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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 10 AND 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: OCTOBER 31, 1998 COMMISSION FILE NUMBER: 0-24015
DUNN COMPUTER CORPORATION
(Exact Name of Registrant as Specified in its Charter)
VIRGINIA 54-1890464
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
1306 SQUIRE COURT
STERLING, VIRGINIA 20166
(Address of principal executive office) (Zip Code)
703-450-0400
Registrant's telephone number, including area code:
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SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
NONE
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SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE
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(Title of class)
Indicate by check mark whether the issuer (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past 12 months (or for such shorter period that the issuer was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes /X/ No / /
Indicate by check mark if there is no disclosure of delinquent filers in
response to Item 405 of Regulation K contained in this form, and no disclosure
will be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K./ /
The aggregate market value of the voting and non-voting common equity held
by non-affiliates computed at $5.25 per share, the closing price of the Common
Stock on January 22, 1999, was $28,624,275.
The number of shares of the issuer's Common Stock, outstanding as of January
29, 1999 was 8,991,493.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information called for by Part III of the Form 10-K will either be
filed with the Commission under Regulation 14A under the Securities Exchange Act
of 1934 or by amendment to this Form 10-K, in either case on or before February
28, 1999.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report regarding matters that
are not historical facts are forward-looking statements (as such term is defined
in the Private Securities Litigation Reform Act of 1995). Because such
statements include risks and uncertainties, actual results may differ materially
from those expressed or implied by such forward-looking statements. Factors that
could cause actual results to differ materially include, but are not limited to,
changes in component costs, the Government's available funding for IT purchases,
the Company's ability to successfully integrate the IDP business and operations,
the actions of competitors, the Company's ability to retain its existing
contracts and to procure additional contracts or other selling vehicles and
general economic conditions. These risks and others are discussed in more detail
in context throughout this document. The Company disclaims any intent or
obligation to update any forward-looking statement.
TABLE OF CONTENTS
PART I
Item 1. Business................................................................... p. 3
Item 2. Properties................................................................. p. 10
Item 3. Legal Proceedings.......................................................... p. 11
Item 4. Submission of Matters to a Vote of Security Holders........................ p. 11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...... p. 11
Item 6. Selected Financial Data.................................................... p. 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................. p. 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................. p. 18
Item 8. Financial Statements and Supplementary Data................................ p. 18
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................. p. 19
PART III
Item 10. Directors and Executive Officers of the Registrant.........................
Item 11. Executive Compensation.....................................................
Item 12. Security Ownership of Certain beneficial Owners and Management.............
Item 13. Certain Relationships and Related Transactions.............................
(Part III information is incorporated by reference to portions of the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A)
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............ p. 19
1
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Dunn Computer Corporation (together with its wholly-owned subsidiaries, the
"Company" or "Dunn") manufactures custom computer systems and provides related
services to departments, agencies and offices of the federal government (the
"Government") and selected businesses. The Company provides its customers with
single-source solutions by manufacturing its own brand of desktop and portable
computers and high performance network client servers and offering services,
which include network consulting, project implementation, and technical support.
The Company currently derives most of its revenues from hardware sales to the
Government, but also provides hardware and services to medium and large
businesses. The Company sells its products and services to more than 300
customers, including entities within the Department of Defense, Administrative
Office of the U.S. Courts, Lockheed Martin Corporation, Blue Cross and Blue
Shield Association and the District of Columbia Government.
Dunn was founded in 1987 and initially resold third party computers to the
Government. In 1991, Dunn began to manufacture and market its own line of
computers to better serve the rapidly changing Government market. In April 1997,
the Company sold 1,000,000 shares of common stock ("Common Stock") in an initial
public offering for net proceeds of $3,917,664. In connection with the offering,
warrants were issued to the underwriter for 100,000 shares of common stock at an
exercise price of $6.00 per share. Beginning April 21, 1998, the warrants are
exercisable for a period of four years.
In September 1997, Dunn completed the acquisition of STMS, Inc. a
Virginia-based network services company ("STMS") which expanded Dunn's
capabilities to provide a wide variety of services including network consulting,
project implementation and technical support. The STMS acquisition provided the
Company new opportunities to sell computer hardware into the commercial
marketplace as part of a total package of information technology ("IT") hardware
and services tailored to meet the commercial customers' needs. By manufacturing
its own computer systems, the cost of which represents a significant portion of
the cost of a total project, the Company believes it has a sustainable
competitive advantage over other network service providers.
On May 1, 1998, Dunn acquired International Data Products, Corp. ("IDP Co.")
and the net assets of IDP Co.'s Puerto Rican affiliate, Puerto Rico Industrial
Manufacturing Operations, Corp. ("PRIMO" and together with IDP Co., "IDP"), for
approximately $22 million, consisting of a combination of cash and Common Stock
(the "IDP Acquisition"). When acquired, IDP was a leading supplier of portable
and desktop computers to the Government. The IDP Acquisition tripled the
Company's customer base within the Government to a total of 950 customers. In
May 1998, in connection with the IDP Acquisition, the Company completed a public
offering of 3,491,493 shares of common stock for net proceeds of $26,287,866.
The Company seeks to establish itself as a leading provider of network
solutions to the Government and to increase sales of its hardware and services
to the commercial market. One of the key elements of this strategy is
integrating the Company's hardware and network services into a total solution
for its Government customers. In the commercial market, management plans to
leverage the Company's customer relationships developed through sales of its
network services to expand sales of its hardware products. Consistent with its
overall strategy, the Company may pursue strategic acquisitions that will
complement its product or service capabilities.
INTEGRATION OF IDP
The Company has begun to integrate IDP's business with that of the Company's
by implementing its plan of reducing overall expenses by eliminating duplicative
operations and positions. Since May 1, 1998, the Company has terminated the
production and warehouse functions at IDP's Gaithersburg, Maryland
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facility and consolidated the manufacturing into its Sterling, Virginia and
Puerto Rican facilities. The Company has fully integrated IDP's sales,
marketing, accounting, personnel, customer service, and engineering departments
of IDP into Dunn and has reduced its overall staff size by approximately 122
employees. The Company also plans to close the Gaithersburg facility by the end
of February, 1999. The Company has incurred additional one-time costs associated
with the integration of IDP. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
The consolidation and integration of businesses following an acquisition
involve a number of uncertainties. In connection with the IDP acquisition, there
can be no assurance that the Company will: (i) achieve its operating and growth
strategies with respect to these businesses; (ii) realize increased revenue
opportunities from the anticipated synergies created by expanded product
offerings; and (iii) acquire additional distribution channels or reduce the
overall selling, general and administrative expenses associated with IDP.
Additionally, the integration of any other business the Company may acquire in
the future could involve unforeseen difficulties, which could have a material
adverse effect on the Company's business, financial condition and results of
operations and ultimately the market price of the Common Stock.
PRODUCTS AND SERVICES
COMPUTER HARDWARE PRODUCTS
DESKTOPS. The Company manufactures a high performance line of Pentium II
desktop computers that may be used on a standalone basis or as part of a
network. The desktops incorporate the newest Intel technology and can
accommodate all the Intel Pentium processors, including the new high performance
450 Mhz Pentium II processor. The Company strives to keep ahead of the
competition by constantly testing and incorporating the latest technology into
its products.
FILESERVERS. The Company markets a single, dual and quad version of the
Intel Pentium servers. All Dunn servers are Microsoft Windows NT, Novell,
Banyan, and Token Ring compatible. The Company believes that its servers offer
the latest or "best of the breed" technology that provides it with a price-
performance advantage over major competition such as Hewlett Packard ("HP") and
Compaq. The Company believes that the server market provides opportunities for
higher profit margins compared to other sectors in the industry. In addition,
because of the complexity of server installation and maintenance, server sales
complement the Company's services business.
PORTABLES. The Company manufactures, on a brand name basis, a
state-of-the-art portable line based on Intel's latest portable processors with
a 13.3 inch or 14.1 inch display and many other advanced features. The system is
assembled and configured in the United States by Dunn and meets the Federal
Government's stringent Buy American and Trade Agreement Act requirements. The
Company markets the portables in both the commercial and Government markets. At
this time, the Company's portables business is a small portion of the business.
NETWORKING HARDWARE & SOFTWARE. The Company integrates, installs, and
maintains major-brand networking hardware and software, which enables the
Company to be a full solutions provider for its customers. A partial list of the
manufacturers that the Company is authorized to sell include 3COM, Banyan,
Cisco, Lotus, Microsoft, Novell and Santa Cruz Operation.
TECHNICAL SERVICES
CONSULTING. Dunn provides its clients with consulting services with respect
to requirements analysis, network audits, security audits, security policy
planning, network capacity planning, server capacity planning, and technology
and feasibility studies. These services are generally provided on a fixed hourly
fee basis with specific deliverables.
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PROJECT IMPLEMENTATION. Dunn performs full life cycle project work for
which it assumes responsibility for all deliverables and project completion.
Providing project management is a key component of Dunn's strategy of being a
full solutions provider.
RAPID RESPONSE. Dunn also offers clients that do not need full-time on-site
support a family of support products all under the "SafetyNet" program. These
products provide a wide range of support options and can be customized to each
client's specific needs. For example, through "Block Services," clients may
purchase blocks of Dunn's technical personnel hours for up to a period of three
years from the purchase date, allowing clients to plan ahead and take advantage
of volume discounts. Under its "Term Maintenance" program, Dunn also provides
full service, term maintenance contracts on specific server and networking
equipment. These contracts are based on a fixed price and term and include all
parts and labor. Alternatively, under the "Extended Value Support" program,
clients may opt for a labor-only product. Finally, the "ClockWork" program
provides clients with standard technical resources on a recurring regular basis.
One or two days per week or per month, clients can augment their existing staff
with expertise they cannot afford to hire full-time. ClockWork provides an
excellent alternative to hiring and full-time outsourcing.
STAFF AUGMENTATION. Dunn provides clients with service professionals whose
full time personnel do not meet all of their service needs. The client generally
assumes all responsibility for the management of Dunn's service personnel, who
may work full time on a particular client account for varying lengths of time,
generally between one week and one year. The Company's technical staff can get
support twenty four hours a day, seven days a week from Novell, Microsoft, 3Com,
Cisco, and others, allowing them to tap on resources beyond their own individual
knowledge and capabilities. The Company believes the availability of this
third-party support sets it apart from its competition.
SUPPORT SERVICES
The Company believes that its dedication to prompt, efficient customer
service and technical support are important factors in customer retention and
overall satisfaction. The Company provides toll-free technical support to its
customers 365 days a year. Product support technicians assist customers with
questions concerning compatibility, installation, determination of defects and
general questions of product use. Company employees provide on-site service to
its customers in the Washington, D.C. area and maintains arrangements with
national service organizations to provide repair service on a world-wide basis.
CONTRACTS
In fiscal 1998, Dunn derived approximately 80% of its net revenues from
sales of hardware and services to the federal Government pursuant to contracts
with the General Services Administration ("GSA") or other agency-specific
contracts. Most of these contracts are "indefinite delivery, indefinite
quantity" or "IDIQ" contracts, meaning that an indefinite amount of product may
be purchased at any time over the life of the contract. Government contracts, by
their terms, generally can be terminated at any time, without cause, for the
convenience of the Government. If a Government contract is so terminated, the
contractor generally is entitled to receive compensation for the services
provided or certain costs incurred at the time of termination and a reasonable
profit on the contract work performed prior to the date of termination. In
addition, all Government contracts require compliance with various contract
provisions and procurement regulations and in certain cases, accounting
requirements. If not cured, certain violations of these regulations could result
in the termination of the contract, imposition of fines, and suspension or
debarment from competing for or receiving awards of additional Government
contracts. Exclusion of the Company from federal procurements, the termination
of any of the Company's significant Government contracts or the imposition of
such penalties could have a material adverse effect on the Company.
4
Substantially all of the Company's federal customers purchase equipment and
services from the Company on a long-term contract basis. By contrast, most of
the commercial customers purchase equipment and services by means of task and
open purchase orders.
Set forth below is a description of some of the Company's more significant
contracts as of October 31, 1998.
DESKTOP V CONTRACT. In May 1997, IDP was awarded a contract by the U.S. Air
Force (the "Air Force") to provide high performance desktop computers, portable
computers and network servers (the "Desktop V contract"). The Desktop V contract
is a Government-wide acquisition contract that is open to all departments and
agencies of the Government except for the Department of the Army and the
Department of the Navy. For fiscal year ended October 31, 1998 ("fiscal 1998"),
Dunn had revenues totaling approximately $18.0 million from the Desktop V
contract, which represented approximately 26% of all of the Company's revenues
for fiscal 1998. In connection with the Desktop V contract, a protestor has
asserted that IDP is bound by a settlement agreement that calls for payments of
1.8% of its revenues derived from such contract. The Company contests this
assertion and the matter is being litigated. See "Legal Proceedings." There can
be no assurance that the Company will be successful in the litigation, and if
not, it may be required to make such payments. The Desktop V contract was
awarded to IDP pursuant to the Section 8(a) program of the U.S. Small Business
Administration ("SBA") and, as such, contains a "termination for convenience"
clause which provides that, in the event the program-eligible owners relinquish
ownership of the business, the contract shall terminate unless the procuring
agency requests a waiver from the SBA. At the time of the IDP acquisition, the
Air Force had requested a waiver. Subsequently, the SBA has opposed the waiver.
The Company has appealed the decision of the SBA. There can be no assurance that
the Company will be successful in its appeal. The loss of the Desktop V contract
could have a material adverse effect on the Company's business. Pending the
outcome of the appeal, the Company is continuing to service orders under the
Desktop V contract.
GSA CONTRACT. The Company has a contract with the GSA (the "GSA Contract").
The Company's GSA contract was awarded in April 1996 and is valid through March
31, 2002. The GSA Schedule enables Government IT purchasers to acquire all of
their requirements from a particular vendor and largely limits the competition
to selected vendors holding GSA contracts. For fiscal year 1998, the Company's
GSA Contract had sales of $6.8 million, which accounted for approximately 10% of
the Company's revenues.
LOCKHEED CONTRACT. Under the Company's contract with Lockheed Martin
Corporation ("Lockheed"), the Company provides computer network servers to
Lockheed for the Defense Department's Worldwide Defense Messaging System
("DMS"). DMS is expected to be the largest private messaging network in the
world, supporting approximately 2,000,000 users. Lockheed is the prime
contractor on the DMS contract. The Company's contract with Lockheed is on a
year-to-year basis, has been renewed three times and can be renewed for up to
two more years. In fiscal 1998, the Company generated revenues of $4.8 million
from the Lockheed contract, which accounted for approximately 7% of the
Company's revenues.
MANUFACTURING AND PRODUCTION
In fiscal 1998, Dunn assembled over 30,000 desktop and portable computers.
The Company's production capacity is 100,000 units per year in the existing
Sterling County facility on a three shift basis. The Company is currently in the
process of having its Sterling County facility certified for the International
Quality Standard ISO 9002, which requires it to meet certain stringent
requirements to ensure that the facilities' manufacturing processes, equipment
and associated quality control systems will satisfy specific customer
requirements. The Company believes that the ISO 9002 quality standard is a
significant factor in the both Government and the commercial market.
5
The Company also leases an approximately 34,000 square-foot facility in
Guayama, Puerto Rico, which is used for manufacturing, technical support, and
personal computer board level repair. The Guayama facility is ISO 9002
certified, and has the capability to manufacture 200,000 systems per year.
COMPETITION AND MARKETING
The markets for the Company's products and services are highly competitive.
Many of the Company's competitors offer broader product lines, have
substantially greater financial, technical, marketing and other resources than
the Company and may benefit from component volume purchasing and product and
process technology license arrangements that are more favorable in terms of
pricing and availability than the Company's arrangements. Competitive pressures
have intensified as large build-to-order multinational computer manufacturers
have entered the Government market. The Company also competes with a large
number of computer systems integrators and resellers. The Company believes that
it is likely that these competitive conditions will continue in the future.
There can be no assurance that the Company will continue to compete successfully
against existing or new competitors that may enter markets in which the Company
operates.
GOVERNMENT MARKET
The Information Technology Reform Act (the "ITRA"), which took effect on
August 8, 1996, has had a profound effect on the way Government procures
computers and related products and services. The most sweeping changes were (1)
the repeal of the Brooks Act that had granted sole authority for purchasing IT
to the GSA and, (2) the change in the GSA Schedule from a single-year small
purchase contracting program to a multi-year, IDIQ contract with no limit on the
value of purchases. Prior to the new legislation, the GSA was responsible for
overseeing all IT purchases as well as assuring fair and open competition. The
new legislation has expanded Dunn's ability to market and sell its products to
Government users directly through its GSA contract and Basic Purchasing
Agreements awarded under the GSA schedule. The Company has invested
significantly to expand its marketing and sales efforts to take advantage of
these changes in the federal market. The customer base acquired as part of IDP
is a key element in its expanded sales and marketing effort.
Since the passage of the ITRA, the Government has increased the amount of
information products acquired through the GSA Schedule. Although Dunn believes
it has benefited from this reform, the emergence of the GSA Schedule as a
significant procurement vehicle has also enabled traditional mass market
commercial computer companies to be more responsive to Government requirements.
The Company currently competes with national commercial computer manufacturers
such as Dell Computer Corporation ("Dell") and Gateway 2000, Inc. ("Gateway")
for a portion of the Government market.
