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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998 Commission File Number 0-14371
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COMPUCOM SYSTEMS, INC.
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(Exact name of Registrant as specified in its charter)
Delaware 38-2363156
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
7171 Forest Lane, Dallas, TX 75230
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 856-3600
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Securities registered pursuant to Section 12(b) of the Act: NONE
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_____]
The aggregate market value of the Common Stock, $.01 par value, held by non-
affiliates (based on the closing price on NASDAQ) on March 29, 1999 was
approximately $82.9 million. For purposes of determining this amount only,
Registrant has defined affiliates as including (a) the executive officers named
in Part III of this 10-K report, (b) all directors of Registrant, and (c) each
stockholder that has informed Registrant by March 29, 1999 that it is the
beneficial owner of 10% or more of the outstanding common stock of Registrant.
The number of shares of the Registrant's Common Stock outstanding as of March
29, 1999 was 47,634,949 shares.
Documents Incorporated by Reference
Portions of the Registrant's Proxy Statement relative to the May 13, 1999 annual
meeting of stockholders of registrant, to be filed within 120 days after the end
of the year covered by this report on Form 10-K, are incorporated by reference
into Items 10, 11, 12 and 13 (Part III) of this Report. Such Proxy Statement,
except for the parts therein which have been specifically incorporated by
reference, shall not be deemed "filed" for the purposes of this report on Form
10-K.
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Item 1 Business
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(a) General Development of the Business
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Introduction
Founded in 1987, CompuCom Systems, Inc., together with its subsidiaries
("CompuCom" or "the Company"), is a leading provider of information technology
products and technology management services to large and medium-sized businesses
throughout the United States. CompuCom helps Fortune 1000 companies manage
information technology to achieve their business goals by providing a wide range
of services in provisioning, support and technology management. Products and
technology management services are sold through a direct sales force to over
6,000 business customers nationwide. Through its majority-owned subsidiary,
ClientLink, Inc. ("ClientLink"), the Company offers software application
development services. ClientLink designs, develops and implements customized
information technology solutions for organizations with mission-critical
business processing needs.
CompuCom is an authorized dealer of major personal computer products,
networking and related products, computer-related peripheral equipment and
software for a number of manufacturers, including Compaq Computer Corporation
("Compaq"), International Business Machines Corporation ("IBM"), Hewlett-Packard
Company ("HP"), Toshiba America Information Systems ("Toshiba"), Intel
Corporation ("Intel"), and Microsoft Corporation ("Microsoft"). To further meet
its customers' needs, CompuCom offers a variety of technology management
services including LAN/WAN project services, consulting, asset tracking, network
management, help desk, field engineering, configuration, software management,
distribution, and procurement utilizing network applications such as Novell
Netware, Windows NT, Windows 95 and Windows 98, and IBM OS/2 Warp.
The Company has been profitable since its inception and has achieved net
revenue growth of 12% compounded over the past five years. However, during
1998, the Company experienced a significant decline in its level of
profitability, recording its first quarterly net loss in the fourth quarter 1998
as a result of a $16.4 million (pretax) restructuring charge. CompuCom believes
the key to improving its net revenue and net earnings performance is the
expansion of its higher margin services business, both internally and through
strategic acquisitions, as well as focusing on lowering its cost structure
through expense control and participation in programs designed to increase
inventory turns. The Company's target customers are becoming increasingly
dependent on information technology to compete effectively in today's markets.
As a result, the decision-making process that organizations face when planning,
selecting and implementing technology solutions is becoming more complex and
requires many of these organizations to outsource the management and support of
their technology needs.
CompuCom operates primarily in three business segments 1) sale of computer
products, 2) services - which include technology support services, network
integration and configuration, and 3) customized application programming.
Separate business segment information is presented for each of these segments.
Recent Developments
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In the fourth quarter of 1998, the Company implemented a restructuring plan
designed to reduce the Company's cost structure by approximately 1.25% to 1.5%
of sales by closing certain facilities and reducing the Company's work force by
approximately 10%. As a result, the Company recorded a restructuring charge in
the fourth quarter of 1998 in the amount of $16.4 million, primarily consisting
of costs associated with the closing of 65 facilities, which had been used as
branch offices, and disposing of related fixed assets, as well as employee
severance and benefits related to the reduction in workforce. This reduction in
workforce included associates from the Company's sales, service and general and
administrative areas, and two executive officers of the Company. Under the new
business strategy, the Company has moved to a virtual office model, where its
sales and service personnel are equipped with remote communications tools,
including Internet access, pagers and portable telephones, which enable them to
remotely access and communicate with the Company's systems. Under its new
business model, the Company retains a presence in all of its markets through its
direct sales force and service personnel.
To implement its new business strategy, several management changes were
made. In October 1998 Thomas C. Lynch was appointed to the position of Executive
Vice President and Chief Operating Officer of the Company. Mr. Lynch has served
for the past three years as Senior Vice President of Safeguard Scientifics, Inc.
the majority shareholder of the Company, where he aided in the management of and
oversaw the operations of a number of associated companies engaged in the
information technologies business. Prior to that time, Mr. Lynch was a Rear
Admiral in the United State Navy, serving on active duty for 31 years.
This document contains "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995 regarding revenues,
margins, operating expenses, earnings, growth rates and certain business trends
that are subject to risks and uncertainties that could cause actual results to
differ materially from the results described herein. Recipients of this
document are cautioned to consider these risks and uncertainties and to not
place undue reliance on these forward-looking statements. See "General
Description of Business", "Competition", "Principal Suppliers" and "Dependence
Upon Major Vendors and Other Suppliers" in this Item and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
Part II, Item 7 of this report for a discussion of important factors that could
affect the validity of any such forward-looking statement.
Item 1(b) Financial Information About Operating Segments
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2
Revenues from external customers, gross margin, operating earnings and
total assets for each segment of the Company's business for the three-year
period ended December 31, 1998 is contained in Footnote 5 to the Consolidated
Financial Statements titled "Segment Information" on page F-11 of this Form 10-K
and is incorporated herein by reference.
Item 1(c) Narrative Description of Business
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GENERAL DESCRIPTION OF BUSINESS
CompuCom markets its product procurement, configuration, field engineering,
network management, help desk services and technology management services
primarily through its direct sales force and service personnel. The Company
focuses on meeting the business objectives of large corporate businesses, which
accounted for the majority of the Company's net revenue in 1998. However, no one
customer accounted for greater than 10% of such revenues in the sale of computer
products or services segments. Order backlog is not considered to be a
meaningful indicator of future business prospects due to the short order
fulfillment cycle.
CompuCom is authorized by various vendors to sell computer products through
its virtual, direct sales force located in or near major metropolitan areas
throughout the United States. Each geographic area typically includes direct
sales representatives, support personnel, system engineers and technicians who
are authorized to repair and maintain Compaq, IBM, HP and certain other
manufacturers' products. As of December 31, 1998, the Company employed
approximately 335 full-time direct sales representatives who sell both products
and services. The Company's sales force is compensated with a base salary and
commissions based on net revenue, gross margin and other relevant factors.
CompuCom's corporate headquarters and operations campus is located in
Dallas, Texas. Essentially all the Company's financial and administrative
functions, including the customer center, information services, service and
sales support, help desk services, human resources, product services, finance,
and executive management are located in the two buildings that comprise this
facility.
The Company has expanded its use of information systems in its internal
operations and its services to customers. The Company's integrated information
systems ("IS") utilize client/server distributed relational database technology
running on a proactively managed wide area network based on frame relay
technology. The system contains five major components: the Distribution
Information Management System, the Service Information Management System, the
Customer Center System, the Warehouse Information Management System, and the
Financial Information Management System. All of these systems operate on mini-
computer platforms which afford the Company maximum system reliability,
availability, and growth capacity.
