exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended April 30, 1997 (Commission File No. 0-21695) and
incorporated herein by reference thereto.
4 Filed as the same numbered Exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended January 31, 1998 (Commission File No. 0-21695) and
incorporated herein by reference thereto.
5 Filed as the same numbered Exhibit to the Company's Annual Report on Form 10-K
for the year ended July 31, 1997.
6 Filed as the same numbered Exhibit to the Company's Quarterly Report on Form
10-Q for the quarter ended October 31, 1997 (Commission File No. 0-21695) and
incorporated herein by reference thereto.
41
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, thereunder duly authorized.
Manchester Equipment Co., Inc.
Date: October 27, 1998 By: ss: Barry Steinberg
---------------
Barry R. Steinberg
President, Chief 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 this Registrant and
in the capacities and on the dates indicated.
ss: Barry R. Steinberg Date: October 27, 1998
------------------
Barry R. Steinberg
President, Chief Executive Officer,
Chairman of the Board and Director
(Principal Executive Officer)
ss: Joel G. Stemple Date: October 27, 1998
---------------
Joel G. Stemple
Executive Vice President and Director
ss: Joseph Looney Date: October 27, 1998
-------------
Joseph Looney
Chief Financial Officer (Principal Accounting Officer)
ss: Joel Rothlein Date: October 27, 1998
-------------
Joel Rothlein
Director
ss: Julian Sandler Date: October 27, 1998
--------------
Julian Sandler
Director
ss: Michael Russell Date: October 27, 1998
---------------
Michael Russell
Director
ss: Bert Rudofsky Date: October 27, 1998
-------------
Bert Rudofsky
Director
42
Manchester Equipment Co., Inc.
Schedule II - Valuation and Qualifying Accounts
(dollars in thousands)
Column C-Additions
Column B- (1)- (2)- Column D- Column E-
Column A - Balance at Charged to Charged to Deductions- Balance at
Description beginning of costs and other (a) end of period
period expenses accounts (b) ---------- -------------
------ -------- ------------
Allowance for doubtful
accounts
Year ended:
July 31, 1996 $718 $132 $ 50 $800
July 31, 1997 $800 $339 $40 $128 $1,051
July 31, 1998 $1,051 $351 $25 $277 $1,150
(a) Write-off amounts against allowance provided.
(b) Recorded in connection with the acquisitions.