The Government continues to rely on agency specific IDIQ contracts for its
more complex computer requirements. The Company believes that national brand
companies such as International Business Machine Corporation, Compaq Computer
Corporation ("Compaq"), Dell Computer, AST Research, Inc. ("AST") and Apple
Computer, Inc. often are dissuaded from bidding for these IDIQ contracts, which
have complex terms and conditions and technical specifications. Some of these
national brand companies have not focused on the Government market at all;
however, there can be no assurance they will not do so in the future.
There has been a consolidation in the industry as a result of acquisitions
and the failure of many firms. The competition has settled into a small group of
competitors comprised of manufacturers and systems integrators. The Company
believes that the Government's selection criteria for vendor selection consists
of price, quality, familiarity with the vendor, and size and financial
capability of the vendor.
6
The following companies are significant competitors of the Company in the
Government market:
COMPANY TYPE
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Dell................................................................... Manufacturer
Gateway................................................................ Manufacturer
Micron Technology, Inc. ("Micron")..................................... Manufacturer
Government Technology Services, Inc.................................... Systems Integrator
Winn Laboratories, Inc................................................. Manufacturer
COMMERCIAL MARKET
The microcomputer products industry is highly competitive. Pricing is very
aggressive in the industry and the Company expects pricing pressures to continue
to intensify. The microcomputer products industry is also characterized by rapid
changes in technology and consumer preferences, short product life cycles and
evolving industry standards.
The commercial market for engineering services is a highly fragmented market
served by thousands of small value-added resellers. These companies typically
service a small geographic area and resell national brand computer hardware. The
Company believes that its consulting division can compete effectively in the
local market because it provides engineering services for Dunn products rather
than desktop and server hardware provided by third parties. The Company believes
that its ability to manufacture the hardware provides the technical services
group a competitive advantage.
Microcomputers are marketed through several distribution channels including
direct marketing, traditional microcomputer retailers, computer superstores,
consumer electronic and office supply superstores and other resellers. There are
many manufacturers of microcomputers, substantially all of which have greater
financial, marketing and technological resources than the Company. The Company
competes with manufacturers such as Compaq, Dell, Gateway, IBM and Packard Bell
NEC, Inc.. The principal elements of competition are product reliability and
quality, customization, price, customer service, technical support and product
availability. There can be no assurance that the Company will in the future be
able to compete effectively against existing competitors, especially companies
who have historically focused their energies on the commercial market.
MARKETING
The Company markets to a wide array of Government organizations including
agencies within the Department of Defense, civilian agencies and the judicial
branch of the Government. The Company also views the commercial market, which
represented 12% of its sales in fiscal 1998, as an increasingly important part
of its business. The Company uses an in-house sales force and program managers
to market its products and services. Although Dunn markets nationally, the
Company's marketing efforts are concentrated in the Washington, D.C.
metropolitan area, which accounts for 68% of Government computer procurement. In
light of the new procurement legislation which gives different Government users
the ability to purchase directly from vendors, the Company believes that
marketing is becoming increasingly important to its Government as well as to its
commercial business.
The Company strives to build a strong relationship with its customers. The
Company believes that a key to building customer loyalty is a team of
knowledgeable and responsive account executives and technical and support staff.
The Company assigns each customer a trained account executive, to whom
subsequent calls to the Company will be directed. The Company believes that
these strong one-on-one relationships improve the likelihood that the customer
may consider the Company for future purchases. Product support technicians are
available 24 hours per day, seven days a week. The Company intends to continue
to provide its customers with the latest technology at the lowest cost.
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The Company attempts to maximize the use of emerging electronic commerce
technologies and believes that both the Government and commercial customers will
continue to expand and utilize these technologies. Internet and on-line computer
services are being used by the Government and many companies to advertise
opportunities as well as reference vendor information. The Company maintains a
web site on the Internet wherein its GSA catalogue and products can be
referenced. In addition, the Company provides the capability for customers to
download updated software and drivers that become available. The Company
believes that its targeted customer base will have a greater acceptance of these
interactive services because its customers tend to have a greater familiarity
with technology products and services.
SUPPLIERS
The Company devotes significant resources to establishing and maintaining
relationships with its suppliers. The Company, where possible, purchases
directly from component manufacturers such as Intel, Microsoft, Hitachi-Nissei
Sanyo America, Ltd., Sony Electronics Corporation and Clevo Corporation
("Clevo"). The Company also purchases multiple products directly from large
national and regional distributors such as TechData Corporation, Ingram Micro
Incorporated and Decision Support Systems, Incorporated ("DSS").
Suppliers provide the Company with incentives in the form of discounts,
rebates, credits, cooperative advertising and market development funds. In
accordance with the terms of certain of the Company's Government contracts, the
Company provides periodic reporting of pertinent supplier contract terms and
conditions to contracting officials. As a product reseller, the Company must
continue to obtain products at competitive prices from leading suppliers in
order to provide competitively priced products for its customers. During fiscal
1997, Dunn purchased approximately 11% of its components from DSS. In the event
that the Company is unable to continue to purchase components from these
suppliers, the Company believes that alternative suppliers are readily
available. The Company believes its relationships with its key suppliers to be
good and believes that generally there are multiple sources of supply available
should the need arise.
INVENTORY
Dunn has traditionally purchased inventory to fill orders received from our
customers. IDP traditionally purchased inventory based on a weighted forecast.
The Company is in the process of conforming IDP's inventory policies and
practices to those of the Company.
PATENTS, TRADEMARKS AND LICENSES
The Company does not maintain a traditional research and development group,
but works closely with computer product suppliers and other technology
developers to stay abreast of the latest developments in computer technology.
While the Company does not believe that its continued success will depend upon
the rights to a patent portfolio, there can be no assurance that the Company
will continue to have access to existing or new technology for use in its
products.
The Company conducts its business under the trademarks and service marks of
"Dunn", "Dunn Computer Corporation", "International Data Products," and "IDP."
The Company believes its trademarks and service marks have significant value and
are an important factor in the marketing of its products.
Because most software used on the Company's computers is not owned by the
Company, the Company has entered into software licensing arrangements with
several software manufacturers, including Microsoft.
8
EMPLOYEES
As of October 31, 1998, the Company employed 236 persons. Of such persons, 3
were employed in executive capacities, 38 in sales and marketing, 55 in
administrative capacities, 32 in technical services and 108 in operations. As of
January 22, 1999 the Company employed 209 persons. None of Dunn's employees are
covered by a collective bargaining agreement. Dunn considers its relationships
with its employees to be good.
The Company believes that its future success will depend in large part upon
its continued ability to attract and retain highly qualified management,
technical and sales personnel. The computer industry is currently undergoing a
shortage of trained and experienced technicians. The Company endeavors to be
attractive to current and prospective employees and has an in-house training
program to produce its own supply of highly qualified technicians and service
providers. However, there can be no assurance that the Company will be able to
attract and retain the qualified personnel necessary for its business.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith, files annual and quarterly reports on Forms 10-K and 10-Q, proxy
statements and other information with the Securities and Exchange Commission
(the "Commission"). The public may read and copy any such materials filed with
the Commission at the Commission's Public Reference Room at 450 Fifth Street,
N.W., Washington, D.C. 20549. The public may obtain information on the operation
of the Public Reference Room by calling the Commission at 1-800-SEC-0330. In
addition, the Commission maintains an Internet site that contains reports, proxy
and information statements, and other information regarding issuers, such as the
Company, that file such materials electronically with the Commission. The
Commission's Internet address is http;//www.sec.gov.
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases an approximately 35,000 square foot facility in Sterling,
Virginia which is used primarily for manufacturing and administrative services.
The lease expires in October, 1999. The Company has an option to renew the
Sterling lease for a period of five years at market rates. The Company is
presently seeking ISO 9002 certification for its Sterling facility. The Sterling
facility has obtained a top secret security clearance in connection with its
performance of one of its government contracts. The facility is owned by C&T
Partnership, an entity comprised of Thomas Dunne, the Company's President, and
his wife Claudia Dunne, the Company's Vice President.
The Company also leases an approximately 55,000 square-foot facility in
Gaithersburg, Maryland. The Company's plan is to vacate this space by February,
1999, and sublet the space. The existing lease expires in February 2000. The
Company also leases a 34,000 square-foot facility in Guayama, Puerto Rico, which
is used for manufacturing, technical support, and personal computer board level
repair. The Company believes that its current facilities are adequate for its
existing needs and that additional suitable space will be available as required.
ITEM 3. LEGAL PROCEEDINGS
By letter dated April 15, 1998, DDI, a competitor of the Company asserted
that IDP is bound by a settlement agreement entered into in connection with
certain litigation, calling for payments to the competitor of 1.8% of the first
$250 million of IDP's gross sales under the Desktop V contract. IDP and the
Company dispute this claim. On June 1, 1998, the Company filed a Complaint for
Declaratory Judgment in the U.S. District Court of the Eastern District of
Virginia seeking a declaration that DDI is not entitled to receive payments
under the settlement agreement. The defendant has counter-claimed against the
Company claiming it did not breach the settlement agreement and is entitled to
the payments. While the Company believes that it has a meritorious claim for
declaratory judgment and meritorious
9
defenses to the counter-claim, there can be no assurance that the Company will
be successful in this litigation and, if the court rules against the Company, it
may be required to pay a percentage of its revenue under the Desktop V contract
to the defendant.
On July 31, 1998, the Company received notice from the SBA that it was
denying the request of the U.S. Air Force to waive the requirement to terminate
IDP's Desktop V contract for the convenience of the Government upon the change
in control of IDP to the Company. The Company has appealed the denial by the SBA
to the SBA's Office of Hearings and Appeals. The appeal is currently pending.
The loss of the Desktop V contract could have a material adverse effect on the
Company's results of operations.
In November 1998, a former employee of the Company filed a demand for
arbitration with the American Arbitration Association, alleging a breach of his
employment agreement with the Company and seeking in excess of $2,350,000 in
damages from the Company. The Company has filed an answer denying the claimant's
allegations and stating a counterclaim against the former officer for breach of
the employment agreement and for conversion of certain of the Company's
property. The Company intends to defend the claimant's claim and pursue its out
counterclaim vigorously.
On December 18, 1998, the Office of the United States Attorney for the
District of Maryland, Northern Division (the "U.S. Attorney"), informed the
Company that it was of the view that a civil False Claims Act violation was
assessable against certain parties, including IDP, George and Oscar Fuster (the
former principal owners of IDP) and the Company involving allegations of
fraudulent misrepresentations by the Fusters in IDP's 1994 application for
participation in the Section 8(a) program administered by the SBA. Remedies
available to the Government, should such a case be brought, include treble
damages, fines, and suspension and debarment. To date, no actual suit has been
filed. The Company and the other parties are currently negotiating a settlement
of this matter with the U. S. Attorney and, based on such negotiations, the
Company believes this matter will be settled without determination of liability
against or monetary payment by the Company.
There are routine legal claims pending against the Company, but in the
opinion of management, liabilities, if any, arising from such claims will not
have a material adverse effect on the financial condition and results of
operation of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
10
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
Prior to the quotation of the Company's Common Stock beginning on April 22,
1997, there was no established trading market for the Company's common stock.
The Company's Common Stock is traded in the over-the-counter market and prices
are quoted on The Nasdaq National Market under the symbol DNCC. The following
table sets forth the high and low selling prices as reported by The Nasdaq
National Market for the periods indicated. These quotations reflect inter-dealer
prices without retail mark-up, mark-down or commission and may not represent
actual transactions.
1997
--------------------
HIGH LOW
--------- ---------
Second Quarter
(from April 22, 1997).................................................... $ 7 1/8 $ 5.0
Third Quarter............................................................ $ 7 1/4 $ 5 5/8
Fourth Quarter........................................................... $ 7 5/16 $ 5 1/2
1998
--------------------
HIGH LOW
--------- ---------
First Quarter............................................................ $ 10.50 $ 6.625
Second Quarter........................................................... $ 10.375 $ 8.188
Third Quarter............................................................ $ 9.938 $ 7.483
Fourth Quarter........................................................... $ 4.75 $ 1.938
On January 22, 1999, the closing price of the Company's Common Stock as
reported by The Nasdaq National Market was $5.25 per share. There were
approximately 1,500 shareholders of the Common Stock of the Company as of such
date.
The Company has not paid cash dividends on its Common Stock and does not
intend to do so in the foreseeable future.
RECENT SALES OF UNREGISTERED STOCK
On May 1, 1998, in connection with the IDP acquisition, the Company acquired
all of the issued and outstanding capital stock of IDP Co. and substantially all
of the net assets of PRIMO. In consideration for the IDP acquisition, the
Company paid the former owners an aggregate of $14.9 million in cash and an
aggregate of 750,000 shares of Common Stock. In November 1998, the Company
received 350,000 shares of the stock previously issued to the Fusters in
connection with a Purchase Price Adjustment Agreement. The shares sold to the
Fusters in the IDP acquisition were sold in reliance upon the exemption from
registration afforded by Section 4(2) of the Securities Act of 1933, as amended.
ITEM 6. SELECTED FINANCIAL DATA
DUNN SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following selected consolidated financial data of Dunn should be read in
conjunction with the consolidated financial statements and the notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations". The consolidated statement of income data set forth below with
respect to the fiscal years ended October 31, 1996, 1997 and 1998 and the
consolidated balance sheet data as of October 31, 1997 and 1998 is derived from
and is referenced to the audited consolidated financial statements of Dunn
included elsewhere in this Prospectus. The consolidated statement of income
11
data set forth below with respect to the fiscal years ended October 31, 1994 and
1995 and the consolidated balance sheet data as of October 31, 1994 and 1995 is
derived from audited consolidated financial statements of Dunn not included in
this 10-K.
YEAR ENDED OCTOBER 31,
-----------------------------------------------------
1994 1995 1996 1997(2) 1998(3)
--------- --------- --------- --------- ---------
CONSOLIDATED STATEMENT OF INCOME DATA:
Net revenues................................................. $ 4,429 $ 7,491 $ 18,099 $ 21,766 $ 66,888
Costs of revenues............................................ 3,444 6,046 14,103 17,549 54,969
Gross profit................................................. 985 1,445 3,996 4,217 11,919
Selling, general and administrative.......................... 1,005 966 1,972 2,198 9,983
Income from operations....................................... (20) 479 2,024 2,019 1,936
Other income (expense)....................................... (32) 8 (9) 98 (270)
Net income (loss) before income taxes........................ (52) 487 2,015 2,117 1,666
Provision for (benefit from) income taxes.................... (11) 244 776 795 686
Net income (loss)............................................ $ (41) $ 243 $ 1,239 $ 1,322 $ 980
Earnings (loss) per share(1)................................. $ (0.01) $ 0.06 $ 0.31 $ 0.29 $ 0.14
Earning (loss) per share assuming dilution(1)................ $ (0.01) $ 0.06 $ 0.31 $ 0.28 $ 0.13
Weighted average shares outstanding(1)....................... 3,158 4,000 4,000 4,552 7,231
Weighted average shares outstanding assuming dilution(1)..... 3,158 4,000 4,000 4,679 7,492
AT OCTOBER 31,
-----------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
CONSOLIDATED BALANCE SHEET DATA:
Working capital.............................................. $ 340 $ 512 $ 1,722 $ 4,339 $ 5,773
Total assets................................................. 2,503 3,647 5,275 18,703 62,965
Long-term debt............................................... 23 75 51
Total liabilities............................................ 2,046 3,047 3,335 10,465 24,592
Stockholders' equity......................................... 457 600 1,939 8,238 38,373
- ------------------------
(1) The earnings per share amounts prior to Fiscal 1998 have been restated as
required to comply with Statement of Financial Accounting Standards No. 128,
EARNINGS PER SHARE. For further discussion of earnings per share and the
impact of Statement No. 128, see Note 2 to the Company's consolidated
financial statements.
(2) Includes the activity of STMS from September 12, 1997 (date of acquisition).
(3) Includes the activity of IDP and PRIMO from May 1, 1998 (date of
acquisition).
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements contained in this section are forward-looking statements
(as such term is defined in the Private Securities Litigation Reform Act of
1995). Because such statements include risks and uncertainties, actual results
may differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ materially
include, but are not limited to, risks associated with the integration of
businesses following an acquisition, competitors with broader product
12
lines and greater resources, the termination of any of the Company's significant
contracts or the Company's inability to attract and retain highly qualified
management, technical and sales personnel.
GENERAL
Over 85% of the Company's revenues are generated from the sale of hardware.
Sales to customers within the Government accounted for 75% of Dunn's revenues in
fiscal 1998. The Company's operating results are characterized by a number of
factors resulting from its emphasis on the Government market. For example, the
Company has historically experienced fluctuating quarterly results due to uneven
purchasing patterns of Government customers relating to the Government's
budgetary cycle. Consequently, sales for the first and fourth quarters typically
account for the greatest proportions of revenues each year. In addition, the
Company's Government contracts, which frequently provide for fixed prices, often
have initially low gross margins which will increase over the term of a contract
due to cost savings from technological improvements and shorter component life
cycles. Since most of the Company's Government contracts have 30-day delivery
terms, the Company attempts to limit its inventory risks by purchasing
components to fill firm orders under fixed-price contracts.
The Company's most significant costs are components used in the manufacture
of desktop, portable and server systems. With the combination of Dunn and IDP,
the Company has been able to realize reduced component costs because of
increased volume discounts.