To further enhance the quality and efficiency of its information systems,
CompuCom has developed a state-of-the-art data warehouse, which increases the
ease with which Company personnel can access historic information and create
customized customer and vendor reports. Customers are provided the ability to
create custom price quotations for new orders from an Internet-based catalog of
products and place orders over the Internet. Customers may also look up
previously purchased items using either the product serial number or the
customer's "asset tag", which the Company places on products at the customer's
request. Customers may also directly access order status and shipment history
over the Internet. Other improvements include enhanced product sales
information, reporting for principal vendors and real time open call status
reporting for service customers. In 1998, the use of "DataMarts", which allow
the definition and creation of data files that can be downloaded over the
Internet, were made available to both customers and CompuCom personnel on an
expanded basis. CompuCom's comprehensive Intranet application was significantly
enhanced during 1998. Accessible only to CompuCom personnel, the Intranet
provides rapid access to Company organization charts, policies, procedures and
other corporate information and has a user-friendly query interface to locate
answers to frequently asked questions.
During 1998 CompuCom expanded the customer management and event tracking
system to include product services, credit and collections, remote help desk and
service dispatch areas, in addition to the customer center. This new
3
system gives CompuCom a unified customer issue and activity tracking capability
which has improved interdepartmental communications regarding customer support
and customer satisfaction.
The Company continues to expand its Sales Force Automation ("SFA") package,
which provides sales representatives access to e-mail and key Company
applications from remote locations, allowing them to spend more time with
customers and improve productivity. During 1998, service engineers were given
access to the SFA tools that were previously available to the sales force. In
addition, field service engineers are able to directly report time and
activities from remote locations using special wireless communications features
("airtime"). CompuCom believes these new capabilities will help improve engineer
productivity and enhance customer service levels.
Competition
The Company's industry is characterized by intense competition, primarily
in the areas of price, product availability and breadth of product line and
service. The Company's marketing network competes for potential clients, with
numerous resellers and distributors. Many established desktop computer
manufacturers (including some of the Company's vendors), direct marketers,
systems integrators and resellers of distributed desktop or networking products
including Entex Information Services, Inc., InaCom Corp. (which recently merged
with Vanstar Corporation), and Microage, Inc. compete with the Company in the
configuration and distribution of computer systems and equipment. In addition,
direct marketers have had a pricing advantage over resellers such as CompuCom.
To help combat the direct marketers' pricing advantage, the Company and its
major vendors are in the process of developing and implementing strategies
designed to reduce costs. In response to the increased competition, particularly
from direct marketers, a number of the Company's competitors have sought to
increase their market share through acquisitions. The Company expects the
consolidation in the industry will continue in 1999. As a result of such
consolidation, CompuCom may face fewer but larger and better-financed
competitors. In order to keep pace, the Company expects to pursue additional
strategic acquisitions. In the highly fragmented computer services business, the
Company competes with several larger competitors; other corporate resellers
pursuing high-end service opportunities, as well as smaller computer services
companies. Some of these competitors have financial, technical, manufacturing,
sales, marketing and other resources that are substantially greater than that of
CompuCom. There can be no assurance that the Company will be able to continue to
compete successfully with new or existing competition.
The Company's Employees
The Company employed approximately 4,800 full-time employees as of December
31, 1998. The Company offers its full-time employees health, long-term
disability, dental and life insurance benefits and has a 401(k) plan and an
employee stock purchase plan for eligible employees. None of the employees is
covered by a collective bargaining agreement. The Company considers its
relations with employees to be good.
SALE OF COMPUTER PRODUCTS SEGMENT
The Company provides procurement services for sophisticated technologies
consisting of personal computer products, network products, peripherals,
software and management technology services to its customers. It is an
authorized dealer of Compaq, HP, IBM, Intel, Microsoft, 3Com and Toshiba as well
as other major manufacturers and software suppliers. The Company sources over
5,000 different desktop products, components and accessories, consisting of
leading as well as alternative brands.
CompuCom integrates of a variety of manufacturers' products into various
desktop and server configurations to meet customers' individual needs. The
Company provides value to its customers by allowing them to choose products or
components from various manufacturers that best suit their desktop and network
needs as opposed to manufacturers' direct sales organizations which typically
configure or market desktop and network systems that include products only from
that particular manufacturer.
The Company provides product support to its customers primarily through the
CompuCom Customer Center ("Customer Center") located in Dallas, Texas. Customer
Center personnel, called inside sales representatives ("ISRs"), may be assigned
to specific customer accounts or to customers in a certain geographical area and
are knowledgeable about computer technology. Each ISR works closely with the
customer and the CompuCom sales representative to keep up-to-date on the
business needs of that customer, and to provide the customer with information
about product availability, services, pricing, shipping and invoicing via a
toll-free telephone number. The primary goal of the Customer Center is to
provide greater support to CompuCom's customers while allowing the direct sales
force to focus on soliciting new business and providing the necessary support
for customer's more complex service needs. At the end of 1998, the Company
employed approximately 400 customer center personnel.
4
During 1996, to meet customers' global business needs, CompuCom helped form
GlobalServe, an alliance of international computer service suppliers. The
objective of the GlobalServe alliance is to provide customers a single point of
contact for accessing computer products and technology management services
worldwide.
CompuCom operates a 300,000 square foot distribution center in Paulsboro,
New Jersey, and a 104,000 square foot distribution center in Stockton,
California. In addition, in 1998 CompuCom opened a 78,000 square foot co-
location facility on the Compaq campus in Houston, Texas. All of these
facilities contain configuration centers. The distribution centers and co-
location facility personnel utilize hand-held, radio frequency devices to stock,
pick and update the status and location of inventory. These devices play a key
role in enabling the Company to efficiently handle increasing volume and are
used in the daily cycle counting process, which the Company believes has
resulted in improved overall inventory integrity and bin accuracy.
CompuCom's distribution, configuration, return merchandise and product
services departments are ISO 9002 certified. ISO 9002 is part of the ISO 9000
set of standards developed by the International Organization of Standardization
("ISO"), which represent common international business quality standards
designed to help demonstrate the capability of a supplier to control the
processes that determine the acceptability of the product being delivered.
Principal Suppliers
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A significant part of CompuCom's net revenues are derived from sales of
personal computer products including Compaq, IBM and HP products. The Company's
agreements with these vendors contain provisions providing for periodic renewals
and permitting termination by the vendor without cause, generally upon 30 to 90
days written notice. Since 1987, Compaq, IBM and HP have regularly renewed their
respective dealer agreements with the Company, although there can be no
assurance that the regular renewals of the Company's dealer agreements will
continue. The termination, or nonrenewal, of the Company's Compaq, IBM or HP
dealer agreements could materially adversely affect the Company's business. The
Company, however, is not aware of any reason for the termination, or nonrenewal,
of any of those dealer agreements and believes that its relationships with
Compaq, IBM and HP are satisfactory.
The Company purchases products from Compaq, IBM and HP at pricing levels
that the Company believes are the lowest prices available to those vendors'
respective resellers, with the exception of special bid pricing for specific
large customer accounts. All of the Company's principal suppliers require that
the Company purchase certain minimum volumes of products in a specified period
to maintain favorable pricing levels. The Company also obtains favorable terms
and incentives from Compaq, IBM and HP by participating in certain vendor
programs offered by those suppliers. The Company has certain selling,
promotional and related expenses reimbursed by vendors under dealer programs
offered by those and other suppliers. However, there can be no assurance that
any of these programs will continue in 1999 or that the Company will continue to
participate in any of these programs at the same level as in 1998.
Sales of Compaq, IBM and HP products accounted for approximately 32%, 18%
and 18%, respectively, of the Company's 1998 product revenues compared to 32%,
19% and 14%, respectively, in 1997 and 31%, 15% and 12%, respectively, in 1996.
Due to the rapid delivery requirements of its customers and to assure
itself of a continuous allotment of products from suppliers, the Company
maintains adequate levels of inventory funded through its credit facilities and
vendor credit. CompuCom's major suppliers at times provide price protection
programs that are intended to reduce the risk of inventory devaluation by
absorbing price declines associated with aging product life cycles. However, the
suppliers have reduced the number of days price protection is generally in
effect. CompuCom has focused on ways to reduce its costs by reducing its
inventory levels. During 1998, the Company opened a co-location facility at
Compaq's manufacturing and headquarters campus in Houston, Texas. The Company
anticipates opening similar facilities close to the Toshiba and IBM
manufacturing facilities during the first half of 1999. CompuCom also has the
option of returning a certain percentage of its current product inventories each
quarter to these principal suppliers as it assesses each product's current and
forecasted demand schedule. If such returns exceed certain specified levels, the
Company may be charged restocking fees ranging up to 5%. CompuCom did not incur
significant restocking fees in 1998 and expects returns to decrease upon the
opening of co-location facilities.