The Company's business during fiscal 1998 was significantly impacted by the
IDP acquisition which was consummated on May 1, 1998. As a result of the
acquisition, the Company's revenues tripled as the Company benefited from the
addition of the IDP customers. Offsetting this increase in revenue were
relatively higher operational costs associated with integrating IDP's operations
which were initially absorbed by the Company following the IDP Acquisition. The
Company has taken a number of measures to consolidate and integrate the IDP
operations with those of Dunn so as to reduce the Company's operating costs.
Such steps have included a reduction in staff, the consolidation of
manufacturing operations in the Sterling, Virginia facility, and the elimination
or merger of duplicative operations.
The Company has recognized certain costs associated with its consolidation
and integration plan as liabilities assumed in the IDP Acquisition. These costs
were recorded as an adjustment to the purchase price of IDP and therefore are
not reflected as expenses in the Company's results of operations. These
liabilities totaled $1,376,000 and were comprised of employee severance costs of
$615,000 and facilities-related costs of $761,000. The severance costs were
recorded for IDP and PRIMO employees to be terminated due to the integration and
consolidation of the Company's operations. The facilities-related costs include
costs associated with the excess production and warehouse capacity at IDP's
Gaithersburg, Maryland facility and an estimate of costs to be incurred once
that facility is entirely vacated. To date, $232,000 of costs have been charged
against these liabilities. The Company does not expect any significant
adjustment to these liabilities as its consolidation and integration plan is
substantially complete.
In addition, the Company incurred $565,000 in costs associated with the
consolidation and integration plan which were recognized as expenses during
fiscal 1998. These costs included compensation and severance costs of $295,000
and facilities-related costs of $270,000. The compensation and severance costs
were for employees of the Company who were terminated as a result of the
consolidation and integration plan. The facilities-related costs were costs of
certain functions at IDP's Gaithersburg, Maryland facility that were relocated
to the Company's Sterling facility subsequent to year-end.
Although the Company will incur certain costs associated with expanding its
operations at its Sterling facility, the Company believes that the cost-cutting
measures it has put in place will significantly reduce its operating costs and
bring its gross profit margin closer to its level prior to the IDP acquisition.
However, there can be no assurance that the Company will successfully implement
its consolidation and integration plans or that profit levels will increase.
13
RESULTS OF OPERATIONS
The following table sets forth for the fiscal years ended October 31, 1994,
1995, 1996, 1997 and 1998, certain income and expense items of Dunn as a
percentage of net revenues.
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
Net Revenues.................................................... 100.00% 100.00% 100.00% 100.00% 100.00%
Costs of revenues............................................... 77.76% 80.71% 77.92% 80.63% 82.18%
--------- --------- --------- --------- ---------
Gross profit.................................................... 22.24% 19.29% 22.08% 19.37% 17.82%
Selling, general and administrative............................. 22.69% 12.90% 10.90% 10.10% 14.92%
--------- --------- --------- --------- ---------
Income (loss) from operations................................... -0.45% 6.39% 11.18% 9.27% 2.90%
Other income (expense).......................................... -0.72% 0.11% -0.05% 0.45% -0.40%
--------- --------- --------- --------- ---------
Net income (loss) before income taxes........................... -1.17% 6.50% 11.13% 9.72% 2.50%
Provision for (benefit from) income taxes....................... -0.24% 3.26% 4.28% 3.65% 1.03%
--------- --------- --------- --------- ---------
Net income (loss)............................................... -0.93% 3.24% 6.85% 6.07% 1.47%
FISCAL YEAR ENDED OCTOBER 31, 1998 COMPARED TO FISCAL YEAR ENDED OCTOBER 31,
1997
Net revenues of Dunn for fiscal year ended October 31, 1998 ("fiscal 1998")
increased 206% to $66.9 million from $21.8 for fiscal year ended October 31,
1997 ("fiscal 1997"). This increase was primarily due to additional revenue
resulting from the third quarter acquisition of International Data Products,
Inc. Net revenues derived from IDP's operations for fiscal 1998 amounted to
approximately $40.5 million.
Gross profit of Dunn for fiscal 1998 increased 183% to $11.9 million from
$4.2 million for fiscal 1997. However, the gross profit as a percentage of net
revenues during the same periods decreased to 17.8% from 19.4%. The decrease in
gross profit margin is a result of an increase in the percentage of lower margin
hardware sales by IDP and excess production capacity. The Company has closed the
production facility in Gaithersburg, Maryland.
Selling and marketing expense of Dunn increased for fiscal 1997 by 336% to
$3,672,000 from $842,000 for fiscal 1997. During the same periods, as a
percentage of net revenues, selling and marketing expenses increased to 5.5%
from 3.9%. The increase was primarily attributable to the acquisition of IDP,
increased advertising in selected publications, increased attendance at trade
shows and the development of a marketing campaign aimed at selected businesses.
General and administrative expense of Dunn for fiscal 1998 increased 365% to
$6.3 million from $1.4 million for fiscal 1997. As a percentage of net revenues,
general and administrative expense increased to 9.4% for fiscal 1998 from 6.2%
for fiscal 1997. The Company charged $564,776 of IDP acquisition integration
costs to G&A for the fiscal year. The Company also recognized approximately
$545,000 in amortization expense for fiscal 1998 as compared to $22,000 for
fiscal 1997. Dunn increased its costs in almost all aspects of general and
administrative expenses as a result of the IDP acquisition. The Company has
taken various actions to reduce general and administrative expenses in future
periods. See Item 1 "Business."
Other income (expense) including interest for fiscal 1998 decreased to an
expense of $271,000 from an income of $98,000 for fiscal 1997. The decrease was
a result of increased interest expense required to support the additional debt
assumed as a result of the acquisition of IDP, and interest expense associated
with certain operating leases. Dunn's effective tax rate increased to 41% for
fiscal 1998 from 37.5% for fiscal 1997 as a result of the increase in the
amortization of Goodwill which is not deductible for tax purposes. Dunn's net
income declined by 26% for fiscal 1998 to $980,000 from $1.3 million for fiscal
1997. Net income as a percentage of net revenues during the same periods
declined to 1.5% from 6.1%.
14
FISCAL YEAR ENDED OCTOBER 31, 1997 COMPARED TO FISCAL YEAR ENDED OCTOBER 31,
1996
Net revenues of Dunn for the fiscal year ended October 31, 1997 ("fiscal
1997") increased 20.3% to $21.8 million from $18.1 million for fiscal year ended
October 31, 1996 ("fiscal 1996"). This increase was primarily due to additional
revenue resulting from the fourth quarter acquisition of STMS and increased
revenues from Government contracts.
Gross profit of Dunn for fiscal 1997 increased 5.5% to $4.2 million from
$4.0 million for fiscal 1996. However, the gross profit as a percentage of net
revenues during the same periods decreased to 19.4% from 22.1%. The decrease in
gross profit margin is a result of an increase in the percentage of lower margin
third party hardware sales, initial lower margins realized on two new contracts
and increased production costs.
Selling and marketing expense of Dunn increased for fiscal 1997 by 77.2% to
$842,000 from $475,000 for fiscal 1996. During the same periods, as a percentage
of net revenues, selling and marketing expenses increased to 3.9% from 2.6%. The
increase was primarily attributable to increased advertising in selected
publications, increased attendance at trade shows and the development of a
marketing campaign aimed at selected businesses.
General and administrative expense of Dunn for fiscal 1997 declined 9.5% to
$1.4 million from $1.5 million for fiscal 1996. As a percentage of net revenues,
general and administrative expense declined to 6.2% for fiscal 1997 from 8.3%
for fiscal 1996. Although Dunn increased its costs in almost all aspects of
general and administrative expenses, the increased costs were offset by a
decline in executive officers' incentive compensation.
Other income (expense) for fiscal 1997 increased to income of $98,000 from
an expense of $9,000 for fiscal 1996. The increase was a result of use of
proceeds from Dunn's initial public offering in April 1997 to reduce debt
obligations and to invest in tax-exempt securities. Dunn's effective tax rate
declined to 37.5% for fiscal 1997 from 38.5% for fiscal 1996 as a result of the
non-taxable interest income. Dunn's net income grew by 6.7% for fiscal 1997 to
$1.3 million from $1.2 million for fiscal 1996. Net income as a percentage of
net revenues during the same periods declined to 6.1% from 6.8%.
LIQUIDITY AND CAPITAL RESOURCES
In fiscal 1998 Dunn generated $2.5 million in cash flow from operations.
Dunn generated cash from its net income of $980,000, a reduction in accounts
receivable of $2.1 million and a reduction of $7.0 million in inventories. The
cash generated was used to reduce accounts payable by $9.5 million The Company
used $14.2 million in its investing activities for the IDP Acquisition. The
balance was used for property and equipment.
Dunn received approximately $26 million in net proceeds from its public
offering in May 1998. Other significant financing activities were provided by
Dunn's bank line of credit with First Union Bank (formerly Signet Bank). The
line of credit expires on February 28, 1999 and currently bears interest at
prime. As of January 25, 1999, Dunn had no outstanding balance on the line of
credit.
Dunn's subsidiary, IDP has borrowing agreements with Deutsche Financial
Services for an aggregate of $25.0 million, of which $13 million is secured by
IDP's inventory and $12 million is secured by IDP's accounts receivable. Each of
these facilities bears an annual interest rate of LIBOR plus 2.05%. Under the
inventory financing facility, IDP normally receives 30 days free of interest
when purchases are made from distributors, and 45 days free of interest when
purchases are made from manufacturers. Under the accounts receivable financing
facility, IDP can borrow against up to 85% of eligible receivables and is
subject to various financial covenants. There is no formal expiration date on
these facilities, although it is subject to annual re-evaluation. As of January
22, 1999 IDP had $8.2 million outstanding on its line of credit. Dunn is a
guarantor of this credit facility. At October 31, 1998, IDP was in violation of
its net worth convenant under this facility. The violation was subsequently
cured through a waiver obtained from the
15
financial institution. The Company is currently negotiating for the
consolidation of its borrowing arrangements. Any financial covenants associated
with the renegotiated borrowing facilities will be based on the Company's
consolidated financial position and results of operations.
As of October 31, 1998, IDP had notes payable to related parties of $906,000
bearing annual interest at rates ranging from 8.0% to 11.0% and are payable upon
demand. The Company paid off these notes as part of the settlement with George
and Oscar Fuster.
As of October 31, 1998, the Company had working capital of $5.8 million. The
Company believes the bank facilities, together with cash on hand and the cash
generated from operations, will provide sufficient financial resources to
finance the current operations of the Company through fiscal 1999.
Dunn has obligations under its operating lease commitments of approximately
$1.0 million and obligations under its existing employment contracts of
approximately $1.0 million for fiscal 1999.
From time to time, the Company may pursue strategic acquisitions or mergers
which may require significant additional capital and, in such event, the Company
may seek additional financing of debt and/or equity.
YEAR 2000 ISSUES
Recently, national attention has focused on the potential problems and costs
resulting from computer programs being written using two digits rather than four
to define the applicable year. Any computer programs that have date-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities. While the Company believes that its internal software applications
and the software in the systems it sells are Year 2000 compliant, there can be
no assurance until the year 2000 that all systems will function adequately.
Further, if the software applications of others on whose services the Company
depends are not Year 2000 compliant, such noncompliance could have a material
adverse effect on the Company. The Year 2000 problem can be corrected either
through software programming or the application can be ported to a client/server
network. The Company believes with its technical services and its client/server
hardware product line, it provides Year 2000 solutions.
In response to the Year 2000 problem and the associated risks, the Company
has developed a comprehensive compliance program to evaluate, address and remedy
the date related problems with respect to the Company's internal systems, third
party relationships, and Company products and services. The compliance program
is managed by the Company's Director of Engineering, and is tailored after the
guidance promulgated by the General Accounting Office (GAO) in their
publication, Year 2000 Computing Crisis: An Assessment Guide and by the
Department of the Navy Year 2000 Action Plan.
The Company has adopted the following five-phase approach that was endorsed
by the GAO and recognized by the U.S. Congress:
AWARENESS PHASE. The Company's management is familiar with the scope of the
Year 2000 impact, the problem is defined, compliance standards are established
and an overall strategy is developed. A Year 2000 program team is organizing and
implementing the Company's Year 2000 compliance program.
ASSESSMENT PHASE. The Year 2000 team determines the impact on the Company's
systems, tools, products and contracts. The team creates an inventory and
evaluation of systems that support the core business sectors. Third party
service providers are contacted concerning their compliance with the Year 2000
problem with regard to the products and services they provide. The team then
prioritizes the conversion or replacement of existing systems that are confirmed
to be Year 2000 non-compliant.
16
RENOVATION PHASE. The Year 2000 program team rectifies the problems
discovered in the assessment phase by modifying or replacing systems that are
Year 2000 non-compliant.
VALIDATION PHASE. The renovated or replaced systems, applications and
databases are tested and certified as Year 2000 compliant.
IMPLEMENTATION PHASE. The renovated or replaced systems are fully
implemented and extensive testing is performed to insure coordination with other
systems and databases. Backup and recovery plans are put in place. The Company
anticipates that it will have all internal Year 2000 solutions in place by July
1, 1999. Internal solutions include information technology systems such as local
and wide area network systems and non-IT systems such as embedded
micro-controllers within facility, security, telephone and others systems. The
Company is assessing the status of third parties with which it has a material
relationship. Third parties include vendors and suppliers of essential hardware,
software and services and Company customers who may fund Year 2000 compliance
efforts in lieu of contracting services to the Company. The Company is assessing
the status of its products and Year 2000-related services. All products sold via
the GSA schedule are Year 2000 compliant. Other products developed and sold by
the Company are being assessed for Year 2000 compliance. The Company also
performs Year 2000-related services for both government and industry and is
assessing the potential risk to the Company of performing these services and is
taking action to mitigate these risks as they are identified.
CONTINGENCY PLANS. The Company currently is developing contingency plans.
The Company anticipates that its internal systems will be Year 2000 compliant by
July 1, 1999. The Year 2000 readiness of third parties with which the Company
has a material relationship and their products and services are being assessed.
The Company will continue to develop contingency plans as required to mitigate
the effects of delays, if any, in internal systems compliance, third party
business interruption, non-compliant Company products and risks associated with
providing Year 2000-related services.
COST FOR YEAR 2000 COMPLIANCE. The Company estimates that the total cost
for Year 2000 compliance will be approximately $75,000. As of January 29, 1999,
the Company has spent approximately $55,000 on Year 2000 compliance.
YEAR 2000 RISKS. The Company expects to fund the remaining aspects of its
program with cash on hand or internally generated cash. The Company believes
that its Year 2000 compliance plan is a comprehensive one and that all internal
systems, including both information technology systems and non-information
technology systems, will be compliant by the end of calendar 1999. The Company,
however, may not be able to identify or remedy all Year 2000 compliance issues
with respect to its internal systems, suppliers, customers, products and
services. As a result, the Year 2000 problem could have a materially adverse
effect on the Company's financial condition or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
17
ITEM 8. FINANCIAL STATEMENTS
PAGE
---------
FINANCIAL STATEMENTS OF DUNN COMPUTER CORPORATION
Report of Ernst & Young LLP, Independent Auditors.......................................................... F-2
Consolidated Balance Sheets................................................................................ F-3
Consolidated Statements of Income.......................................................................... F-4
Consolidated Statements of Stockholders' Equity............................................................ F-5
Consolidated Statements of Cash Flows...................................................................... F-6
Notes to Consolidated Financial Statements................................................................. F-7
FINANCIAL STATEMENTS OF INTERNATIONAL DATA PRODUCTS, CORP.
Report of KPMG Peat Marwick, LLP, Independent Auditor...................................................... F-24
Combined Balance Sheets as of September 30, 1996 and 1997.................................................. F-25
Combined Statements of Income and Retained Earnings for the three years in the period ended September 30,
1997..................................................................................................... F-26
Combined Statements of Cash Flows for the three years in the period ended September 30, 1997............... F-27
Notes to Combined Financial Statements..................................................................... F-28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL ISSUES
None.
PART III
The Notice and Proxy Statement for the 1998 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A under the Securities Exchange Act of1934,
as amended, which is incorporated by reference in this Annual Report on Form
10-K pursuant to General Instruction G(3) of Form 10-K, will provide the
information required under Part III, including Item 10 (directors and executive
officers of the Company), Item 11 (executive compensation), Item 12 (security
ownership of certain beneficial owners and management), and Item 13 (certain
relationships and related transactions).
18
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report
1. Financial Statements
Dunn Computer Corporation
Report of Ernst & Young LLP, Independent Auditors
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
International Data Production Corporation and combined company
Report of KPMG Peat Marwick, LLP, Independent Auditor
Combined Balance Sheets as of September 30, 1996 and 1997
Combined Statements of Income and Retained Earnings for the three years in the
period ended September 30, 1997
Combined Statements of Cash Flows for the three years in the period ended
September 30, 1997
Notes to Combined Financial Statements
2. Financial Statement Schedules
Statements not listed above have been omitted because they are not
applicable or the information required to be set forth therein is included in
the Consolidated Financial Statements or the notes thereto under Item 8.
3. Exhibits.
EXHIBIT
NUMBER DESCRIPTION
- --------------------------------------------------------------------------------------
2.1 Acquisition Agreement, dated March 9, 1998, by and among Dunn, the Company,
George D. Fuster, D. Oscar Fuster, Carol N. Fuster and Wendy E. Fuster (refiling
to add index of exhibits and schedules). (Filed as Exhibit 2.1 to the Company's
Registration Statement on Form S-1, Amendment No. 2, dated April 23, 1998 (File
No. 333-47631) and hereby incorporated by reference.)
2.2 Agreement of Merger, dated as of March 18, 1998, by and among Dunn Merger Corp.,
a Delaware corporation, Dunn and the Company. (Filed as Exhibit 2.2 to the
Company's Registration Statement on Form S-1, Amendment No. 2, dated April 23,
1998 (File No. 333-47631) and hereby incorporated by reference.)
2.3 Stock Purchase Agreement, dated September 12, 1997, by and among STMS
Acquisition Corp., Dunn, STMS, Inc., John Signorello, Timothy McNamee, Steve
Salmon and certain other stockholders of Dunn. (Filed as Exhibit 2.3 to Dunn's
Current Report on Form 8-K, dated September 12, 1997, filed September 27, 1997
(File No. 0-22263) and hereby incorporated by reference).
3.1 Articles of Incorporation of the Company, dated February 25, 1998, and effective
as of February 26, 1998. (Filed as Exhibit 3.1 to the Company's Registration
Statement on Form S-1, Amendment No. 1, dated April 23, 1998 (File No.
333-47631) and hereby incorporated by reference.)
19
EXHIBIT
NUMBER DESCRIPTION
- --------------------------------------------------------------------------------------
3.2 By-laws of the Company, effective as of March 5, 1998. (Filed as Exhibit 3.2 to
the Company's Registration Statement on Form S-1, Amendment No. 2, dated April
23, 1998 (File No. 333-47631) and hereby incorporated by reference.)
4.1 Specimen common stock certificate for the Company. (Filed as Exhibit 4.1 to the
Company's Registration Statement on Form S-1, Amendment No. 2, dated April 23,
1998 (File No. 333-47631) and hereby incorporated by reference.)
10.1 GSA Schedule (Filed as Exhibit 10.2 to Dunn's Registration Statement on Form
SB-2, Amendment 1, dated March 14, 1997 (File No. 333-19635) and hereby
incorporated by reference).
10.2 Agreement, dated November 21, 1995, by and between GCH Systems, Inc. and Dunn
regarding Lockheed (Filed as Exhibit 10.4 to Dunn's Registration Statement on
Form SB-2, Amendment 1, dated March 14, 1997 (File No. 333-19635) and hereby
incorporated by reference).
10.3 Agreement, dated March 25, 1997, by and between Dunn and the Social Security
Administration (Filed as Exhibit 10.5 to Dunn's Registration Statement on Form
SB-2, Amendment 2, dated April 4, 1997 (File No. 333-19635) and hereby
incorporated by reference).
10.4 Agreement, dated June 12, 1995, by and between Dunn and the Administrative
Office of the U.S. Courts (Filed as Exhibit 10.6 to Dunn's Registration
Statement on Form SB-2, Amendment 2, dated April 4, 1997 (File No. 333-19635)
and hereby incorporated by reference).
10.5 Agreement, dated September 29, 1994, by and between Dunn and the Health Care
Finance Administration (Filed as Exhibit 10.7 to Dunn's Registration Statement
on Form SB-2, Amendment 2, dated April 4, 1997 (File No. 333-19635) and hereby
incorporated by reference).
10.6 Agreement effective September 8, 1997, by and between Virginia Contracting
Authority and Dunn (Filed as Exhibit 10.6 to Dunn's Form 10-KSB, dated January
30, 1998 (File No. 0-22263) and hereby incorporated by reference).
10.7 Employment Agreement by and between Dunn and John D. Vazzana (Filed as Exhibit
99.1 to Dunn's Registration Statement on Form SB-2, Amendment 2, dated April 4,
1997 (File No. 333-19635) and hereby incorporated by reference).
10.8 Employment Agreement by and between Dunn and Thomas P. Dunne (Filed as Exhibit
99.2 to Dunn's Registration Statement on Form SB-2, Amendment 2, dated April 4,
1997 (File No. 333-19635) and hereby incorporated by reference).
10.9 Deed of Lease, dated October 31, 1994, between C&T Partnership and Dunn and
addenda thereto (Filed as Exhibit 10.9 to Dunn's Form 10-KSB, dated January 30,
1998 (File No. 0-22263) and hereby incorporated by reference).
10.10 Deed of Lease, dated February 7, 1997, between APA Properties No. 6 L.P. and
STMS, Inc. and First Amendment thereto, dated July 23, 1997 (Filed as Exhibit
10.10 to Dunn's Form 10-KSB, dated January 30, 1998 (File No. 0-22263) and
hereby incorporated by reference).
10.11 1997 Stock Option Plan, as amended. (Filed as Exhibit 10.11 to the Company's
Registration Statement on Form S-1, Amendment No. 2, dated April 23, 1998 (File
No. 333-47631) and hereby incorporated by reference.)
20
EXHIBIT
NUMBER DESCRIPTION
- --------------------------------------------------------------------------------------
10.12 General Service Administration Schedule for International Data Products, Corp.
(Filed as Exhibit 10.12 to the Company's Registration Statement on Form S-1,
Amendment No. 2, dated April 23, 1998 (File No. 333-47631) and hereby
incorporated by reference.)
10.13 Agreement, dated May 5, 1997, by and between International Data Products, Corp.
and the U.S. Air Force, the Desktop V Contract. (Filed as Exhibit 10.13 to the
Company's Registration Statement on Form S-1, Amendment No. 2, dated April 23,
1998 (File No. 333-47631) and hereby incorporated by reference.)
10.14 Agreement, dated January 6, 1998, by and between International Data Products,
Corp. and the Department of the Navy. (Filed as Exhibit 10.14 to the Company's
Registration Statement on Form S-1, Amendment No. 2, dated April 23, 1998 (File
No. 333-47631) and hereby incorporated by reference.)
10.15 Deed of Lease, dated January 31, 1995, between Northtech Business Park and
International Data Products. (Filed as Exhibit 10.15 to the Company's
Registration Statement on Form S-1, Amendment No. 2, dated April 23, 1998 (File
No. 333-47631) and hereby incorporated by reference.)
10.16 Deed of Lease, dated July 15, 1994, between Puerto Rico Industrial Development
Company and Puerto Rico Industrial Manufacturing Operations, Corp. (Filed as
Exhibit 10.16 to the Company's Registration Statement on Form S-1, Amendment No.
2, dated April 23, 1998 (File No. 333-47631) and hereby incorporated by
reference.)
10.17 Agreement, dated July 11, 1995, by and between International Data Products,
Corp. and the Social Security Administration. (Filed as Exhibit 10.17 to the
Company's Registration Statement on Form S-1, Amendment No. 2, dated April 23,
1998 (File No. 333-47631) and hereby incorporated by reference.)
10.18 Form of Employment Agreement by and between the Company and each of George D.
Fuster and D. Oscar Fuster (refiling to reflect revised form). (Filed as Exhibit
10.18 to the Company's Registration Statement on Form S-1, Amendment No. 2,
dated April 23, 1998 (File No. 333-47631) and hereby incorporated by reference.)
10.19 Consent Agreement by and among Dunn, the Company, Network 1 Financial
Securities, Inc., a Texas corporation, and Damon Testaverde, William Hunt and
Richard Hunt, dated as of April 20, 1998. (Filed as Exhibit 10.20 to the
Company's Registration Statement on Form S-1, Amendment No. 2, dated April 23,
1998 (File No. 333-47631) and hereby incorporated by reference.)
10.20 Loan and Security Agreement, dated as of May 28, 1996 by and between Dunn and
SIGNET BANK and Amendment Nos. 1, 2 and 3 thereto (Filed as Exhibit 4.2 to
Dunn's Form 10-KSB, for the fiscal year ended October 31, 1997 (File No.
0-22263) and hereby incorporated by reference).
10.21 Amendment No. 4, dated February 28, 1998 to the Loan and Security Agreement by
and between Dunn and First Union National Bank, successor by merger to Signet
Bank, dated as of May 28, 1996. (Filed as Exhibit 10.23 to the Company's
Registration Statement on Form S-1, Amendment No. 2, dated April 23, 1998 (File
No. 333-47631) and hereby incorporated by reference.)
*10.22 Employee Stock Purchase Plan.
*10.23 Employment Agreement, Termination Agreement, by and among the Company, George D.
Fuster and D. Oscar Fuster, dated as of November 23, 1998.
21
EXHIBIT
NUMBER DESCRIPTION
- --------------------------------------------------------------------------------------
*10.24 Purchase Price Adjustment Agreement by and among the Company, George D. Fuster
and D. Oscar Fuster, dated as of November 23, 1998.
*21.1 List of Subsidiaries.
*23.1 Consent of Ernst & Young LLP, Independent Auditors.
*23.2 Consent of Ernst & Young LLP, Independent Auditors.
*23.3 Consent of KPMG Peat Marwick LLP, Independent Auditors.
*27.1 Financial Data Schedule.
- ------------------------
* Filed herewith
(b) Reports on Form 8-K
None
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DUNN COMPUTER CORPORATION
By: /s/ THOMAS P. DUNNE
-----------------------------------------
Thomas P. Dunne
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: February 12, 1999
Pursuant to and in accordance with the requirements of the Securities
Exchange Act of 1934, this report has been signed by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ THOMAS P. DUNNE
- ------------------------------ President, Chief Executive February 12, 1999
Thomas P. Dunne Officer and Director
Executive Vice President,
/s/ JOHN D. VAZZANA Chief Financial Officer
- ------------------------------ (and principal February 12, 1999
John D. Vazzana accounting officer) and
Director
/s/ CLAUDIA N. DUNNE
- ------------------------------ Vice President and February 12, 1999
Claudia N. Dunne Director
/s/ VADM E. A. BURKHALTER USN
(RET.)
- ------------------------------ Director February 12, 1999
VADM E. A. Burkhalter USN
(Ret.)
/s/ DANIEL SINNOTT
- ------------------------------ Director February 12, 1999
Daniel Sinnott
23
INDEX TO FINANCIAL STATEMENTS
DUNN COMPUTER CORPORATION (A VIRGINIA CORPORATION)
Report of Ernst & Young LLP, Independent Auditors..................................... F-1
Consolidated Balance Sheets as of October 31, 1997 and 1998........................... F-2
Consolidated Statements of Income for the three years in the period ended October 31,
1998................................................................................ F-3
Consolidated Statements of Stockholders' Equity for the three years in the period
ended October 31, 1998.............................................................. F-4
Consolidated Statements of Cash Flows for the three years in the period ended
October 31, 1998.................................................................... F-5
Notes to Consolidated Financial Statements............................................ F-6
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
Report of KPMG Peat Marwick LLP, Independent Auditors................................. F-24
Combined Balance Sheets as of September 30, 1996 and 1997............................. F-25
Combined Statements of Income and Retained Earnings for the three years in the period
ended September 30, 1997............................................................ F-26
Combined Statements of Cash Flows for the three years in the period ended
September 30, 1997.................................................................. F-27
Notes to Combined Financial Statements................................................ F-28
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors
We have audited the accompanying consolidated balance sheets of Dunn
Computer Corporation (a Virginia Corporation) as of October 31, 1997 and 1998,
and the related consolidated statements of income, stockholders' equity and cash
flows for the three years in the period ended October 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Dunn Computer Corporation as of October 31, 1997 and 1998, and the consolidated
results of its operations and its cash flows for the three years in the period
ended October 31, 1998 in conformity with generally accepted accounting
principles.
/s/ ERNST & YOUNG LLP
Vienna, Virginia
February 3, 1999
F-1
DUNN COMPUTER CORPORATION
CONSOLIDATED BALANCE SHEETS
OCTOBER 31,
------------------------
1997 1998
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents.................. $ 341,966 $ --
Accounts receivable, net of allowance for
doubtful accounts of $77,000 and $46,000
as of October 31, 1997 and 1998,
respectively............................. 9,712,010 16,675,204
Employee and stockholder advances.......... -- 71,287
Other receivables.......................... -- 117,685
Investment in sales-type leases,
net--current portion..................... -- 959,243
Inventory, net............................. 4,487,301 10,928,736
Deferred tax asset......................... -- 630,000
Income tax receivable...................... -- 597,325
Prepaid expenses and other current
assets................................... 87,457 248,143
----------- -----------
Total current assets......................... 14,628,734 30,227,623
Property and equipment, net.................. 633,428 1,927,148
Equipment on lease, net...................... -- 4,096,483
Investment in sales-type leases,
net--long-term portion..................... -- 2,140,099
Goodwill and other intangible assets, net.... 2,974,840 24,231,852
Investments.................................. 275,000 150,000
Other assets................................. 191,075 191,395
----------- -----------
Total assets................................. $18,703,077 $62,964,600
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................... $ 9,296,497 $12,151,163
Accrued expenses........................... 557,264 4,726,765
Line-of-credit............................. -- 3,256,060
Notes payable--current portion............. 12,840 33,514
Notes payable--related parties............. -- 905,960
Unearned revenue........................... 422,907 3,381,291
----------- -----------
Total current liabilities.................... 10,289,508 24,454,753
Notes payable-long-term portion.............. 49,952 51,265
Deferred tax credit.......................... 100,000 --
Other long-term liabilities.................. 25,462 85,890
Commitments.................................. -- --
Stockholders' equity:
Preferred Stock, $.001 par value; 2,000,000
shares authorized, no shares issued and
outstanding.............................. -- --
Common Stock, $.001 par value; 20,000,000
shares authorized, 5,150,000 and
9,391,493 shares issued and outstanding
at October 31, 1997 and 1998,
respectively............................. 5,150 9,392
Additional paid-in capital................. 5,087,371 37,670,245
Treasury stock, 400,000 shares at October
31, 1998................................. -- (3,432,500)
Retained earnings.......................... 3,145,634 4,125,555
----------- -----------
Total stockholders' equity................... 8,238,155 38,372,692
----------- -----------
Total liabilities and stockholders' equity... $18,703,077 $62,964,600
----------- -----------
----------- -----------
See accompanying notes.
F-2
DUNN COMPUTER CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED OCTOBER 31,
-------------------------------------
1996 1997 1998
----------- ----------- -----------
Net revenues...................................... $18,098,638 $21,766,465 $66,888,478
Costs of revenues................................. 14,102,442 17,549,655 54,969,061
----------- ----------- -----------
Gross profit...................................... 3,996,196 4,216,810 11,919,417
Selling and marketing............................. 475,471 842,218 3,671,765
General and administrative........................ 1,496,979 1,332,975 5,201,745
Amortization of goodwill and other intangible
assets.......................................... -- 22,448 544,687
Acquisition integration costs..................... -- -- 564,776
----------- ----------- -----------
Income from operations............................ 2,023,746 2,019,106 1,936,444
Other income (expense):
Other income.................................... 49,343 -- 119,375
Interest income................................. -- 109,877 104,606
Interest expense................................ (57,925) (11,813) (494,504)
----------- ----------- -----------
Net income before income taxes.................... 2,015,164 2,117,170 1,665,921
Provision for income taxes........................ 776,000 794,870 686,000
----------- ----------- -----------
Net income........................................ $ 1,239,164 $ 1,322,300 $ 979,921
----------- ----------- -----------
----------- ----------- -----------
Earnings per share................................ $ 0.31 $ 0.29 $ 0.14
----------- ----------- -----------
----------- ----------- -----------
Earnings per share--assuming dilution............. $ 0.31 $ 0.28 $ 0.13
----------- ----------- -----------
----------- ----------- -----------
See accompanying notes.
F-3
DUNN COMPUTER CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ADDITIONAL RECEIVABLE
----------------- PAID-IN FROM TREASURY RETAINED
SHARES AMOUNT CAPITAL STOCKHOLDER STOCK EARNINGS TOTAL
--------- ------ ----------- ----------- ----------- ---------- -----------
Balance at October 31, 1995............... 4,000,000 $4,000 $ 111,857 $(100,000) -- $ 584,170 $ 600,027
Cash receipts from stockholder............ -- -- -- 100,000 -- -- 100,000
Net income................................ -- -- -- -- -- 1,239,164 1,239,164
--------- ------ ----------- ----------- ----------- ---------- -----------
Balance at October 31, 1996............... 4,000,000 4,000 111,857 -- -- 1,823,334 1,939,191
Issuance of common stock, net of offering
expenses of $1,083,336.................. 1,000,000 1,000 3,916,664 -- -- -- 3,917,664
Issuance of stock related to acquisition
of STMS................................. 150,000 150 974,850 -- -- -- 975,000
Issuance of options related to acquisition
of STMS, recorded at fair value......... -- -- 84,000 -- -- -- 84,000
Net income................................ -- -- -- -- -- 1,322,300 1,322,300
--------- ------ ----------- ----------- ----------- ---------- -----------
Balance at October 31, 1997............... 5,150,000 5,150 5,087,371 -- -- 3,145,634 8,238,155
Repurchase of common stock originally
issued in the acquisition of STMS....... -- -- -- -- (457,500) -- (457,500)
Repurchase of stock option originally
issued in the acquisition of STMS....... -- -- (75,750) -- -- -- (75,750)
Issuance of common stock, net of offering
expenses of $1,330,229.................. 3,491,493 3,492 26,284,374 -- -- -- 26,287,866
Issuance of stock related to acquisitions
of IDP and PRIMO........................ 750,000 750 6,374,250 -- -- -- 6,375,000
Return of common stock originally issued
in the acquisitions of IDP and PRIMO.... -- -- -- -- (2,975,000) -- (2,975,000)
Net income................................ -- -- -- -- -- 979,921 979,921
--------- ------ ----------- ----------- ----------- ---------- -----------
Balance at October 31, 1998............... 9,391,493 $9,392 $37,670,245 $ -- $(3,432,500) $4,125,555 $38,372,692
--------- ------ ----------- ----------- ----------- ---------- -----------
--------- ------ ----------- ----------- ----------- ---------- -----------
See accompanying notes.