Dependence upon Major Vendors and Other Suppliers
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The Company is dependent upon the continued supply of products and
components from its suppliers, particularly Compaq, IBM and HP. Historically,
certain suppliers occasionally experience shortages of select products that
render components unavailable or necessitate product allocations among
resellers. While certain shortages existed throughout 1998, particularly in the
third quarter, the Company believes the product availability issues are a result
of the present dynamics of the personal computer industry as a whole, which
include shortened product life cycles and increased
5
frequency of new product introductions into the marketplace. While there can be
no assurance that product unavailability or product allocations, or both, will
not increase in 1999, the impact of such an interruption is not expected to be
materially disruptive due to the breadth of alternative product lines available
to the Company.
The Company's product margins as a percentage of product revenue decreased
to 9.8% in 1998 as compared to 10.4% in 1997, due primarily to heightened
competition from direct marketers and other resellers. The Company believes
that gross margins will continue to be reactive to industry-wide changes and
pricing strategies. As such, CompuCom anticipates further decline in product
gross margins in 1999. Future profitability will depend upon the Company's
ability to effectively manage inventory levels in response to changes in its
major suppliers' price protection and return programs, the Company's ability to
attract and retain quality services personnel while effectively managing the
utilization of such service personnel, and the Company's ability to respond to
increased competition from its suppliers' direct selling initiatives. It will
also depend on increased focus on providing technical service and support to
customers, product demand, competition, manufacturer product availability and
pricing strategies, effective utilization of vendor programs, as well as the
Company's ability to reduce operating expenses at a pace at least equal to the
decline in product gross margin percentages.
SERVICES SEGMENT
Service revenue is primarily derived from field engineering, LAN/WAN
projects, consulting, configuration, help desk, asset tracking, network
management, and software management. CompuCom continues to focus on expanding
its presence in the service market. This commitment is reflected in the
increase in its service personnel. As of December 31, 1998, the Company
employed over 2,900 service personnel, including system engineers, network
engineers, configuration technicians and field engineers, compared to
approximately 800 as of the beginning of 1995. These service personnel provide
configuration, field engineering, network management, help desk services and
technology management to the Company's customers.
During 1998, net service revenue increased 9% from 1997 levels as a result
of the Company's continued efforts to increase sales of technology management
services to meet customer needs and to improve profitability. Service revenue
has grown at a compounded annual rate of 37% over the past three years as a
result of the Company's strategic efforts, which include: the development of
additional service offerings; additional training for its engineers; enhanced
management support to the services business; and more emphasis on sales of
services in the sales representatives compensation plan. In addition, the
Company emphasized the hiring of quality service personnel, increasing the
number of its service employees from approximately 800 at the beginning of 1995
to over 2,900 by the-end of 1998. To further enhance its service growth,
CompuCom employs an ongoing program in which college graduates are hired and
placed in various engineering training and certification programs. At the
completion of these programs, these engineers become a part of the Company's
billable workforce. The technology management services business is an integral
part of CompuCom's strategy to provide customers with value-added service
solutions to meet their technology needs.
CompuCom maintains three configuration centers, one in each of the
Company's two distribution centers, located in Paulsboro, New Jersey and
Stockton, California, and in the Compaq co-location facility in Houston, Texas.
These centers contain configuration systems that have the ability to set up and
configure product that includes both standard and nonstandard components or
software to enable CompuCom to meet increasing customer demand for advanced,
complex system and network configuration technologies.
CompuCom provides hardware maintenance services ranging from simple desktop
repairs, installations, moves, adds, and changes to complex network repairs,
application setups and software upgrades. These services are performed based
upon the specific customer needs, such as on-site support, warranty support,
change and upgrade management, contracted response or time and material.
The Company's systems management service offerings include: network audits,
which consist of an on-site detailed analysis of the current configuration and
health of the customer's network environment; network control center design,
which includes building a network control center at the customer's location; and
remote network monitoring of the customer's network performed by CompuCom's
network control center located at the Company's headquarters in Dallas, Texas.
CompuCom offers help desk support through its Remote Help Desk Services
located at the Company's headquarters in Dallas, Texas and at Paulsboro, N.J.
These help desk services offer information systems departments the skills and
resources needed to design, implement and operate a consolidated, resolution-
oriented help desk to support a customer's information technology investments.
CompuCom's help desk services include call management, problem management and
event tracking. The Company's help desk support group consists of personnel
with expertise in software applications, network operating systems and hardware,
who provide technical support to end-users and system
6
administrators. The help desk support group also has access to a "known
solutions database" to help solve common problems. The help desk solution is
tightly integrated with the Company's other service offerings.
CUSTOMIZED APPLICATION PROGRAMMING SEGMENT
Through its majority-owned subsidiary, ClientLink, located in Atlanta,
Georgia, the Company offers software application development services.
ClientLink designs, develops, and implements enterprise-wide information
technology (IT) solutions for Fortune 500 companies. ClientLink's primary focus
is in development and support of client/server and Internet based applications.
This is accomplished through custom application development for critical
business functions and consulting and implementing IT support solutions. These
solutions are normally offered on a fixed-price and fixed-time frame basis.
ClientLink's approach allows organizations to achieve their business objectives,
better control their budgets and delivery timeframes, and increase their
competitiveness in the marketplace by rapidly deploying the solution.
ClientLink focuses its marketing efforts on establishing and maintaining
relationships with Fortune 1000 companies in various industries with intensive
information access and processing needs, including telecommunications, financial
services, utilities, health care services, manufacturing, and retail.
The market for custom business systems is highly competitive. ClientLink
competes with consulting firms of all sizes, software integration firms, the
internal information systems groups of its clients and, to a lesser extent,
software vendor companies. ClientLink has competed directly with firms such as
Deloitte & Touche and SHL Systemhouse (a subsidiary of MCI) for some of its
larger projects.
During 1998, four customers accounted for 84% of ClientLink's revenues.
Individually, these customers accounted for 42%, 16%, 15% and 11% of
ClientLink's 1998 revenues. During 1997, two customers accounted for 91% of
ClientLink's revenues. Individually, these customers accounted for 56% and 35%
of ClientLink's 1997 revenues. During 1996, two customers accounted for 87% of
ClientLink's revenues. Individually, these customers accounted for 46% and 41%
of ClientLink's 1996 revenues.
Item 1(d) Financial Information About Foreign and Domestic Operations and Export
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Sales
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The Company does not have any foreign operations nor does it engage in
any material export sales.
Item 2 Properties
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The Company's principal executive and administrative offices are located
on a 20-acre campus-type setting consisting of two buildings containing
approximately 250,000 square feet of office space in Dallas, Texas. The Company
purchased this facility during 1996, refurbished it, and fully occupied the
facility by the end of 1997. One of the buildings is an eight-story structure
and contains executive offices, customer center, finance, purchasing, and human
resources. An adjoining three-story building contains the Company's information
systems group and its remote help desk personnel. The Company expects to
complete a sale/leaseback transaction on its headquarters facilities during the
first half of 1999.
The Company distributes products primarily from three leased warehouse
facilities. In August 1996, the Company entered into a lease for approximately
300,000 square feet of warehouse space located in Paulsboro, New Jersey, which
has a five-year term, with a cancellation option exercisable on July 31, 1999.
In addition to warehousing space, this facility contains a state-of-the-art
90,000 square foot configuration center, allowing CompuCom to meet increasing
customer demand for advanced complex system integration and network
technologies. It also provides adequate space for channel assembly. Its western
distribution center has approximately 104,000 square feet of leased warehouse
space in Stockton, California, under a lease that expires in May 1999. In 1998,
CompuCom opened a 78,000 square foot co-location facility located at Compaq's
headquarters and manufacturing campus in Houston, Texas.
See Note 14 to the accompanying Notes to Consolidated Financial
Statements for additional information regarding lease costs.