F-4
DUNN COMPUTER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED OCTOBER 31,
-----------------------------------
1996 1997 1998
---------- ---------- -----------
OPERATING ACTIVITIES
Net income........................................ $1,239,164 $1,322,300 $ 979,921
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization of property and
equipment..................................... 32,300 46,029 1,139,210
Amortization of goodwill and of other intangible
assets........................................ -- 22,448 544,687
Changes in operating assets and liabilities:
Accounts receivable........................... (951,553) (5,354,279) 2,057,540
Employee and stockholder advances............. -- -- 10,234
Income tax receivable......................... -- -- 316,461
Investment in sales-type leases............... -- -- (3,099,342)
Inventory..................................... 211,763 (2,865,750) 7,015,014
Prepaid expenses and other assets............. 9,460 (85,966) 31,480
Accounts payable.............................. 471,636 3,920,267 (9,542,573)
Accrued expenses.............................. (193,084) 51,930 900,886
Income taxes payable.......................... 260,947 (519,308) (13,290)
Deferred tax asset (credit)................... (66,276) 88,914 (761,714)
Unearned revenue.............................. 67,640 (110,734) 2,958,384
---------- ---------- -----------
Net cash provided by (used in) operating
activities...................................... 1,081,997 (3,484,149) 2,536,898
INVESTING ACTIVITIES
Purchases of property and equipment............... (21,040) (93,389) (945,794)
Acquisitions, net of cash acquired................ -- (928,550) (14,185,021)
Sale (purchase) of investments.................... (150,000) -- 7,315
---------- ---------- -----------
Net cash used in investing activities............. (171,040) (1,021,939) (15,123,500)
FINANCING ACTIVITIES
Net proceeds from issuance of common stock........ -- 3,917,664 26,287,866
Repurchase of common stock and options............ -- -- (533,250)
Proceeds of loans for purchase of certain
assets.......................................... -- 64,226 --
Payments on notes payable......................... -- (10,551) (928,980)
Payments on notes payable to related parties...... -- -- (587,181)
Net payments on bank line of credit............... (252,231) -- (11,993,819)
Repayment from stockholder........................ 100,000 -- --
Payments on capital leases........................ -- (20,949) --
---------- ---------- -----------
Net cash (used in) provided by financing
activities...................................... (152,231) 3,950,390 12,244,636
Net increase (decrease) in cash and cash
equivalents..................................... 758,726 (555,698) (341,966)
Cash and cash equivalents at beginning of the
year............................................ 138,938 897,664 341,966
---------- ---------- -----------
Cash and cash equivalents at end of the year...... $ 897,664 $ 341,966 $ --
---------- ---------- -----------
---------- ---------- -----------
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid..................................... $ 57,925 $ 11,813 $ 494,504
---------- ---------- -----------
---------- ---------- -----------
Income taxes paid................................. $ 581,000 $1,323,308 $ 525,000
---------- ---------- -----------
---------- ---------- -----------
See accompanying notes.
F-5
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Dunn Computer Corporation (the "Corporation") was incorporated on July 27,
1987 under the laws of the Commonwealth of Virginia. On January 3, 1997, Dunn
Computer Corporation ("Dunn"), a Delaware corporation, was formed as a holding
company for the stock of Dunn Computer Corporation, the Virginia corporation. On
January 6, 1997, the Board of Directors and stockholders of the Corporation
approved and effected a 2,799.160251 for 1 stock exchange with Dunn whereby the
holders of the Corporation's common stock would receive 2,799.160251 shares of
common stock in Dunn for each share of common stock in the Corporation.
On September 12, 1997, Dunn acquired all of the outstanding stock of STMS,
Inc. ("STMS"), a Virginia Corporation.
On February 26, 1998, Dunn Computer Corporation (the "Company") was
incorporated in the Commonwealth of Virginia to become a holding company for
Dunn and International Data Products Corp. ("IDP"), as provided for in the
Acquisition Agreement. The Acquisition Agreement provides for the acquisition of
all of the stock of IDP by the Company and the acquisition of substantially all
of the net assets of Puerto Rico Industrial Manufacturing Operations, Corp.
("PRIMO"), an affiliate of IDP, by a newly formed subsidiary of the Company
(collectively, the "IDP Acquisition"). Effective May 1, 1998, the Company's
acquisitions of IDP and PRIMO were consummated. Simultaneously, a subsidiary of
the Company merged into Dunn, whereby each outstanding share of common stock of
Dunn was exchanged on a one-for-one basis for a share of common stock of the
Company and each outstanding option and warrant of Dunn was converted into an
option or warrant, respectively, of the Company on substantially the same terms
as applied to each option or warrant of Dunn immediately prior to the merger.
Dunn became a wholly-owned subsidiary of the Company. All references in the
accompanying consolidated financial statements as to the number of shares of
common stock and per-share amounts have been restated to reflect the stock
exchanges described above. Also, the Company has authorized 2,000,000 shares of
preferred stock with rights and preferences to be determined by the Board of
Directors at a later date.
The Company is engaged in the business of selling build-to-order computer
systems and related equipment and providing computer training and maintenance
service to business and government agencies. The Company operates in a
competitive environment subject to technological change and the emergence of new
technologies, although the Company believes that its products and services are,
or would be, upgradable to new technologies.
2. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
F-6
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
The Company maintains demand deposits with several financial institutions.
At times, deposits exceed federally insured limits, but management does not
consider this a significant concentration of credit risk. The Company considers
all highly liquid investments with a maturity of three months or less at the
time of purchase to be cash equivalents. At October 31, 1998, the Company's cash
management process resulted in an overdraft of $741,000 included in accounts
payable.
OTHER RECEIVABLES
In connection with the acquisition of STMS, the Company purchased a 47.5%
interest in Glacier Corporation ("Glacier"). This investment was recorded at its
fair value of $125,000 on the STMS acquisition date. During fiscal 1998, the
Company relinquished its voting rights with respect to its investment in Glacier
in exchange for a promissory note equivalent to $125,000. The Company reduced
the carrying value of its investment in Glacier by the amount of the promissory
note. The balance of the promissory note is included in other receivables and
will be reduced as payments are received. The Company believes that the carrying
amount of its investment ($0) in Glacier (which only includes equity rights)
represents the lower of cost or market at October 31, 1998. The Company is
accounting for its investment in Glacier using the cost method since the Company
has no voting rights with respect to its investment.
INVESTMENTS
At October 31, 1997 and 1998, investments consisted of shares of common
stock of a privately-held internet company, Worldwide Internet Solutions
Network, Inc. ("WIZnet"), with a cost basis of approximately $150,000. The
Company believes that this carrying amount represents the lower of cost or
market. The Company is accounting for this investment using the cost method
since the Company's investment represents less than 20% of the privately-held
internet company's outstanding stock. The President and Chief Executive Officer
of WIZnet is a member of the Company's Board of Directors.
INVENTORY
Inventory is stated at the lower of cost or market as determined by the
first-in first-out (FIFO) method. The Company periodically evaluates its
inventory obsolescence reserve to ensure inventory is recorded at net realizable
value.
IMPAIRMENT OF LONG-LIVED ASSETS
Each year, management determines whether any property and equipment or any
other assets have been impaired based on the criteria established in Statement
of Financial Accounting Standards No. 121 ("SFAS 121"), "ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF." The
Company made no adjustments to the carrying values of the assets during the
years ended October 31, 1996, 1997 and 1998.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangibles represent the unamortized excess of the cost
of acquiring subsidiary companies over the fair values of such companies' net
tangible assets at the dates of acquisition. Goodwill related to the Company's
acquisitions as described in Note 5 is being amortized on a straight-line basis
over periods ranging from twenty to forty years. Other intangibles, including
contracts, are being amortized on a straight-line basis over a five year period.
F-7
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACQUISITION-RELATED LIABILITIES
During fiscal year 1998, the Company recorded $1,376,000 of
acquisition-related liabilities in connection with the IDP Acquisition. These
liabilities were recorded after certain actions had been identified, quantified
and approved by management of the Company having authority to commit the Company
to the plan. Those certain actions included closing the IDP facility in
Maryland, integrating IDP and the Company's production, warehouse, sales,
marketing and administrative functions, eliminating duplicative jobs and
expanding space in the Company's office space in Virginia. The Company vacated
the production and warehouse space in the IDP facility in June 1998 and intends
to vacate the remaining space in the facility in February, 1999. During fiscal
1998, $232,000 of costs were charged against the liability. The
acquisition-related liabilities at October 31, 1998 consisted of the following:
Workforce-related............................................... $ 545,000
Facilities...................................................... 600,000
---------
Total........................................................... $1,145,000
---------
---------
Workforce-related charges, consisting principally of severance costs, were
recorded based on specific identification of employees to be terminated, along
with their job classifications or functions and their locations. The
facilities-related charges include the cost of the Company's excess facilities
(Maryland facility) and an estimate of the costs to be incurred once the
facility is entirely vacated. This estimate represents the lower of the amount
of the remaining lease obligations, net of any sublease rentals, or the expected
lease settlement costs. These costs have been estimated from the time when the
space is expected to be vacated and when there are no plans to utilize the
facility in the future. Costs incurred prior to vacating the facilities will be
charged to operations. Periodically, the accruals related to the acquisition-
related charges are reviewed and compared to their respective cash requirements.
As a result of those reviews, the accruals are adjusted for changes in cost and
timing assumptions of previously approved and recorded initiatives.
STOCK COMPENSATION
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 ("SFAS 123"), "ACCOUNTING FOR
STOCK-BASED COMPENSATION". SFAS 123 allows companies to account for stock-based
compensation under either the new provisions of SFAS 123 or the provisions of
Accounting Principles Board Opinion No. 25 ("APB 25"), "ACCOUNTING FOR STOCK
ISSUED TO EMPLOYEES," but requires pro forma disclosure in the footnotes to the
consolidated financial statements as if the measurement provisions of SFAS 123
had been adopted. The Company continues accounting for its stock-based
compensation in accordance with the provisions of APB 25.
REVENUE RECOGNITION
The Company generally recognizes revenues from computer sales and sales-type
leases at the time of shipment. Revenues are earned principally pursuant to
various contracts with agencies of the Federal government and commercial
customers. The length of the Company's contracts generally range from one to
three years.
Service revenues are recognized over the contractual period as the services
are provided. Revenues from operating leases are recognized over the contract
term. The Company has assigned payments from one of its operating leases to a
financing company in exchange for the present value of the minimum lease
payments. This amount is nonrefundable by the Company. The Company has recorded
this amount as
F-8
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION (CONTINUED)
unearned revenues and will recognize revenues over the lease term as payments
are received by the Company and remitted to the financing company. The agreement
is cancelable by the lessee upon thirty days notice.
The products sold are generally covered by a warranty for periods ranging
from two to three years. The Company accrues a warranty reserve for revenues
recognized during the year to record estimated costs to provide warranty
services.
Unearned revenue also relates to cash received from credit card sales as of
year end for which the related inventory was shipped subsequent to year end.
During the year ended October 31, 1996, the Company had revenues from two
agencies of the Federal government which represented 22% and 14% of total
revenues. In addition, during 1996, the Company had revenues from one Federal
government contractor and one commercial customer which represented 17% and 16%
of total revenues, respectively. During the year ended October 31, 1997, the
Company had revenues from one agency of the Federal government and one Federal
government contractor which represented 21% and 11% of total revenues,
respectively. As of October 31, 1997, accounts receivable from agencies of the
Federal government represented 64% of total accounts receivable. During the year
ended October 31, 1998, the Company had revenues from one agency of the Federal
government which represented 40% of total revenues. As of October 31, 1998,
accounts receivable from agencies of the Federal government represented 67% of
total accounts receivable.
For the year ended October 31, 1998, approximately 27% of the Company's
revenues were from Federal contracts that were awarded under Section 8(a) of the
Small Business Act.
ADVERTISING EXPENSES
The Company expenses advertising costs as incurred. Advertising costs
amounted to approximately $61,000 and $468,000 during fiscal 1997 and 1998,
respectively. Advertising costs for fiscal 1996 were immaterial to the financial
statements.
ACQUISITION INTEGRATION COSTS
The Company expenses acquisition integration costs as incurred. Acquisition
integration costs consist of compensation costs for employees whose jobs will be
terminated in fiscal 1998 or 1999 and costs for facilities that will be closed
in fiscal 1999. Severance and facility closing costs related to the Company's
decision to exit certain activities of the acquired business have been accounted
for as acquisition-related liabilities.
INCOME TAXES
The Company provides for income taxes in accordance with the liability
method.
EARNINGS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 ("SFAS 128"), EARNINGS PER SHARE. SFAS
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities. The definition of diluted earnings per share is very
similar to the previous definition of fully diluted
F-9
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER SHARE (CONTINUED)
earnings per share. All earnings per share amounts for all periods have been
presented, and where appropriate, restated to conform to the SFAS 128
requirements.
FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations
of credit risk consist primarily of cash, investments and accounts receivable.
The cash is held by high credit quality financial institutions. For accounts
receivable, the Company performs ongoing credit evaluations of its customers'
financial condition and generally does not require collateral. The Company
maintains reserves for credit losses, and such losses have been within
management's expectations. The concentration of credit risk is mitigated by the
diverse customer base and the amount of receivables due by the Federal
government. The carrying amount of the receivables approximates their fair
value.
SUPPLEMENTAL INFORMATION OF NON-CASH INVESTING AND FINANCING ACTIVITIES
YEARS ENDED OCTOBER 31,
---------------------------
1997 1998
------------ -------------
Fair value of assets acquired.................................... $ 5,970,000 $ 58,951,000
Less: Cash paid.................................................. 1,044,000 14,900,000
Stock issued, net of value of stock returned (SEE NOTE 10)....... 1,059,000 3,400,000
------------ -------------
Liabilities assumed (including $1,376,000
of acquisition-related liabilities in 1998).................... $ 3,867,000 $ 40,651,000
------------ -------------
------------ -------------
RECENT PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 ("SFAS 130"), "REPORTING COMPREHENSIVE
INCOME", which establishes standards for reporting the components of
comprehensive income and requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
included in a financial statement that is displayed with the same prominence as
other financial statements. Comprehensive income includes net income as well as
certain non-owners items that are reported directly within a separate component
of stockholders' equity. The provisions of SFAS 130 are effective for fiscal
years beginning after December 15, 1997. The Company has adopted SFAS 130 on
November 1, 1998. The adoption did not have a material impact on the Company's
consolidated financial position or results of operations.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131 ("SFAS 131"), "DISCLOSURES ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION", which is required to be
adopted for companies with fiscal years beginning after December 15, 1997. SFAS
131 changes the way public companies report segment information in annual
financial statements and also requires those companies to report selected
segment information in interim financial reports to stockholders. SFAS 131
supersedes Statement of Financial Accounting Standards No. 14, "FINANCIAL
REPORTING FOR SEGMENTS OF A BUSINESS ENTERPRISE." The Company adopted SFAS 131
on November 1, 1998. The adoption did not have a material impact on the
disclosure for segment information on the financial statements.
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132 ("SFAS 132"), "EMPLOYERS' DISCLOSURES
ABOUT PENSIONS AND OTHER POSTRETIREMENT
F-10
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT PRONOUNCEMENTS (CONTINUED)
BENEFITS," which is required to be adopted for companies with fiscal years
beginning after December 15, 1997. SFAS 132 amends Statements of Financial
Accounting Standards No. 87 "EMPLOYERS' ACCOUNTING FOR PENSIONS,"No. 88.
EMPLOYERS' ACCOUNTING FOR SETTLEMENTS AND CURTAILMENTS OF DEFINED BENEFIT
PENSION PLANS AND FOR TERMINATION BENEFITS" and No. 106 "EMPLOYERS' ACCOUNTING
FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS," by revising employers'
disclosures about pension and other postretirement benefit plans. SFAS 132
doesn't change the measurement or recognition of those plans. The disclosure
requirements of SFAS 132 will not have a material impact on the Company's
consolidated financial position or results of operations.
In March 1998, AcSEC issued Statement of Position 98-1 ("SOP 98-1"),
"ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED FOR OR OBTAINED FOR
INTERNAL USE." SOP 98-1 is effective for fiscal years beginning after December
15, 1998. SOP 98-1 will require the capitalization of certain costs incurred
after the date of adoption in connection with developing or obtaining software
for internal use. The Company currently expenses such costs as incurred. The
Company has not yet assessed what the impact of SOP 98-1 will be on the
Company's future earnings or financial position.
3. PROPERTY AND EQUIPMENT AND EQUIPMENT ON LEASE
Property and equipment, including leasehold improvements, are stated at
cost. Property and equipment are depreciated and amortized using the
straight-line method over the estimated useful lives of five years. Leasehold
improvements are amortized over the lesser of the related lease term or the
useful life.
Property and equipment consisted of the following:
OCTOBER 31,
------------------------
1997 1998
---------- ------------
Computer and office equipment....................................... $ 505,920 $ 1,443,992
Furniture and fixtures.............................................. 57,076 302,741
Leasehold improvements.............................................. 96,326 454,913
Other............................................................... 143,060 416,018
---------- ------------
802,382 2,617,664
Less accumulated depreciation and amortization...................... (168,954) (690,516)
---------- ------------
$ 633,428 $ 1,927,148
---------- ------------
---------- ------------
The Company owns equipment that is currently at a customer's site under an
operating lease agreement (See Note 2--Revenue Recognition). The cost and
related accumulated depreciation for the equipment on lease amounted to
$4,763,671, and $667,188, respectively, at October 31, 1998.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets were comprised of:
OCTOBER 31,
---------------------------
1997 1998
------------ -------------
Goodwill......................................................... $ 2,397,287 $ 24,198,986
Contracts........................................................ 600,000 600,000
Less accumulated amortization.................................... (22,447) (567,134)
------------ -------------
$ 2,974,840 $ 24,231,852
------------ -------------
------------ -------------
F-11
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. ACQUISITIONS
STMS
On September 12, 1997, the Company acquired all of the outstanding stock of
STMS, Inc., a Virginia corporation ("STMS"), for 150,000 shares of the Company's
common stock, options to purchase 25,000 shares of the Company's common stock,
and $1,044,500 in cash used specifically to repay certain debt of STMS. The
transaction was accounted for using the purchase method. The 150,000 shares of
common stock were valued at the market price of Company's common stock or
$975,000 on the date of the transaction. The options to purchase 25,000 shares
of common stock were issued to a stockholder/creditor of STMS and were valued at
fair value of $84,000 using the Black-Scholes option-pricing model. The purchase
price was allocated to the assets and liabilities acquired based on their
estimated fair values. In conjunction with the acquisition, the Company recorded
goodwill in the amount of $2,397,287 and other intangible assets (contracts) in
the amount of $600,000. The operations of STMS are included in the consolidated
financial statements of the Company beginning September 12, 1997 (date of
acquisition).
The Company granted options to purchase an aggregate of 1,330,000 shares of
the Company's common stock, at an exercise price equivalent to its fair market
value at the date of grant, to the former stockholders of STMS in conjunction
with their three-year employment agreements. The options vest over a three-year
period.
During February 1998, the Company repurchased an aggregate of 50,000 shares
of common stock and the option to purchase 25,000 shares of common stock
originally issued in connection with the STMS acquisition (see Note 10).
IDP AND PRIMO
On May 1, 1998, the Company acquired all of the outstanding stock of IDP and
substantially all of the net assets of PRIMO for $14.9 million in cash and
750,000 shares of common stock of the Company, both subject to adjustment in the
event that the combined net assets of IDP and PRIMO fell below a certain level
stipulated in the Acquisition Agreement (See Note 10). The transaction was
accounted for using the purchase method. The 750,000 shares of common stock were
valued at the market price of the Company's common stock ($8.50 per share) on
the date of the transaction. The purchase price was preliminarily allocated to
the assets and liabilities acquired based on their estimated fair values. In
conjunction with the acquisition, the Company recorded goodwill (as adjusted) in
the amount of $21,801,699. The operations of IDP, including PRIMO, are included
in the consolidated financial statements of the Company beginning May 1, 1998
(date of acquisition).
In connection with the IDP acquisition, two of the IDP sellers entered into
employment agreements with the Company pursuant to which they each received
options to purchase 300,000 shares of the Company's common stock. The grant
price of the options was equivalent to the fair market value of the underlying
common stock on the grant date and the options vested immediately.
During November 1998, the Company entered into an Employment Agreement
Termination Agreement and a Purchase Price Adjustment Agreement with the two
former stockholders of IDP whereby employment of the former stockholders of IDP
was terminated and the former IDP stockholders agreed to return 350,000 shares
of the Company's common stock originally issued in connection with the IDP
Acquisition. See Note 10 for additional information.
F-12
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. ACQUISITIONS (CONTINUED)
IDP AND PRIMO (CONTINUED)
The selected unaudited pro forma information for the years ended October 31,
1997 and 1998 includes the operating results of the Company as if the Company
acquired STMS, IDP, and PRIMO on November 1, 1996.
YEARS ENDED OCTOBER 31,
--------------------------
1997 1998
------------ ------------
(UNAUDITED)
Pro Forma net revenues...................................... $109,106,000 $110,310,000
------------ ------------
------------ ------------
Pro Forma net income (loss)................................. $ 365,000 $ (6,768,000)
------------ ------------
------------ ------------
Pro Forma earnings per share................................ $ 0.04 $ (0.75)
------------ ------------
------------ ------------
Pro Forma earnings per share--assuming dilution............. $ 0.04 $ (0.75)
------------ ------------
------------ ------------
Pro Forma weighted average shares outstanding............... 8,202,000 8,981,000
------------ ------------
------------ ------------
Pro Forma weighted average shares outstanding-- assuming
dilution.................................................. 8,329,000 8,981,000
------------ ------------
------------ ------------
6. BANK LINES OF CREDIT AND NOTES PAYABLE
In April 1996, the Company entered into a line of credit agreement with a
bank that was subsequently amended in December 1997 to allow the Company to
borrow an amount limited to the minimum of its borrowing base or $4,000,000. As
of October 31, 1998, the Company's borrowing base, which is based on certain
percentages of total accounts receivable less overdue accounts, is $959,843.
Outstanding borrowings bear interest at the prime rate. As of October 31, 1997,
there were no outstanding borrowings under this line of credit facility. As of
October 31, 1998, the Company had borrowed $201,000 against this line of credit
facility and had an unused borrowing capacity of $758,843. The Company pays a
commitment fee equivalent to a certain percentage (approximately . 3/8%) of the
unused borrowings under the line of credit facility. The line of credit is
secured by all assets of Dunn, a subsidiary of the Company. Under the line of
credit agreement, the Company is required to maintain a net worth of $1,250,000
as well as to submit periodic financial statements. For the years ended October
31, 1996, 1997 and 1998, the Company is in compliance with the covenants. The
line of credit agreement expires February 28, 1999.
Notes payable consisted of the following:
OCTOBER 31,
--------------------
1997 1998
--------- ---------
Asset loans, bearing interest at annual interest rates
ranging from 7.9% to 10.46%; due in aggregate monthly
payments of $2,695 through August, 2002, secured by
certain assets of the Company........................... $ 64,227 $ 78,549
Other..................................................... -- 6,230
--------- ---------
64,227 84,779
Less current portion...................................... 12,840 33,514
--------- ---------
Notes payable, long-term.................................. $ 49,952 $ 51,265
--------- ---------
--------- ---------
F-13
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. BANK LINES OF CREDIT AND NOTES PAYABLE (CONTINUED)
Principal payments on the long-term debt for each of the fiscal years from
1999 to 2003 and thereafter are due as follows:
YEAR ENDING
OCTOBER 31,
-----------
1999............................................................................. $ 33,514
2000............................................................................. 22,408
2001............................................................................. 17,809
2002............................................................................. 11,048
-----------
Total............................................................................ $ 84,779
-----------
-----------
Notes payable to related parties are payable to certain stockholders and
their relatives, and employees. These notes payable were assumed by the Company
in the IDP Acquisition. All notes payable to related parties are classified as
current liabilities as the outstanding balances are due upon demand. Notes
payable to related parties bear interest at annual interest rates ranging from 8
to 11%. The total amounts outstanding on these related parties' notes payable
were approximately $905,960 at October 31, 1998. Interest expense on these notes
payable amounted to $58,297 during the period from May 1, 1998 through October
31, 1998. The total amounts outstanding on these notes payable were repaid
subsequent to October 31, 1998 (See Note 10).
The Company has a line of credit facility of $25,000,000, of which
$13,000,000 is secured by IDP's inventory and $12,000,000 is secured by IDP's
accounts receivable. This line of credit facility was assumed by the Company in
the IDP Acquisition. The outstanding balance on this line of credit at October
31, 1998 was approximately $3,055,060. The interest rate applicable to this line
of credit as of October 31, 1998 was 7.33% (LIBOR rate plus 2.05%). There is no
formal expiration date on this facility although it is subject to annual
re-evaluation by the financial institution. The Company was in violation of its
net worth financial covenant at October 31, 1998. This violation at October 31,
1998, and any subsequent violations through January 31, 1999, were subsequently
cured through a waiver obtained from the financial institution. The Company has
classified all outstanding balances as current.
F-14
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. RELATED PARTY TRANSACTION
Thomas Dunne, the Company's President, and his wife, Claudia Dunne, the
Company's Vice President, acquired a building for the purpose of leasing office
space to the Company. In connection with the acquisition of the building, the
Company guaranteed the building's $1 million mortgage. The term of the mortgage
is 25 years. The Company subsequently executed a noncancelable operating lease
with Mr. and Mrs. Dunne. The Company believes that the lease agreement is on
terms no less favorable to the Company than could be obtained from unaffiliated
third parties (see Note 8).
8. COMMITMENTS
OPERATING LEASES
The Company leases office space under a noncancelable operating lease
agreement with two stockholders (see Note 7). The lease agreement terminates in
October 1999, but provides for a five year renewal at the Company's option.
Additionally, the Company leases various office equipment and other office space
under non-cancelable operating leases. Rent expense under these leases was
$154,000, $175,000 and $499,100 for the years ended October 31, 1996, 1997, and
1998, respectively.
Future minimum lease payments under noncancelable operating leases,
including the leases assumed in the STMS and IDP acquisitions, at October 31,
1998 are as follows:
1999.............................................. $1,041,245
2000.............................................. 469,703
2001.............................................. 285,709
2002.............................................. 293,843
2003 and thereafter............................... 225,304
----------
Total............................................. $2,315,804
----------
----------
The Company will receive $1,898,436 in aggregate sublease income through
fiscal 2003.
EMPLOYMENT AGREEMENTS
The Company has employment agreements with certain key executives under
which the Company is required to pay the following base salaries annually over
the next two years.
1999.............................................. $1,005,000
2000.............................................. 637,501
----------
Total............................................. $1,642,501
----------
----------
F-15
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INVESTMENT IN SALES-TYPE LEASES
During 1998, the Company leased equipment to certain customers under
sales-type leases. The components of the Company's net investment in sales-type
leases are as follows:
OCTOBER 31,
1998
------------
Total minimum lease payments receivable......................................... $ 3,446,095
Less--unearned interest....................................................... (346,753)
------------
Net investment in sales-type leases............................................. 3,099,342
Less--current portion......................................................... 959,243
------------
$ 2,140,099
------------
------------
Future minimum lease payments due under noncancelable leases as of October 31,
1998 are as follows:
YEAR ENDING
OCTOBER 31,
- --------------------------------------------------------------------------------
1999............................................................................ $ 1,165,453
2000............................................................................ 1,165,453
2001............................................................................ 1,115,189
------------
$ 3,446,095
------------
------------
10. STOCKHOLDERS' EQUITY
EQUITY TRANSACTIONS
On April 21, 1997, the Company sold 1,000,000 shares of common stock in an
initial public offering for net proceeds of $3,917,664. In connection with the
offering, warrants were issued to the underwriter for 100,000 shares of common
stock at an exercise price of $6.00 per share. Beginning April 21, 1998, the
warrants are exercisable for a period of four years.
During February 1998, the Company repurchased 50,000 shares of its common
stock held by former stockholders of STMS. The shares were repurchased at the
current market price of $9.15 per share. The Company accounted for the
repurchase as a treasury stock transaction. The Company also repurchased options
to purchase 25,000 shares of the Company's common stock that were originally
issued in connection with the STMS acquisition. The repurchase price of $75,750
represents the difference between the fair market value of the underlying common
stock on the repurchase date and the grant price multiplied by the 25,000
options. The Company accounted for the repurchase as a reduction of additional
paid-in capital.
The IDP Acquisition Agreement provided for an adjustment of the purchase
price if the combined net worth of IDP and PRIMO exceeded or was below a
specified level. Since the net worth on the closing balance sheet of IDP and
PRIMO was below the specified level, the Company and the former IDP stockholders
agreed to adjust the purchase price. In November 1998, the Company entered into
a Purchase Price Adjustment Agreement with the two former stockholders of IDP
whereby 350,000 shares of the Company's common stock originally issued in
connection with the IDP acquisition were returned to the Company. The Company
accounted for the return as a treasury stock transaction and valued such shares
at the fair market value of the Company's common stock on the date of
acquisition. In connection with the
F-16
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCKHOLDERS' EQUITY (CONTINUED)
EQUITY TRANSACTIONS (CONTINUED)
transaction, the Company and the two former stockholders also agreed to cancel
the employment agreements in exchange for payments totaling $500,000, for which
the Company recorded an adjustment to its purchase price allocation. In
addition, the Company agreed to pay the balance of the notes payable to related
parties of $905,960 in full by November 25, 1998. The two former stockholders
retained their options to purchase the Company's common stock subject to all
original terms and conditions. (See Note 5)
In connection with the acquisitions of IDP and PRIMO, the Company completed
a public offering of 3,491,493 shares of common stock for net proceeds of
$26,287,866.
STOCK OPTIONS
On January 6, 1997, the Company adopted the 1997 Stock Option Plan (the
"Option Plan") which permits the Company to grant up to 600,000 options to
officers, directors and employees who contribute materially to the success of
the Company. In September 1997, the Company increased the number of options
available for grant under the plan to 2,200,000. Stock options are generally
granted at prices which the Company's Board of Directors believes approximates
the fair market value of its common stock at the date of grant. The options vest
over a stated period of time not to exceed four years. The contractual term of
the options is five years.
Common stock option activity was as follows:
WEIGHTED-
AVERAGE
EXERCISE
SHARES PRICE
---------- -----------
Outstanding at October 31, 1996....................................... -- $ --
Options granted....................................................... 1,927,000 6.11
Options exercised..................................................... -- --
Options canceled or expired........................................... (70,000) 4.15
---------- -----
Outstanding at October 31, 1997....................................... 1,857,000 6.18
Options granted....................................................... 865,400 7.46
Options exercised..................................................... -- --
Options canceled or expired........................................... (226,583) 5.35
---------- -----
Outstanding at October 31, 1998....................................... 2,495,817 $ 6.70
---------- -----
---------- -----
Exercisable at October 31, 1998....................................... 600,000 $ 8.75
---------- -----
---------- -----
The total options outstanding include 600,000 options granted to the former
IDP stockholders that are not included in the Option Plan.
As of October 31, 1998, there were 304,183 options available for future
grants under the Option Plan.
F-17
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK OPTIONS (CONTINUED)
The following table summarizes information about fixed-price stock options
outstanding at October 31, 1998:
NUMBER
OUTSTANDING AVERAGE WEIGHTED-
RANGE OF AT OCTOBER REMAINING AVERAGE
EXERCISE 31, CONTRACTUAL EXERCISE
PRICES 1998 LIFE PRICE
- ---------------------------------------------------------- ------------- --------------- -----------
$4.15-$5.75............................................... 395,317 3.99 $ 4.39
$6.00-$6.75............................................... 1,500,500 3.91 6.49
$8.75..................................................... 600,000 9.58 8.75
------------- --- -----
------------- --- -----
$4.15-$8.75............................................... 2,495,817 5.29 $ 6.70
------------- --- -----
------------- --- -----
Had compensation expense related to the stock options been determined based
on the fair value at the grant date for options granted during the years ended
October 31, 1996, 1997, and 1998 consistent with the provisions of SFAS 123, the
Company's net income and earnings per share would have been as follows:
YEARS ENDED OCTOBER 31,
---------------------------
1997 1998
------------ -------------
Net income--pro forma............................................ $ 1,098,900 $ (2,535,579)
------------ -------------
Earnings per share--pro forma.................................... $ 0.24 $ (0.35)
------------ -------------
------------ -------------
Earnings per share--assuming dilution--pro forma................. $ 0.23 $ (0.35)
------------ -------------
------------ -------------
The effect of applying SFAS 123 on pro forma net income as stated above is
not necessarily representative of the effects on reported net income for future
years due to, among other things, the vesting period of the stock options and
the fair value of additional options in the future years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing fair value model with the following
weighted-average assumptions used for grants in 1997 and 1998: dividend yield of
0%, expected volatility of 46%, and 84%, respectively; risk-free interest rates
of 5.75% and 5.50%, respectively; and expected life of the option term of five
years. The weighted average fair values of the options granted in 1997 and 1998
with a stock price equal to the exercise price is $6.18 and $5.21, respectively.
The weighted average fair value of options granted in 1998 with a stock price
greater than the exercise price is $7.36.
11. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
F-18
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES (CONTINUED)
Components of the Company's net deferred tax asset (credit) balance are as
follows:
OCTOBER 31,
--------------------
1997 1998
--------- ---------
Deferred tax asset:
Accrued expenses.................................... $ 24,800 $ 810,378
Net operating loss carryforwards.................... 454,000 970,689
Basis differences of acquired assets................ -- 939,468
Asset reserves...................................... 14,000 1,106,423
--------- ---------
Total deferred asset................................ 492,800 3,826,958
Deferred tax credit:
Acquisition of intangible assets.................... (100,000) (100,000)
Depreciation........................................ -- (35,789)
Change from cash to accrual method for tax
purposes.......................................... (38,800) --
Valuation allowance................................. (454,000) (3,061,169)
--------- ---------
Net deferred tax asset (credit)..................... $(100,000) $ 630,000
--------- ---------
--------- ---------
As of October 31, 1998, the Company had approximately $2,500,000 in net
operating loss carryforwards related to STMS and IDP which expire between 2012
and 2017. These carryforwards may be significantly limited under Section 382 of
the Internal Revenue Service Code and the SRLY rules. The Company has recorded a
valuation allowance for a portion of the deferred tax assets because
realizability of those assets is uncertain.