Item 3 Legal Proceedings
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The Company and its subsidiaries are involved in various claims and
legal actions arising in the ordinary course of business. In the opinion of
management, the ultimate disposition of these matters will not have a material
adverse effect on the Company's consolidated financial position and results of
operations, taken as a whole.
Item 4 Submission of Matters to a Vote of Security Holders
- ------ ---------------------------------------------------
None have been submitted in the fourth quarter 1998.
7
PART II
Item 5 Market for Registrant's Common Stock
The Company's common stock is listed on the NASDAQ National Market
(Symbol: CMPC). As of December 31, 1998, there were approximately 8,400
beneficial holders of the Company's common stock. The high and low sales prices
reported within each quarter for the years ended December 31, 1998 and 1997 are
as follows:
1998 1997
---------------- ----------------
High Low High Low
------ ------ ------ ------
First quarter $ 9.75 $ 7.50 $11.13 $ 4.00
Second quarter 8.50 5.88 7.88 5.75
Third quarter 7.13 3.56 11.00 6.25
Fourth quarter 5.25 2.25 10.88 8.25
The last sale price reported for the Company's common stock on March 29
1999 was $3.69.
The Company has historically reinvested earnings in the growth of its
business and has not paid cash dividends on its common stock. In addition, the
Company's current credit facilities restrict the amount of dividends the Company
may pay on its common stock.
Item 6 Selected Financial Data
Selected financial data for the Company is presented below:
For the Years Ended December 31,
------------------------------------------------------------------------
Operating Results 1998 1997 1996 1995 1994
- ----------------- ----------- ----------- ----------- ----------- -----------
(in thousands, except per share amounts)
Net revenues $ 2,254,465 $ 1,949,802 $ 1,995,191 $ 1,441,597 $ 1,255,813
Gross margin 283,960 267,545 240,963 174,908 141,693
Earnings before income taxes 668 * 58,658** 50,616*** 34,335 24,432
Net earnings 401 * 35,194** 30,471*** 20,670 14,659
Earnings/(loss) per common share:
Basic (.01)* .75** .66*** .54 .43
Diluted (.01)* .71** .61*** .45 .34
Balance Sheet Data
Total assets $ 545,489 $ 462,590 $ 692,985 $ 508,704 $ 429,531
Long-term debt 81,929 97,400 236,450 120,364 118,974
Convertible subordinated notes 3,000 3,000 3,000 18,214
Stockholders' equity 210,281 210,200 171,098 138,341 94,368
* Includes restructuring charges of $16.4 million ($9.9 million, net of
tax) or ($.21) per share
** Includes nonrecurring gains on prepayment of secured note related to
sale of subsidiary in 1994 of $1.0 million and gain on sale of Company's
former headquarters of $2.4 million or $.07 per share
*** Includes nonrecurring gain on sale of securities of $5.2 million
(Basic - $.12 per share, Diluted - $.10 per share)
8
Item 7 Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
The following table presents the Company's total revenue, gross margin
and gross margin percentage by revenue source. Operating expenses, financing
expenses, nonrecurring gains, income taxes and net earnings are shown as a
percentage of total net revenue for the three years ended December 31:
1998 1997 1996
-----------------------------------
($ in millions)
Revenue:
Product $ 1,980 $ 1,700 $ 1,817
Service 258 236 169
Other 16 14 9
-----------------------------------
Total revenue $ 2,254 $ 1,950 $ 1,995
===================================
Gross margin:
Product $ 194 $ 176 $ 181
Service 82 84 56
Other 8 7 4
-----------------------------------
Total gross margin $ 284 $ 267 $ 241
===================================
Gross margin percentage:
Product 9.8% 10.4% 10.0%
Service 32.0% 35.7% 33.3%
Other 48.6% 48.8% 39.2%
-----------------------------------
Total gross margin percentage 12.6% 13.7% 12.1%
-----------------------------------
Operating expenses:
Selling 4.9% 4.0% 4.0%
Service 2.4% 2.5% 2.0%
General and administrative 3.0% 3.1% 2.8%
Depreciation and amortization 0.7% 0.6% 0.5%
Restructuring charges 0.7%
-----------------------------------
Total operating expenses 11.7% 10.2% 9.3%
-----------------------------------
Earnings from operations 0.9% 3.5% 2.8%
Interest (0.8%) (0.8%) (0.7%)
Nonrecurring gain 0.3% 0.4%
-----------------------------------
Earnings before income taxes 0.1% 3.0% 2.5%
Income taxes 0.1% 1.2% 1.0%
-----------------------------------
Net earnings 0.0% 1.8% 1.5%
===================================
9
OVERVIEW
On May 13, 1998, the Company acquired Computer Integration Corporation
("CIC") and on June 26, 1998, the Company acquired Dataflex Corporation
("Dataflex") (collectively "the acquisitions").
On October 22, 1998 the Company's Board of Directors approved a
restructuring plan designed to reduce the Company's cost structure by
approximately 1.25% to 1.5% of sales by closing branch facilities and reducing
the Company's workforce by approximately 10%. The Company retains local presence
in all existing markets. As a result, the Company recorded a restructuring
charge in the fourth quarter of 1998 of $16.4 million (pretax), primarily
consisting of costs associated with the closing of certain facilities and
disposing of related fixed assets, as well as employee severance and benefits
related to the reduction in workforce. See Note 4 to the Consolidated Financial
Statements.
1998 Compared to 1997
Product revenue, which is primarily derived from the sale of distributed
desktop computer products to corporate customers, increased approximately 17% to
$1.98 billion in 1998 from $1.70 billion in 1997. The majority of the increase
in product revenue was due to the acquisitions, which contributed approximately
$219 million in product revenue. Excluding the acquisitions, product revenue for
the Company increased approximately 3.6% in 1998 compared to 1997. This
increase in product revenues, excluding the acquisitions, is primarily due to an
increase in desktop, laptop, and server units shipped and increased software
sales. Excluding the acquisitions, the Company shipped approximately 26% more
of these units in 1998 compared to 1997. This increase was partially offset by
a decrease in the average sales price of units sold resulting from manufacturer
price reductions. Although the trend of declining average sales prices slowed
in 1998 relative to 1997, the Company expects this trend will continue in the
short term. Product gross margin as a percentage of product revenue decreased
to 9.8% in 1998 from 10.4% in 1997. The decline in product gross margins is
primarily due to heightened competition from other corporate resellers and
direct marketers. The Company expects to continue to experience declining
product gross margins in the short term.
Service revenue increased 9.2% to $257.9 million in 1998 from $236.2
million in 1997. Service revenue is primarily derived from field engineering,
LAN/WAN projects, consulting, configuration, help desk, asset tracking, network
management, and software management. Service revenue reflects revenue
generated by the actual performance of specific services and does not include
product sales associated with service projects. The increase in service revenue
was primarily due to increases in field engineering, which is typically driven
in part by product unit sales volume, and the acquisitions. Excluding the
acquisitions, service revenue increased approximately 4.9%. Service gross
margin as a percentage of service net revenue decreased to 32.0% in 1998
compared to 35.7% in 1997. The decrease was primarily caused by lower billing
per engineer for the Company's service personnel, particularly in the systems
engineering group. The Company does not expect to see improvement in its
service gross margin percentage in the short term.
Operating expenses increased 32.6% or $65.0 million for 1998 compared to
the same prior year period. As a percentage of net revenue, operating expenses
increased to 11.7% in 1998 compared to 10.2% in 1997. The percentage and dollar
increases resulted primarily from increased selling expenses and restructuring
charges.
Selling expense increased $30.1 million or 38.0% in 1998 compared to
1997. As a percentage of net revenues, selling expense increased to 4.9% in 1998
from 4.0% in 1997. These increases resulted from an increase in the Company's
sales force as a result of the acquisitions, the hiring of additional sales
representatives, and higher commission expense. Service expense increased in
absolute dollars in 1998 compared to 1997 primarily due to the growth in the
Company's service business and increased spending on training as a result of an
increase in the size of the Company's engineering force. However, as a
percentage of net revenues for 1998 compared to 1997, service expense decreased
10
slightly. General and administrative expense increased in absolute dollars in
1998 compared to 1997 primarily due to expenditures to broaden the Company's
electronic commerce capabilities, costs related to the Company's ongoing campus
recruiting program and the integration of the acquisitions. However, as a
percentage of net revenues for 1998 compared to 1997, general and administrative
expense decreased slightly. As a result of the Company's fourth quarter 1998
restructuring activities, management expects to realize reductions in operating
expenses from its fourth quarter 1998 levels. These reductions may not result in
lower operating expenses in comparison to the same period of the prior year. The
Company's operating expenses are reported net of reimbursements by certain
manufacturers for specific training, promotional and marketing programs. These
reimbursements offset the expenses incurred by the Company.
Depreciation and amortization expense increased for 1998 both in
absolute dollars and as a percentage of net revenue when compared to 1997. The
increase in depreciation expense is associated with upgrading the Company's
hardware and software and increased depreciation as a result of the acquisitions
completed during 1998. The Company also expects to realize a slight decrease in
depreciation expense associated with the closing of branch facilities and
disposal of those related depreciable assets. Increased amortization expense is
the result of an increase in goodwill from the acquisitions completed during the
second quarter of 1998.
Financing expense increased approximately 25.4% for 1998 compared to
1997, primarily as a result of increased borrowings due to the acquisitions. The
Company's effective interest rate was 6.6% for 1998 compared to 6.7% in 1997.
The Company increased the availability in its working capital facility from $125
million to $165 million in June of 1998 to accommodate the acquistions. The
interest rate on the working capital facility is subject to adjustment based on
certain performance criteria. The Company's effective interest rate was 7.5% at
December 31, 1998.
During the third quarter of 1997, the Company recognized a previously
deferred nonrecurring after-tax gain of $1.0 million. Recognition of the gain
was due to the early payment of a secured note related to the 1994 sale of the
Company's former subsidiary, PC Parts Express, Inc. (known as PC Service Source,
Inc.).
During the fourth quarter of 1997, the Company recognized a nonrecurring
after-tax gain of $2.4 million on the sale of the Company's former headquarters.
As a result of the factors discussed above, net earnings, excluding the
restructuring charge in 1998 and the nonrecurring gains in 1997, decreased 68%
to $10.3 million in 1998 from $31.8 million in 1997. Some of the factors that
may impact future profitability include the following: the Company's ability to
effectively manage inventory levels in response to changes in its major
suppliers' price protection and return programs, the Company's ability to
effectively manage the utilization of service personnel, the Company's ability
to respond to increased competition from its suppliers' direct selling
initiatives, the Company's ability to reduce operating expenses at a pace equal
to the decline in margin percentages, demand for product, competition,
manufacturer product availability, effective utilization of vendor programs, and
the Company's ability to implement its recently announced virtual office
strategy.
1997 Compared to 1996
Product revenue declined 7% to $1.70 billion in 1997 from $1.82 billion
in 1996. Although the Company shipped more desktop, laptop and server units in
1997 compared to 1996, the units were sold at a lower average sales price
primarily due to manufacturer price reductions, which contributed to the overall
decrease in product revenue. In addition, the Company believes the product
revenue decline was attributable to an increase in direct marketers' market
share and the Company's effort during much of 1997 to improve product margins by
reducing its low-margin product business.
Product gross margin as a percentage of product net revenue increased to
10.4% in 1997 from 10.0% in 1996. This increase was primarily due to the
Company's effort to reduce its low-margin product business, and an increase in
the amount of manufacturer-sponsored incentives in 1997 compared to 1996.
Service revenue increased 39% to $236 million in 1997 from $169 million
in 1996. The increase in service revenue reflected the Company's continued focus
on growing the service business. Also contributing to the revenue growth in
service was the increase in the number of units sold during 1997 as compared to
1996, which increased demand for services such as configuration and
installation. Service gross margin as a percentage of service net revenue
increased to 35.7% in 1997 from 33.3% in 1996, primarily due to an increase in
billing per engineer of the Company's service personnel and growth in the
Company's higher-end service offerings, such as systems engineering and
consulting, which typically have higher margins than some of the Company's other
services.
11
As a percentage of net revenue, operating expenses for 1997 increased to
10.2% compared to 9.3% in 1996. On an absolute dollar basis, operating expenses
for 1997 increased approximately $15 million compared to 1996. These increases
were attributed to increases in service operating expenses, general and
administrative expenses and depreciation expense. Selling expenses decreased
due to the decline in product sales, but remained flat as a percentage of net
revenue when compared to 1996. Service expenses increased both as a percentage
of net revenue and in absolute dollars as a result of the growth in the
Company's service business. Service revenue represented 12% of total revenue in
1997 as compared to 8% in 1996. However, the Company's efforts to control
expenses resulted in a decrease in service expense as a percentage of service
revenue to 21.0% in 1997 as compared to 23.5% in 1996. General and
administrative expenses increased both in dollars and as a percentage of net
revenues. These increases were mainly due to the continued investment in the
Company's information system resources required to broaden the Company's
electronic commerce capabilities and improve efficiency within the Company's
customer center.
Depreciation and amortization expense increased in absolute dollars and
as a percentage of net revenue for 1997 compared to 1996. These increases
primarily reflected depreciation of enhancements to the Company's information
systems, facility improvements associated with the Company's new headquarters
and operations campus and furniture and fixtures required to support business
activity.
Financing expenses remained relatively flat in dollars when 1997 is
compared to 1996, but increased slightly as a percentage of revenue due to the
decrease in revenues. The Company's borrowing levels were slightly higher in
1997 as compared to 1996; however, these higher levels were offset by a lower
effective interest rate for 1997 due to changes the Company made in its
financing arrangements. The Company's effective interest rate for 1997 was 6.7%
as compared to 7.1% for 1996.
During the third quarter of 1997, the Company recognized a previously
deferred nonrecurring after-tax gain of $1.0 million. Recognition of the gain
was due to the prepayment of a secured note related to the 1994 sale of the
Company's former subsidiary, PC Parts Express, Inc. (now known as PC Service
Source, Inc.).
During the fourth quarter of 1997, the Company recognized a nonrecurring
after-tax gain of $2.4 million on the sale of the Company's former headquarters.
During the second quarter of 1996, the Company participated in the
secondary stock offering of PC Service Source, Inc. resulting in an after-tax,
nonrecurring gain on the sale of securities of $5.2 million.
As a result of the factors discussed above, net earnings, excluding the
nonrecurring gains in 1997 and 1996, increased 26% to $31.8 million in 1997
from $25.2 million in 1996. The earnings per share impact of the 1997
nonrecurring gains was $.07 on a diluted basis, while in 1996, the earnings per
share impact of the nonrecurring gain was $.10 on a diluted basis.
Liquidity and Capital Resources
Working capital at December 31, 1998 was $164 million compared to $235
million at December 31, 1997. This net decrease was primarily the result of an
increase in accounts payable and a decrease in inventory, partially offset by an
increase in accounts receivable. The Company's accounts payable balance
fluctuates relative to the timing of product receipts and the mix of vendors.
The decrease in inventory is primarily due to the Company's effort to reduce its
risk associated with changes in its suppliers' price protection and return
programs through increasing its inventory turns. The Company increased its
inventory turns from 8.5 in 1997 to 11.5 in 1998. The increase in accounts
receivable is mainly attributable to the acquisitions completed in 1998 which
resulted in higher revenues in the fourth quarter 1998 versus the fourth quarter
1997.
The Company's liquidity has been negatively impacted by the increase in
the dollar volume of vendor rebate programs. Under these programs, the Company
is required to pay a higher initial price for product and claim a rebate to
reduce the price. The collection of these rebates can take several months. Due
to the increased volume of product sold under these programs, the Company's
initial price for the product is often higher than the sales price the Company
can obtain from its customers. As of December 31, 1998, these programs are a
material factor in the Company's financing needs.
12
The Company's capital asset requirements are generally funded through
financing arrangements and internally generated funds. During 1998, the Company
increased the size of its credit facilities in order to finance the acquisitions
completed during 1998. As of December 31, 1998, the Company's financing
arrangements consist of a $175 million Securitization Facility, a $165 million
working capital facility and a $25 million real estate loan (collectively, the
"Credit Agreements"). The term of the working capital facility is five years.