The components of the provision for income taxes are as follows:
YEARS ENDED OCTOBER 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
Current tax expense:
Federal..................................... $ 709,195 $ 671,070 $ 411,709
State....................................... 133,081 125,900 91,144
--------- --------- ---------
842,276 796,970 502,853
Deferred tax expense:
Federal..................................... (55,800) (1,800) 155,675
State....................................... (10,476) (300) 27,472
--------- --------- ---------
(66,276) (2,100) 183,147
--------- --------- ---------
Total provision for income taxes.............. $ 776,000 $ 794,870 $ 686,000
--------- --------- ---------
--------- --------- ---------
F-19
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES (CONTINUED)
The reconciliation of income tax from the Federal statutory rate of 34% is:
YEARS ENDED OCTOBER 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
Tax at statutory rates:....................... $ 685,156 $ 719,838 $ 566,413
Non-deductible expenses....................... 9,610 8,291 35,480
State income tax, net of federal benefit...... 81,234 66,741 84,107
--------- --------- ---------
$ 776,000 $ 794,870 $ 686,000
--------- --------- ---------
--------- --------- ---------
In September 1997 and in May 1998, respectively, the Company acquired the
stock of STMS and IDP in tax-free exchanges. The stock acquisitions were
accounted for using the purchase method. Included in the Company's deferred tax
assets at October 31, 1998 is approximately $3,800,000 representing the
differences between the assigned values and tax bases of the assets and
liabilities acquired, as well as net operating loss carry forwards acquired.
These deferred tax assets were fully reserved at the dates of acquisition. To
the extent these deferred tax assets are subsequently realized, the resulting
tax benefit will be applied to reduce goodwill recorded in connection with the
acquisitions and there will be no impact on income tax expense.
12. RETIREMENT PLANS
401(K) PLANS
Effective April 1, 1995, the Company adopted a 401(k) (the "Plan").
Employees are eligible to participate after completing six months of services
and attaining age 18. Employees can defer up to 15% of compensation. Employee
contributions are subject to Internal Revenue Service limitations. All employees
who contribute to the Plan are eligible to share in discretionary Company
matching contributions. During the years ended October 31, 1996, 1997 and 1998,
the Company contributed $3,300, $11,855 and $0, respectively, to the Plan.
In connection with the IDP Acquisition, the Company assumed IDP's
tax-deferred savings plan under Section 401(k) of the Internal Revenue Code
which is offered to all employees who have attained the age of 21. The plan
provides for contributions by employees as well as matching and discretionary
contributions by the Company. The Company made contributions of approximately
$123,000 during the period from May 1, 1998 through October 31, 1998.
DEFINED BENEFIT PLAN
The Company has a defined benefit plan (the "Pension Plan") covering
substantially all salaried employees. The Pension Plan benefits are based on
years of service and the employee's compensation. The Company's funding policy
is to annually contribute amounts sufficient to meet minimum funding
requirements set forth in the Employee Retirement Income Security Act of 1974
("ERISA"). Contributions are intended to provide not only for benefits
attributed to service to date, but also for those expected to be earned in the
future. The assets of the Pension Plan are invested in money market and
corporate debt and equity instruments. The Company contributed, in the
aggregate, approximately $135,000 for the Pension Plan years ending October 31,
1995 and 1996 and $63,777 for the Pension Plan year ending October 31, 1997.
Such amounts met the minimum funding requirements under ERISA. The Company has
accrued,
F-20
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. RETIREMENT PLANS (CONTINUED)
DEFINED BENEFIT PLAN (CONTINUED)
but not yet paid, $70,063, which amount represents its minimum funding
requirements under ERISA for fiscal 1998.
On January 6, 1997, the Company amended the Pension Plan to change the
benefits to be paid out after retirement from 100% to 40% of its initial
liability. This will result in a reduction of the projected benefit obligation
by $150,000.
The following table sets forth the Pension Plan's funded status as reported
on activity, and amounts recognized in the Company's consolidated financial
statements:
OCTOBER 31,
--------------------
1997 1998
--------- ---------
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested
benefits of $(171,593) and $(309,886) at October
31, 1997 and 1998, respectively................... $(321,599) $(376,404)
--------- ---------
--------- ---------
Projected benefit obligation.......................... (321,599) (376,404)
Pension Plan assets at fair value..................... 147,041 306,341
--------- ---------
Funded status--projected benefit obligation in excess
of fair value of Pension Plan assets................ $(174,518) $ (70,063)
--------- ---------
--------- ---------
YEARS ENDED OCTOBER 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
Net periodic pension cost:
Service cost..................................... $ 59,066 $ 44,140 $ 48,195
Interest cost.................................... 17,892 19,355 27,034
Actual return on assets.......................... (33,982) 21,295 (95,523)
Net amortization and deferral.................... 38,127 (33,340) 90,219
--------- --------- ---------
Total net periodic pension cost.................. $ 81,103 $ 51,540 $ 69,925
--------- --------- ---------
--------- --------- ---------
F-21
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. RETIREMENT PLANS (CONTINUED)
DEFINED BENEFIT PLAN (CONTINUED)
Key assumptions used in the actuarial valuation were:
OCTOBER 31,
------------------
1996 1997 1998
---- ---- ----
Weighted average discount rate.................... 7.5% 7.5% 7.5%
Rate of return on assets:
Pre-retirement.................................. 8.0% 8.0% 8.0%
Post-retirement................................. 8.0% 8.0% 8.0%
13. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per share:
YEARS ENDED OCTOBER 31,
----------------------------------
1996 1997 1998
---------- ---------- ----------
Numerator:
Net income........................................ $1,239,164 $1,322,300 $ 979,921
---------- ---------- ----------
---------- ---------- ----------
Denominator:
Denominator for basic earnings per
share--weighted-average shares.................. 4,000,000 4,552,055 7,231,397
Effect of dilutive securities:
Employee stock options............................ -- 124,906 251,132
Warrants.......................................... -- 1,887 9,722
---------- ---------- ----------
Dilutive potential common shares.................. -- 126,793 260,854
Denominator for diluted earnings per
share--adjusted weighted-average shares and
assumed conversions............................. 4,000,000 4,678,848 7,492,251
---------- ---------- ----------
---------- ---------- ----------
Basic earnings per share.......................... $ 0.31 $ 0.29 $ 0.14
---------- ---------- ----------
---------- ---------- ----------
Diluted earnings per share........................ $ 0.31 $ 0.28 $ 0.13
---------- ---------- ----------
---------- ---------- ----------
14. CONTINGENCIES
EMPLOYEE TERMINATION
In November 1998, a former employee of the Company (who had previously been
an employee and stockholder of STMS) filed a demand for arbitration with the
American Arbitration Association, alleging a breach of his employment agreement
with the Company and seeking "in excess of $2,350,000" in damages from the
Company. The Company has filed an answer denying the former employee's
allegations and a counterclaim for this former employee's breach of the
employment agreement and for conversion of certain of the Company's property,
and intends to defend the former employee's claim and to pursue its own claim,
vigorously. The Company believes that it has meritorious defenses to the former
employee's claim. The Company can't estimate at this time the amount of the
liability to be incurred, if any, but doesn't believe that this matter will have
a material adverse effect upon the Company's financial position
F-22
DUNN COMPUTER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. CONTINGENCIES (CONTINUED)
or results of operations and, as such, the Company has not recorded any amount
relating to this matter in the accompanying consolidated financial statements.
IDP ACQUISITION
On December 18, 1998, the Company became aware of a threatened action by the
Office of the United States Attorney for the District of Maryland, Northern
Division (U.S. Attorney), against parties including IDP, the former stockholders
of IDP, and the Company, in which the U.S. Attorney may allege fraudulent
misrepresentations by the former stockholders of IDP in a 1994 application by
IDP for participation in the Section 8(a) program administered by the United
States Small Business Administration. To date, no actual suit has been filed.
The Company is currently negotiating a resolution to this matter with the U.S.
Attorney and the other parties. The Company believes that it has meritorious
defenses to each of these allegations and intends to vigorously defend itself if
a suit is filed. The Company can't estimate at this time the amount of the
liability to be incurred, if any, but doesn't believe that this matter will have
a material adverse effect upon the Company's financial position or results of
operations and as such, the Company has not recorded any amount relating to this
matter in the accompanying consolidated financial statements.
In May 1997, the U.S. Air Force awarded a contract to IDP. Dynamic
Decisions, Inc. ("DDI"), a competitor for this contract, protested the contract
award to the Small Business Administration ("SBA"), which protest was denied.
DDI filed suit against the SBA and Air Force seeking review of the award
decision. IDP intervened in the litigation and the litigation was subsequently
settled. Based on the terms of the settlement, IDP agreed to pay DDI 1.8% of the
first $250 million of IDP's gross sales under the contract. On June 1, 1998, the
Company filed a Complaint for Declaratory Judgment in U.S. District Court for
the Eastern District of Virginia seeking a declaration that DDI is not entitled
to receive payments under the settlement agreement. This filing is based on the
Company's position that DDI breached the settlement agreement. DDI has
counter-claimed against the Company denying it breached the settlement agreement
and seeking the payments. The Company believes that it has meritorious defenses
to the claim and intends to vigorously defend itself. The Company can't estimate
at this time the amount of the liability to be incurred, if any, but doesn't
believe that this matter will have a material adverse effect upon the Company's
financial position or results of operations and as such, the Company has not
recorded any amount relating to this matter in the accompanying consolidated
financial statements.
F-23
REPORT OF KPMG PEAT MARWICK LLP, INDEPENDENT AUDITORS
The Boards of Directors
International Data Products, Corp. and Puerto Rico Industrial Manufacturing
Operations, Corp.:
We have audited the accompanying combined balance sheets of International
Data Products, Corp. and combined company as of September 30, 1996 and 1997, and
the related combined statements of income and retained earnings and cash flows
for each of the years in the three-year period ended September 30, 1997. These
combined financial statements are the responsibility of the Companies'
management. Our responsibility is to express an opinion on these combined
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the 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 combined financial statements referred to above present
fairly, in all material respects, the financial position of International Data
Products, Corp. and combined company as of September 30, 1996 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended September 30, 1997 in conformity with generally accepted
accounting principles.
/s/ KPMG Peat Marwick LLP
McLean, Virginia
November 7, 1997
F-24
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
COMBINED BALANCE SHEETS
SEPTEMBER 30,
---------------------------
ASSETS 1996 1997
- ------------------------------------------------------------------------------------- ------------- ------------
Current assets:
Cash and cash equivalents.......................................................... $ 314,677 1,013,198
Accounts receivable--trade (net of allowance of $127,733 as of September 30, 1996
and $131,821 as of September 30, 1997) 6,635,990 5,724,022
Employee and stockholder advances.................................................. 109,883 119,390
Inventory, net..................................................................... 15,339,842 15,991,331
Income taxes receivable............................................................ -- 401,775
Deferred income taxes.............................................................. 9,557 443,415
Prepaid expenses................................................................... 1,368,640 790,160
Other current assets............................................................... 210,486 327,150
------------- ------------
Total current assets................................................................. 23,989,075 24,810,441
Fixed assets, net of accumulated depreciation and amortization....................... 1,640,423 2,252,851
Deferred income taxes................................................................ -- 17,631
Investment in joint venture, at cost................................................. 31,200 31,200
Other assets......................................................................... 77,570 199,732
------------- ------------
Total assets....................................................................... $ 25,738,268 27,311,855
------------- ------------
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit..................................................................... $ 6,585,689 5,634,687
Accounts payable--trade............................................................ 11,654,404 12,810,200
Accrued expenses................................................................... 745,797 1,446,074
Income taxes payable............................................................... 180,372 58,456
Notes payable--current portion..................................................... 425,554 368,792
Notes payable--related parties..................................................... 1,604,462 1,498,397
Other liabilities.................................................................. 152,553 58,950
------------- ------------
Total current liabilities............................................................ 21,348,831 21,875,556
Long-term liabilities:
Notes payable, net of current portion.............................................. 224,926 164,308
Deferred income taxes.............................................................. 10,538 --
Deferred rent...................................................................... 226,222 163,165
------------- ------------
Total liabilities.................................................................... 21,810,517 22,203,029
------------- ------------
Commitments and contingencies
Stockholders' equity:
International Data Products, Corp. common stock, no par value, 5,000 shares
authorized, 100 shares issued and outstanding.................................... 40,000 40,000
Puerto Rico Industrial Manufacturing Operations Corp. common stock, no par value,
10,000 shares authorized, 7,000 shares issued and outstanding.................... 132,000 132,000
Retained earnings.................................................................. 3,755,751 4,936,826
------------- ------------
Total stockholders' equity........................................................... 3,927,751 5,108,826
------------- ------------
Total liabilities and stockholders' equity........................................... $ 25,738,268 27,311,855
------------- ------------
------------- ------------
See accompanying notes to combined financial statements.
F-25
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
COMBINED STATEMENTS OF INCOME AND RETAINED EARNINGS
YEARS ENDED SEPTEMBER 30,
-----------------------------------------
1995 1996 1997
------------- ------------ ------------
Sales................................................................. $ 80,432,480 84,291,838 71,920,739
Cost of sales......................................................... 69,024,772 71,889,685 58,995,644
------------- ------------ ------------
Gross profit.......................................................... 11,407,708 12,402,153 12,925,095
Operating expenses.................................................... 8,709,038 11,232,702 11,598,705
------------- ------------ ------------
Income from operations................................................ 2,698,670 1,169,451 1,326,390
Other income (expenses):
Bid protest settlement.............................................. -- 750,000 --
Interest income..................................................... 36,736 120,369 31,359
Interest expense.................................................... (524,329) (884,818) (593,012)
Miscellaneous, net.................................................. 4,411 5,742 (1,109)
------------- ------------ ------------
Income before income taxes............................................ 2,215,488 1,160,744 763,628
Income tax expense (benefit).......................................... 278,305 (17,708) (417,447)
------------- ------------ ------------
Net income............................................................ 1,937,183 1,178,452 1,181,075
Retained earnings, beginning of year.................................. 640,116 2,577,299 3,755,751
------------- ------------ ------------
Retained earnings, end of year........................................ $ 2,577,299 3,755,751 4,936,826
------------- ------------ ------------
------------- ------------ ------------
See accompanying notes to combined financial statements.
F-26
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
COMBINED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30,
----------------------------------------
1995 1996 1997
------------ ------------ ------------
Cash flows from operating activities:
Net income........................................................................... $ 1,937,183 1,178,452 1,181,075
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Depreciation and amortization.................................................... 259,356 411,979 573,228
Deferred income taxes............................................................ (21,602) (363,121) (462,026)
Loss on disposal of fixed assets................................................. 3,167 3,963 --
(Increase) decrease in:
Accounts receivable -- trade, net.............................................. (8,083,405) 9,167,428 911,968
Employee and stockholder advances.............................................. (139,101) 102,282 (9,507)
Inventory, net................................................................. (4,253,509) (6,374,158) (651,489)
Prepaid expenses and other assets.............................................. (90,802) (731,624) 339,654
Income taxes receivable........................................................ 76,000 -- (401,775)
Increase (decrease) in:
Accounts payable -- trade...................................................... 5,465,918 (3,151,190) 1,155,796
Accrued expenses............................................................... 105,756 148,761 700,277
Other liabilities.............................................................. (141,337) 184,064 (156,660)
Income taxes payable........................................................... 317,641 (137,269) (121,916)
------------ ------------ ------------
Net cash provided by (used in) operating activities.................................... (4,564,735) 439,567 3,058,625
------------ ------------ ------------
Cash flows from investing activities:
Acquisitions of fixed assets......................................................... (664,085) (882,550) (1,186,157)
Proceeds from sale of fixed assets................................................... 32,378 15,723 --
------------ ------------ ------------
Net cash used in investing activities.................................................. (631,707) (866,827) (1,186,157)
------------ ------------ ------------
Cash flows from financing activities:
Net (repayments) borrowings on line of credit........................................ 524,098 (1,336,363) (951,002)
Proceeds from notes payable.......................................................... 4,677,424 2,789,644 320,758
Principal payments on notes payable.................................................. (179,977) (811,781) (543,703)
------------ ------------ ------------
Net cash (used in) provided by financing activities.................................... 5,021,545 641,500 (1,173,947)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents................................... (174,897) 214,240 698,521
Cash and cash equivalents, beginning of year........................................... 275,334 100,437 314,677
------------ ------------ ------------
Cash and cash equivalents, end of year................................................. $ 100,437 314,677 1,013,198
------------ ------------ ------------
------------ ------------ ------------
Supplemental Cash Flow Information:
The Company paid income taxes of approximately $26,000, $224,000 and
$713,000, and paid interest of approximately $365,000, $629,000 and $496,000,
during the years ended September 30, 1995, 1996, and 1997, respectively.
See accompanying notes to combined financial statements.
F-27
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS
SEPTEMBER 30, 1995, 1996, AND 1997
(1) BASIS OF PRESENTATION AND RELATED MATTERS
ORGANIZATION
The International Data Products, Corp. combined financial statements include
the accounts of International Data Products, Corp. ("IDP") and Puerto Rico
Industrial Manufacturing Operations, Corp. ("PRIMO"). IDP and PRIMO are under
common family ownership control. All material intercompany accounts and
transactions have been eliminated in combination. IDP and PRIMO combined is
hereinafter referred to as the "Company".