As of December 31, 1998, the Securitization Facility was fully utilized and the
Company had approximately $106 million of availability under the working capital
facility. The $25 million real estate loan is payable as follows: the first
quarterly payment of $500,000 is due on April 1, 1999, quarterly payments
increase to $1,000,000 on January 1, 2000, and then increase to $2,000,000 on
January 1, 2001, with a final payment of $3,500,000 due on November 2, 2002. The
Company expects to complete a sale/leaseback on its headquarters building during
the first half of 1999. The proceeds from the sale/leaseback would be used to
payoff the real estate loan and pay down a portion of the working capital
facility.
The Securitization Facility terminates on April 15, 1999. The Company is
currently negotiating a replacement securitization facility and expects to have
this agreement executed prior to April 15, 1999. For the month of February 1999,
the Company was out of compliance with one covenant ratio of its existing
Securitization Facility. The Company does not expect this violation to
negatively impact negotiations relative to the replacement securitization
facility or to negatively impact its liquidity. On December 31, 1998, the
Company was not in compliance with certain financial covenants under the Credit
Agreements. However, the Company has received an amendment related to such
covenants from its lenders for periods up to and including April 15, 1999. The
Company is also currently negotiating a replacement working capital facility and
expects to have this agreement executed prior to April 15, 1999. Although the
new facility is expected to contain provisions that could result in lower
interest rates as the Company's financial performance improves, the initial
interest rates are expected to be higher than the Company's current effective
interest rate. If the Company is not successful in implementing the replacement
credit agreements, management believes there are a number of viable alternatives
to ensure continued financing.
The Company's business is not capital asset intensive, and capital
expenditures in any year normally would not be significant in relation to the
overall financial position of the Company. Capital expenditures were
approximately $14 million in 1998 as compared to $22 million in 1997. The
majority of the 1998 expenditures were related to the upgrading of Company
hardware and software at both headquarters and branch locations. The majority of
the 1997 expenditures were related to facility improvements required to prepare
the Company's new headquarters and operations campus for occupancy, as well as
information systems enhancements. The Company does not expect its capital
expenditure requirements in 1999 to be materially different from its 1998
expenditures.
Year 2000 Readiness Disclosure
The Year 2000 issue results from the fact many computer programs were
previously written using two digits rather than four to define the applicable
year. Programs written in this way may recognize a date ending in "00" as the
year 1900 rather than the year 2000. This could result in a system failure or
miscalculations causing business delays and disruptions of operations. The
Company has developed a step-by-step plan which details the tasks, deliverables,
resources, and target dates necessary to monitor the Company's information
systems at the turn of the century and beyond. Assessment of the Company's
systems has been divided into five areas Core information systems and
components ("Core IS"), Distributed Desktop systems, Non-IS systems, new IS
purchases by the Company, and mergers and acquisitions.
The Company's Core IS include purchasing, order management, warehouse
management, distribution, service dispatch, service parts, engineer billing,
human resources and financial information systems. Distributed Desktop systems
include all desktop computers and related components used by the Company's
associates, wherever they are located. Initial assessment of these systems has
included the identification of each hardware, software, tool, and package
comprising these systems to determine whether or not they support Year 2000 date
codes. Testing, remediation, and validation of the Company's Core IS and
distributed desktop systems is planned to be completed by June 1999.
Remediation includes the enhancement, upgrading, migration, or replacement of
non-compliant hardware, software, tools and/or systems. Validation entails
testing of all systems including a "quality control" environment in which the
date is artificially set forward to the Year 2000 to simulate the turn of the
century and beyond. The Company has also purchased a Year 2000 compliance
software package that will generate audit reports on a regular basis to report
back any noncompliant Distributed Desktop systems. The Company began using this
software package in January 1999 and will produce and review the reports on a
regular basis through 2000.
Non-IS systems include all microcontroller systems and back-up processes of Core
IS. Microcontroller systems comprise all electronic systems such as telephones,
security systems, alarms, etc. Initial assessment and remediation of the
13
Company's Non-IS systems is currently expected to be completed during the first
quarter of 1999. The Company reviews each of its new potential hardware and
software purchases to ensure they are Year 2000 compliant. The Company
completed three acquisitions during 1998; however, these acquisitions have been
integrated into the Company and the major processes of the acquired systems have
been replaced with the Company's Core IS.
As part of its Year 2000 assessment, the Company must also consider the
compliance of third parties with which the Company has a material relationship,
namely its vendors, suppliers, and customers. The Company relies on vendors and
suppliers for hardware, software, and tools used within its own business
environment. The Company has developed a Year 2000 questionnaire which has been
sent to its vendors and suppliers in order to ascertain whether vendors and
suppliers warrant their hardware, software, and tools to be Year 2000 compliant
and whether vendors and suppliers have adequately addressed the Year 2000 issue.
The Company has documented compliance via the questionnaire for approximately
85% of hardware, software, and tools currently in use. For the remaining 15% of
questionnaires, if documented compliance is not received, the Company's plan is
to upgrade or replace for compliance, or decommission if necessary during the
second quarter of 1999.
The Company is required to disclose a reasonable description of its most
reasonably likely worst case Year 2000 scenario. Although noncompliance could
result in a system failure, business delays, and/or disruptions in operations,
the Company is in the process of developing a contingency plan in case a Year
2000 problem occurs. As a reseller of computer products, the Company only passes
through to its customers the applicable vendor's warranties; it makes no
warranties regarding Year 2000 compliance on any of the products it resells.
However, if one of the Company's major vendors or suppliers is found to be Year
2000 noncompliant which is not corrected on a timely basis, it could have a
material adverse effect on the Company's results of operations. Due to that
fact, the Company is still in the process of obtaining assurances from its
vendors and suppliers regarding their readiness for Year 2000.
The Company's plan also includes the availability of a test team that will test
the Company's information systems on an on-going basis to further validate that
additions or modifications to any of the Company's systems do not create Year
2000 compliance issues. The Company's expectations with respect to the Year 2000
issues noted above are based on the premise there will be no material general
failure of external systems (including power, communications, transportation or
financial systems) necessary for the ordinary conduct of business. At the
present time, the company is developing a contingency plan to operate in the
event its computer systems or those of its vendors, suppliers, or customers are
not Year 2000 compliant. The Company expects to have this contingency plan
completed by June 1999.
The Company currently anticipates it will spend approximately $1,400,000 on Year
2000 compliance, of which approximately $800,000 has been spent through December
31, 1998. The majority of the remaining expense is expected to be for
previously identified desktop equipment and full-time associates dedicated to
the Year 2000 compliance effort. All previous as well as future expenditures on
Year 2000 compliance have or will come from operating cash flow.
Item 7a Quantitative and Qualitative Disclosure About Market Risk
The Company is exposed to interest rate risk primarily through its
Securitization Facility, working capital facility and real estate loan. The
Company utilizes the Securitization Facility and working capital facility
borrowings to meet its working capital needs. The term loan was used to finance
the purchase of the Company's headquarters and operations campus. Under the
Securitization Facility, the Company had borrowings of approximately $173.0
million outstanding at December 31, 1998 which have a variable interest rate of
4.95% plus an agreed upon spread. Under the working capital facility, the
Company had $56.1 million outstanding at December 31, 1998 with an effective
interest rate of 7.5%. Under the real estate loan, the Company had borrowings of
approximately $25.0 million with an effective interest rate of 7.5%. If the
Company's effective interest rate were to increase from 7.5% to 8.25% (a 10%
increase), the effect on the Company's financial statements would be immaterial.
Currently, the Company does not enter into financial instruments for trading or
other speculative purposes or to manage interest rate exposure.
Item 8 Financial Statements and Supplementary Data
The consolidated financial statements and schedule filed with this
report appear on pages F-2 through F-22, and are listed on page F-1.
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
14
None.
PART III
Item 10 Directors and Executive Officers of the Registrant
The executive officers of the Company as of March 29, 1999 are as
follows:
Name Age Position
---- --- --------
Edward Anderson /(1)/ 52 President and Chief Executive Officer
Thomas C. Lynch /(2)/ 56 Executive Vice President and Chief Operating Officer
M. Lazane Smith /(3)/ 44 Senior Vice President, Finance and Chief Financial Officer
/(1)/ Mr. Anderson has served as President and Chief Executive Officer since
January 1994. Mr. Anderson joined the Company in August 1993 as Chief
Operating Officer and has been a Director of the Company since 1993.
/(2)/ Mr. Lynch joined the Company as Executive Vice President and Chief
Operating Officer in October 1998. Prior to joining the Company, he
served as Senior Vice President of Safeguard Scientifics, Inc. from
1996 until 1998. Prior to his association with Safeguard, he was a Rear
Admiral in the United States Navy, serving on active duty for 31 years.
/(3)/ Ms. Smith has held the position of Senior Vice President, Finance and
Chief Financial Officer since February 1997. Ms. Smith joined the
Company in 1993 as Corporate Controller and was promoted to Vice
President Finance and Corporate Controller in 1994.
Directors
The Company incorporates by reference the information contained under
the caption "ELECTION OF DIRECTORS" in its definitive Proxy Statement relative
to its May 13, 1999 annual meeting of stockholders, to be filed within 120 days
after the end of the year covered by this Form 10-K Report pursuant to
Regulation 14A under the Securities Exchange Act of l934, as amended.
Disclosure of Delinquent Filers Pursuant to Item 405 of Regulation S-K
The Company incorporates by reference the information contained under the
caption "Section 16(a) Beneficial Ownership Reporting Compliance" in its
definitive Proxy Statement relative to its May 13, 1999 annual meeting of
stockholders, to be filed within 120 days after the end of the year covered by
this Form 10-K Report pursuant to Regulation 14A under the Securities Exchange
Act of 1934, as amended.
Item 11 Executive Compensation
The Company incorporates by reference the information contained under
the captions "EXECUTIVE COMPENSATION AND OTHER ARRANGEMENTS" in its definitive
Proxy Statement relative to its May 13, 1999 annual meeting of stockholders, to
be filed within 120 days after the end of the year covered by this Form 10-K
Report pursuant to Regulation 14A under the Securities Exchange Act of 1934, as
amended.
Item 12 Security Ownership of Certain Beneficial Owners and Management
15
The Company incorporates by reference the information contained under
the caption "STOCK OWNERSHIP OF DIRECTORS, EXECUTIVE OFFICERS AND GREATER THAN
5% STOCKHOLDERS" in its definitive Proxy Statement relative to its May 13, 1999
annual meeting of stockholders, to be filed within 120 days after the end of the
year covered by this Form 10-K Report pursuant to Regulation 14A under the
Securities Exchange Act of 1934, as amended.
Item 13 Certain Relationships and Related Transactions
The Company incorporates by reference the information contained under
the caption "RELATIONSHIPS AND RELATED TRANSACTIONS WITH MANAGEMENT AND OTHERS"
in its definitive Proxy Statement relative to its May 13, 1999 annual meeting of
stockholders, to be filed within 120 days after the end of the year covered by
this Form 10-K Report pursuant to Regulation 14A under the Securities Exchange
Act of 1934, as amended.
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Financial Statements and Schedules.
The financial statements and financial statement schedule filed with
this report are listed on page F-1.
(b) Reports on Form 8-K.
No reports on Form 8-K have been filed by the Registrant during the
twelve months ended December 31, 1998.
(c) Exhibits.
The following is a list of exhibits required by Item 601 of Regulation
S-K filed as part of this Report. Where so indicated by footnote, exhibits,
which were previously filed, are incorporated by reference. For exhibits
incorporated by reference, the location of the exhibit in the previous filing is
indicated in parentheses.
16
Exhibit
No. Description
- ------- -----------
3(a) Certificate of Incorporation of CompuCom Systems, Inc. (1)
(Exhibit B)
3(b) Certificate of Amendment of the Certificate of Incorporation of
CompuCom Systems, Inc. (4) (Exhibit 3(b))
3(c) Certificate of Amendment of the Certificate of Incorporation of
CompuCom Systems, Inc., filed November 30, 1992 (6) (Exhibit
4(c))
3(d) Certificate of Amendment of the Certificate of Incorporation of
CompuCom Systems, Inc., filed July 1, 1993 (6) (Exhibit 4(d))
3(e) Bylaws of CompuCom Systems, Inc., revised April 1, 1991 (4)
(Exhibit 3(c))
4(a) Form of Stock Certificate evidencing Common Stock, $.01 par
value, of CompuCom Systems, Inc. (2) (Exhibit 4(b))
4(b)** CompuCom Systems, Inc. 1983 Stock Option Plan, as amended (5)
(Exhibit 4(k))
4(c)** CompuCom Systems, Inc. 1993 Stock Option Plan, as amended (14)
(Exhibit A)
4(d)** CompuCom Systems, Inc. 1984 Non-Qualified Stock Option Plan, as
amended (3) (Exhibit 4(g))
4(e)** CompuCom Systems, Inc. Stock Option Plan for Directors (10)
(Exhibit 4(g))
4(f)** Stock Option Agreement dated July 21, 1995 between CompuCom
Systems, Inc. and Delbert W. Johnson (10) (Exhibit 4(i))
4(g)** Stock Option Grant Agreement between CompuCom Systems, Inc. and
Thomas C. Lynch, dated as of October 22, 1998 (19) (Exhibit
10.1)
4(h)** CompuCom Systems, Inc. Employee Stock Purchase Plan (16)
(Appendix A)
4(i) Certificate of Designation dated March 31, 1994, establishing
Series B Cumulative Convertible Preferred Stock of CompuCom
Systems, Inc. (8) (Exhibit 4(i))
4(j) Form of Stock Certificate evidencing Series B Cumulative
Convertible Preferred Stock, $.01 par value, of CompuCom
Systems, Inc. (9) (Exhibit 4(h))
10(a)** CompuCom Systems, Inc. 401(k) Matched Savings Plan, as amended
and restated effective January 1, 1989 (7) (Exhibit 10(a))
10(b)** Amendment 1996-1 to CompuCom Systems, Inc. 401(k) Matched
Savings Plan, effective May 1, 1996 (11) (Exhibit 10.9)
10(c)** Amendment No. 1 to CompuCom Systems, Inc. 401(k) Matched Savings
Plan, effective January 1, 1998 (exhibits omitted) (17) (Exhibit
10.1)
10(d)** Amendment No. 2 to CompuCom Systems, Inc. 401(k) Matched Savings
Plan, effective January 26, 1998 (exhibits omitted) (17)
(Exhibit 10.2)
10(e) Amended and Restated Agreement for Inventory Financing, dated
September 20, 1996, between CompuCom Systems, Inc. and IBM
Credit Corporation (13) (Exhibit 10(d))
10(f) IBM Credit Corporation agreement with CompuCom Systems, Inc. to
extend the terms of the Agreement for Inventory Financing to
March 21, 1999 *
10(g) Security Agreement for Wholesale Financing, dated December 27,
1993, between CompuCom
17
Systems, Inc. and Compaq Computer Corporation (7) (Exhibit
10(e))
10(h) Intercreditor Agreement, dated December 27, 1993, among
NationsBank of Texas, N.A., CompuCom Systems, Inc. and Compaq
Computer Corporation (7) (Exhibit 10(f))
10(i) Subordination Agreement, dated August 22, 1994, among Hewlett-
Packard Company, NationsBank of Texas, N.A., and IBM Credit
Corporation, pertaining to certain assets of CompuCom Systems,
Inc. (9) (Exhibit 10(h))
10(j) Intercreditor Agreement, dated as of April 1, 1996, among
NationsBank of Texas, N.A., CompuCom Systems, Inc. and IBM
Credit Corporation (11) (Exhibit 10.4)
10(k) Amended and Restated Credit Agreement, dated as of November 3,
1997, among CompuCom Systems, Inc., certain lenders party
hereto, and NationsBank of Texas, N.A., as administrative lender
(exhibits and schedules omitted) (15) (Exhibit 16(t))
10(l) Amendment #1 to Amended and Restated Credit Agreement, dated as
of June 26, 1998, among CompuCom Systems, Inc., certain lenders
party hereto, and NationsBank of Texas, N.A., as Administrative
Lender (exhibits omitted) (18) (Exhibit 10.1)