IDP was incorporated in Maryland on February 27, 1984. The Company sells
computer equipment and provides computer training and maintenance service
primarily to agencies and suppliers of the federal government. For each of the
three years ended September 30, 1995, 1996 and 1997, approximately 1 percent, 8
percent and 6 percent, respectively, of the Company's revenue was from federal
contracts that were awarded under section 8(a) of the Small Business Act.
Puerto Rico Industrial Manufacturing Operations, Corp. is incorporated under
the laws of the Commonwealth of Puerto Rico. PRIMO manufactures computers and
peripheral equipment for IDP. Substantially all of PRIMO's sales are to IDP,
which have been eliminated in the accompanying combined financial statements.
The Company operates in a competitive environment subject to technological
change and the emergence of new technologies, although the Company believes that
its products and services are, or would be, upgradable to new technologies.
CASH AND CASH EQUIVALENTS
The Company maintains demand deposits with several financial institutions.
At times, deposits exceed federally insured limits, but management does not
consider this a significant concentration of credit risk. Cash equivalents
consist of highly liquid investments with original maturities of 90 days or
less. The fair market value of such instruments approximates cost.
INVENTORY
Inventory consists of parts and material and is stated at the lower of cost,
using weighted average cost method, or market. The Company has established
reserves for obsolete and excess inventory at $0 and $796,404 as of September
30, 1996 and 1997, respectively.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and depreciated using the
straight-line method based on estimated useful lives of three to seven years.
Maintenance and repair costs are charged to expense as incurred. Leasehold
improvements are capitalized and amortized over the lesser of the life of the
improvement or the remaining term of the lease.
REVENUE RECOGNITION
The Company recognizes revenues from hardware and software sales at time of
receipt by the customer. Service revenues are recognized over the contractual
period as the service is provided.
F-28
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(1) BASIS OF PRESENTATION AND RELATED MATTERS (CONTINUED)
ADVERTISING
The Company expenses the production costs of advertising the first time the
advertising is published, except for direct response advertising, which is
capitalized and amortized over its expected period of future benefit (generally
three months) based on the ratio of current direct response revenue to estimated
total direct response revenue. Direct response advertising consists primarily of
magazine advertisements which include item order numbers unique to the
advertising campaign.
At September 30, 1996, approximately $246,000 of advertising costs were
reported as prepaid expenses. There were no advertising costs reported as
prepaid expenses at September 30, 1997. For the years ended September 30, 1995,
1996 and 1997, total advertising expense was approximately $252,000, $255,000,
and $535,000, respectively.
WARRANTY EXPENSE
The Company reserves for estimated future warranty costs that may be
required to satisfy contractual requirements. Such provisions are accrued as the
related revenue is recognized. The typical warranty period ranges from one to
three years.
INCOME TAXES
The Company applies the asset and liability method of accounting for income
taxes. Under the asset and liability method, deferred tax assets and liabilities
are recognized for the estimated future tax consequences attributable to
differences between the financial statement carrying amounts and income tax
bases of assets and liabilities. Deferred tax assets and liabilities are
measured using enacted tax rates in effect for the year in which those temporary
differences are expected to be recovered 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. The income tax provisions for IDP and PRIMO are
prepared separately and combined for financial reporting purposes.
PRIMO has been granted a tax exemption, with certain normal reservations,
from Puerto Rico income (90%), property (90%), and municipal license taxes (60%)
on its manufacturing operations under the Puerto Rico Tax Incentives Act of
1987, Act No. 8, as amended. This tax exemption is for a period of 20 years
ending on September 12, 2014.
CHANGE IN REPORTING PERIODS
PRIMO's reporting periods, as previously audited, were the year ended
December 31, 1995 and the nine months ended September 30, 1996. For purposes of
presenting the combined financial statements of the Company, PRIMO's financial
statements were conformed to reflect each of the years ended September 30, 1995
and 1996, respectively.
USE OF ESTIMATES
The preparation of the combined financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect certain reported assets
F-29
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(1) BASIS OF PRESENTATION AND RELATED MATTERS (CONTINUED)
and liabilities and disclosures of contingent assets and liabilities. Actual
results may differ from those estimates.
(2) ACCOUNTS RECEIVABLE
Accounts receivable, which are substantially all billed or billable, at
September 30, 1996 and 1997 consist of the following:
1996 1997
------------ ----------
U.S. Government and agencies....................................... $ 3,934,632 5,236,309
Commercial......................................................... 270,201 327,535
JTP Joint Venture (note 3)......................................... 2,431,157 160,178
------------ ----------
$ 6,635,990 5,724,022
------------ ----------
------------ ----------
Management of the Company believes that substantially all of the outstanding
accounts receivable will be collected within one year.
Revenues from several U.S. government agencies totaled approximately
$72,820,000, $69,111,000 and $57,871,000, for the years ended September 30,
1995, 1996 and 1997, respectively, including approximately $22,298,000,
$22,117,000 and $15,282,000 from the JTP Joint Venture in 1995, 1996 and 1997,
respectively (see note 3).
(3) INVESTMENT IN JOINT VENTURE
In November 1993, IDP formed a joint venture entity, Justice Technology
Partners Joint Venture ("JTP") with two other companies for the purpose of
obtaining and performing under a certain contract. JTP has a contract with a
federal government agency involving the sale and maintenance of computer
equipment. IDP provides the computer equipment to the joint venture and records
sales at cost plus its estimated share of the joint venture profits.
IDP has a 24 percent interest in JTP and the initial investment of $31,200
is recorded at cost. IDP's equity in the estimated earnings of the joint venture
is included in accounts receivable.
Summarized financial information for this unconsolidated joint venture
entity, as of and for the years ended December 31, 1995 and 1996, is as follows:
DECEMBER 31,
--------------------
1995 1996
--------- ---------
(IN THOUSANDS)
Contract revenue......................................................... $ 44,574 43,417
Net income............................................................... 7,902 5,992
Total current assets..................................................... 3,437 12,252
Total assets............................................................. 3,487 12,293
Total liabilities........................................................ 3,006 9,979
--------- ---------
--------- ---------
Distributions received in excess of profit recognized, amounting to
approximately $59,000 is included as a reduction of accounts receivable at
September 30, 1996; and profits recognized in excess of
F-30
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(3) INVESTMENT IN JOINT VENTURE (CONTINUED)
distributions received, amounting to approximately $116,000 is included in
accounts receivable at September 30, 1997.
(4) FIXED ASSETS
Fixed assets as of September 30, 1996 and 1997 consist of the following:
1996 1997
------------ -----------
Furniture and equipment........................................... $ 1,499,006 2,385,410
Transportation equipment.......................................... 425,404 445,353
Leasehold improvements............................................ 230,105 357,123
Testing lab and equipment......................................... 195,152 340,072
Production equipment.............................................. 159,931 143,585
------------ -----------
Total............................................................. 2,509,598 3,671,543
Less accumulated depreciation and amortization.................... (869,175) (1,418,692)
------------ -----------
Fixed assets, net................................................. $ 1,640,423 2,252,851
------------ -----------
------------ -----------
(5) INDEBTEDNESS
Notes payable consists of the following:
SEPTEMBER 30,
--------------------------
1996 1997
------------ ------------
Secured demand bank loan, interest at 10.25%...................... $ 374,760 291,689
Secured automobile loans, interest ranging from 3.7% to 11.5%..... 275,720 241,411
------------ ------------
Total notes payable............................................... 650,480 533,100
Less current portion.............................................. 425,554 368,792
------------ ------------
Notes payable, noncurrent......................................... $ 224,926 164,308
------------ ------------
------------ ------------
Principal payments on the long-term debt for each of the fiscal years from
1998 to 2002 and thereafter are due as follows:
YEAR ENDING SEPTEMBER 30,
- ----------------------------------------------------------------------------------
1998.............................................................................. $ 368,792
1999.............................................................................. 65,723
2000.............................................................................. 49,292
2001.............................................................................. 42,598
2002.............................................................................. 6,695
----------
$ 533,100
----------
----------
Other notes payable consist of automobile loans and a demand bank loan. The
automobile loans are secured by the respective automobile, and the demand loan
is secured by the Company's accounts at the
F-31
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(5) INDEBTEDNESS (CONTINUED)
respective bank. The notes mature at intervals between November 1997 and
September 2001. Interest rates on the notes range from 3.7 percent to 11.5
percent.
Notes payable to related parties are payable to certain stockholders and
their relatives, and employees. All notes payable to related parties are
classified as current liabilities as they are callable by the holder at any
time. Notes payable to related parties bear interest at rates ranging from 8 to
11 percent. The total amounts outstanding on these related party notes payable
were approximately $1,604,000 and $1,498,000 at September 30, 1996 and 1997,
respectively.
The Company has a line of credit facility of $15,000,000, of which
$5,000,000 is secured by the Company's inventory and $10,000,000 is secured by
accounts receivable. The outstanding balance on this line of credit at September
30, 1996 and 1997 was approximately $6,586,000 and $5,635,000, respectively. The
interest rates applicable to this line of credit as of September 30, 1996 and
1997 were 8.25 percent and 8.5 percent, respectively. Subsequent to year-end,
the amounts available under this credit facility were increased to $25,000,000
with an additional temporary overline of $7,000,000 available through January
31, 1998. There is no formal expiration date on this facility although it is
subject to annual re-evaluation by the financial institution.
(6) INCOME TAXES
For combined financial reporting purposes, income (loss) before income taxes
for the years ended September 30, 1995, 1996 and 1997 include the following
components:
1995 1996 1997
------------ ---------- -----------
Income (loss) before income taxes:
Domestic (IDP)..................................... $ 355,436 (222,933) (1,769,240)
Foreign (PRIMO).................................... 1,860,052 1,383,677 2,532,868
------------ ---------- -----------
$ 2,215,488 1,160,744 763,628
------------ ---------- -----------
------------ ---------- -----------
As discussed in Note 2, PRIMO has been granted a 90 percent exemption, with
certain reservations, for income taxes on its manufacturing operations under the
Tax Incentives Act of Puerto Rico of 1987, Act No. 8, as amended. This exemption
is for a period of twenty years and ends in September 2014. Further, PRIMO has
no temporary differences that would create deferred tax assets or liabilities as
of September 30, 1996 or 1997.
F-32
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(6) INCOME TAXES (CONTINUED)
The components of income tax expense (benefit) for the Company for the years
ended September 30, 1995, 1996 and 1997 are as follows:
1995 1996 1997
---------- ---------- ----------
Current:
Federal................................................. $ 197,116 232,015 (60,439)
State................................................... 43,637 51,363 (13,380)
Foreign (PRIMO)......................................... 59,154 62,035 118,398
---------- ---------- ----------
299,907 345,413 44,579
---------- ---------- ----------
Deferred:
Federal................................................. (17,687) (297,303) (356,045)
State................................................... (3,915) (65,818) (105,981)
---------- ---------- ----------
(21,602) (363,121) (462,026)
---------- ---------- ----------
$ 278,305 (17,708) (417,447)
---------- ---------- ----------
---------- ---------- ----------
Income tax expense (benefit) amounted to $278,305 for 1995, an effective
rate of 13 percent; ($17,708) for 1996, an effective rate of (2) percent; and
($417,447) for 1997, an effective rate of (55) percent. The actual expense
(benefit) differs from the "expected expense (benefit)" for those years,
computed by applying the U.S. federal corporate tax rate of 34 percent in 1995,
1996 and 1997 to earnings (loss) before income tax expense, as follows:
1995 1996 1997
---------- ---------- ----------
Computed "expected" tax expense (benefit)......................................... $ 753,266 394,653 259,634
Increase (decrease) in income taxes resulting from:
Foreign income not subject to U.S. federal taxes, net of foreign taxes.......... (573,264) (408,416) (742,756)
State and local income tax expense (benefit), net of federal benefit............ 24,881 (15,605) (78,710)
Increase in valuation allowance................................................. -- -- 122,690
Nondeductible meals and entertainment expenses.................................. 31,645 27,199 17,581
Other, net...................................................................... 41,777 (15,539) 4,114
---------- ---------- ----------
$ 278,305 (17,708) (417,447)
---------- ---------- ----------
---------- ---------- ----------
F-33
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(6) INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at September 30, 1996 and
1997 are presented below:
1996 1997
---------- ----------
Deferred tax assets:
Inventory obsolescence reserve...................................... $ -- 267,870
Warranty reserve.................................................... -- 76,799
Accrued interest on related party notes............................. 67,207 116,331
Deferred rent....................................................... 90,266 85,779
Section 263(A) inventory adjustment................................. 26,682 45,020
Accrued vacation.................................................... 42,319 43,977
Allowance for doubtful accounts..................................... 49,330 50,908
Other............................................................... -- 30,242
---------- ----------
Total gross deferred tax assets....................................... 275,804 716,926
Less: valuation allowance............................................. -- (122,690)
---------- ----------
Net deferred tax assets............................................... 275,804 594,236
---------- ----------
Deferred tax liabilities:
Income from JTP joint venture....................................... (266,247) (133,190)
Other............................................................... (10,538) --
---------- ----------
Total deferred tax liabilities........................................ (276,785) (133,190)
---------- ----------
Net deferred tax asset (liability).................................... $ (981) 461,046
---------- ----------
---------- ----------
The net deferred tax asset (liability) is reflected in the accompanying
balance sheets as:
1996 1997
--------- ---------
Current deferred tax assets.............................................. $ 9,557 443,415
Noncurrent deferred tax assets........................................... -- 17,631
Noncurrent deferred tax liabilities...................................... (10,538) --
--------- ---------
Net deferred tax asset (liability)....................................... $ (981) 461,046
--------- ---------
--------- ---------
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
asset will be realized. The ultimate realization of the deferred tax asset is
dependent upon the generation of future taxable income during the periods in
which temporary differences become deductible. Management considers scheduled
reversals of deferred tax liabilities, projected future taxable income, and tax
planning strategies that can be implemented by IDP in making this assessment.
Management has established a valuation allowance of $122,690 in 1997 to reduce
the deferred tax asset to a level where based upon the level of historical
taxable income, scheduled reversal of deferred tax liabilities, and projections
of future taxable income over the periods in which the temporary differences
become deductible based on available tax planning strategies, management
presently believes that it is more likely than not that IDP will realize the
benefits of these deductible differences.
F-34
INTERNATIONAL DATA PRODUCTS, CORP. AND COMBINED COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(7) COMMITMENTS AND CONTINGENCIES
LEASES
The Company is obligated under various noncancelable operating leases for
office/warehouse space and office equipment. The future minimum lease
obligations under these noncancelable operating leases as of September 30, 1997
are approximately as follows:
YEAR ENDING SEPTEMBER 30,
- --------------------------------------------------------------------------------
1998............................................................................ $ 625,283
1999............................................................................ 661,680
2000............................................................................ 292,397
2001............................................................................ 38,568
2002 and thereafter............................................................. --
------------
$ 1,617,928
------------
------------
Rent expense under these operating leases amounted to approximately
$453,000, $556,000, and $538,000 for the periods ended September 30, 1995, 1996,
and 1997, respectively. Rent payments are being expensed on a straight-line
basis over the life of the lease, with the difference recorded as deferred rent.
BID PROTEST SETTLEMENT
During the year ended September 30, 1996, IDP settled a contract award
dispute with a third party and recorded a $750,000 gain on settlement. Costs
relating to the bid protest were expensed in the period incurred and recorded as
operating expenses.
(8) RETIREMENT PLAN
IDP maintains a tax-deferred savings plan under Section 401(k) of the
Internal Revenue Code which is offered to all employees who have attained the
age of 21. The plan provides for contributions by employees as well as matching
and discretionary contributions by IDP. IDP made contributions of approximately
$150,000, $210,000, and $261,000 to the plan during the years ended September
30, 1995, 1996, and 1997.
F-35
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors
We have audited the consolidated financial statements of Dunn Computer
Corporation (a Virginia corporation) as of October 31, 1997 and 1998, and for
each of the three years in the period ended October 31, 1998 and have issued our
report thereon dated February 3, 1999 (included elsewhere in this Form 10-K).
Our audits also included the financial statement schedule listed in Item 14 of
this Form 10-K. The schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole
presents fairly, in all material respect, the information set forth herein.
/s/ Ernst & Young LLP
Vienna, Virginia
February 3, 1999
S-1
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNT AND RESERVE DUNN COMPUTER
CORPORATION
BALANCE AT
BEGINNING OF BALANCE AT
CLASSIFICATION YEAR ADDITIONS DEDUCTIONS END OF YEAR
- -------------------------------------------------------------- ------------ ---------- ----------- -----------
Allowance for doubtful accounts:
Year ended October 31, 1996................................... $ -- $ 15,000 $ -- $ 15,000
Year ended October 31, 1997................................... $ 15,000 $ 62,000 $ -- $ 77,000
Year ended October 31, 1998................................... $ 77,000 $ 59,000 $ 90,000(1) $ 46,000
Inventory reserve:
Year ended October 31, 1996................................... $ -- $ 20,000 $ -- $ 20,000
Year ended October 31, 1997................................... $ 20,000 $ 230,000 $ -- $ 250,000
Year ended October 31, 1998................................... $ 250,000 $ -- $ -- $ 250,000
- ------------------------
(1) Write-offs of accounts receivable
S-2