10(m) Amended and Restated Receivables Purchase Agreement, dated as of
November 3, 1997, between CompuCom Systems, Inc. and CSI
Funding, Inc. (exhibits omitted) (15) (Exhibit 10(u))
10(n) Amended and Restated Transfer and Administration Agreement,
dated as of November 3, 1997, among CSI Funding, Inc., CompuCom
Systems, Inc., Enterprise Funding Corporation and NationsBank,
N.A. (exhibits omitted) (15) (Exhibit 10(v))
10(o) Business Partner Agreement, dated September 15, 1994, between
IBM Corporation and CompuCom Systems, Inc., with Dealer Profile,
Remarketer General Terms, and attachments (9) (Exhibit 10(n))
10(p) IBM Corporation Remarketer Announcement, dated March 13, 1996,
modifying its Business Partner Agreement with CompuCom Systems,
Inc. to automatically extend its term for an additional 12
months upon its expiration (13) (Exhibit 10(r))
10(q) Agreement for Participation in the IBM Business Partner PC,
Authorized Assembler Program, dated January 16, 1997 between IBM
Corporation and CompuCom Systems, Inc. (15) (Exhibit 10(y))
10(r) Agreement to Extend Participation in the IBM Business Partner
PC, Authorized Assembler Program, dated November 18, 1997
between IBM Corporation and CompuCom Systems, Inc. to December
31, 1998 (15) (Exhibit 10(z))
10(s) U.S. Reseller Agreement, dated January 23, 1993, between Compaq
Computer Corporation and CompuCom Systems, Inc. (7) (Exhibit
10(l))
10(t) Software License Agreement, dated January 15, 1998, between
Compaq Computer Corporation and CompuCom Systems, Inc. (15)
(Exhibit 10(bb))
10(u) Channel Installation Agreement for Microsoft Products, dated
January 15, 1998, between Compaq Computer Corporation and
CompuCom Systems, Inc. (15) (Exhibit 10(cc))
10(v) U.S. Reseller Agreement, dated March 1, 1996, between Hewlett-
Packard Company and CompuCom Systems, Inc. (11) (Exhibit 10.8)
10(w) U.S. Agreement for Authorized Reseller Participation in Channel
Assembly Program, dated March 1, 1997, between Hewlett-Packard
Company and CompuCom Systems, Inc. (15) (Exhibit 10(ee))
10(x) Administrative Services Agreement, dated January 1, 1988,
between CompuCom Systems, Inc. and Safeguard Scientifics, Inc.,
with Letter Amendment dated as of April 1, 1991 (4) (Exhibit
10(z))
10(y) Lease dated May 16, 1996, between CompuCom Systems, Inc. and The
Riggs National Bank of Washington, D.C. for premises at 1225
Forest Parkway, Paulsboro, New Jersey (exhibits omitted)
18
(12) (Exhibit 10.8)
10(z) Ratification Agreement dated January 9, 1992 between CompuCom
Systems, Inc. and The Arch Street Group with respect to
assignment of Lease dated November 1, 1988 between The Arch Road
Group and Photo & Sound Company (attached) for premises at 4686
Frontier, Stockton, California (4) (Exhibit 10(dd))
10(aa) Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Financing Statement, dated as of September 27,
1996, from CompuCom Systems, Inc. to NationsBank of Texas, N.A.
(exhibits omitted) (12) (Exhibit 10.7)
10(bb) Contract of Sale between CompuCom Systems, Inc., as seller, and
MacFarlan Realty Partners, L.L.C., as purchaser, for property
located at 10100 North Central Expressway, Dallas, Texas, dated
effective October 23, 1997 (15) (Exhibit 10(jj))
10(cc) First Amendment to Contract of Sale between CompuCom Systems,
Inc., as seller, and MacFarlan Realty Partners, L.L.C., as
purchaser, for property located at 10100 North Central
Expressway, Dallas, Texas, dated effective December 9, 1997 (15)
(Exhibit 10(kk))
10(dd) $7,840,000 Secured Promissory Note, dated December 30, 1997,
from MacFarlan Realty Partners, L.L.C., to CompuCom Systems,
Inc. (15) (Exhibit 10(ll))
10(ee) Note Modification Agreement and Settlement Agreement, dated as
of November 30, 1998, between MacFarlan Realty Partners L.L.C.
and CompuCom Systems, Inc. *
10(ff)** $1,181,250 Amended and Restated Secured Term Note, dated
February 12, 1997, from Edward R. Anderson to CompuCom Systems,
Inc. (13) (Exhibit 10(ff))
10(gg)** First Amendment, dated February 19, 1999, to Amended and
Restated Secured Term Note from Edward R. Anderson to CompuCom
Systems, Inc. *
10(hh)** Pledge Agreement, dated August 31, 1994, between Edward R.
Anderson and CompuCom Systems, Inc. (9) (Exhibit 10(nn))
10(ii)** $661,251 Secured Term Note, dated June 16, 1997, from Daniel F.
Brown to CompuCom Systems, Inc. (15) (Exhibit 10(pp))
10(jj)** Pledge Agreement, dated June 16, 1997, from Daniel F. Brown and
CompuCom Systems, Inc. (15) (Exhibit 10(qq))
10(kk)** $796,875 Secured Term Note, dated December 23, 1998, from Thomas
C. Lynch to CompuCom Systems, Inc. *
10(ll) Pledge Agreement, dated December 23, 1998, between Thomas C.
Lynch and CompuCom Systems, Inc. *
10(mm) $2,021,875 Secured Term Note, dated October 22, 1998, from
Edward R. Anderson to CompuCom Systems, Inc. *
10(nn) Pledge Agreement, dated October 22, 1998, between Edward R.
Anderson and CompuCom Systems, Inc. *
10(oo)** Executive Employment Agreement, dated October 24, 1997, between
Edward R. Anderson and CompuCom Systems, Inc. (15) Exhibit
10(rr))
10(pp)** Employment Agreement Amendment, dated February 19, 1999, between
Edward R. Anderson and CompuCom Systems, Inc. *
10(qq)** Executive Employment Agreement, dated October 24, 1997, between
M. Lazane Smith and CompuCom Systems, Inc. (15) (Exhibit 10(ss))
10(rr)** Employment Separation Letter Agreement, dated January 18, 1999,
between William Barry and CompuCom Systems, Inc., with attached
General Release and Agreement, and Employee
19
Non-Disclosure, Non-Solicitation and Non-Competition Agreement *
21 List of Subsidiaries *
23 Consent of KPMG LLP *
27.1 Financial Data Schedule *
- -------------------
* Filed herewith
** These exhibits relate to management contracts or to compensatory
plans, contracts or arrangements in which directors and/or
executive officers of the registrant may participate, required
to be filed as exhibits to this Form 10-K.
(1) Filed on April 19, 1989 as an exhibit to the 1989 Annual Meeting
Proxy Statement and incorporated herein by reference.
(2) Filed on April 2, 1990 as an exhibit to the Annual Report on
Form 10-K (No. 0-14371) and incorporated herein by reference.
(3) Filed on March 29, 1991 as an exhibit to the Annual Report on
Form 10-K (No. 0-14371) and incorporated herein by reference.
(4) Filed on March 30, 1992 as an exhibit to the Annual Report on
Form 10-K (No. 0-14371) and incorporated herein by reference.
(5) Filed on March 31, 1993 as an exhibit to the Annual Report on
Form 10-K (No. 0-14371) and incorporated herein by reference.
(6) Filed on March 14, 1994 as an exhibit to the Registration
Statement on Form S-8 (No. 33-76382) and incorporated herein by
reference.
(7) Filed on March 31, 1994 as an exhibit to the Annual Report on
Form 10-K (No. 0-14371) and incorporated herein by reference.
(8) Filed on May 15, 1994 as an exhibit to the Quarterly Report on
Form 10-Q (No. 0-14371) and incorporated herein by reference.
(9) Filed on March 31, 1995 as an exhibit to the Annual Report on
Form 10-K (No. 0-14371) and incorporated herein by reference.
(10) Filed on October 10, 1995 as an exhibit to the Registration
Statement on Form S-8 (No. 33-63309) and incorporated herein by
reference.
(11) Filed on May 13, 1996 as an exhibit to the Quarterly Report on
Form 10-Q (No. 0-14371) and incorporated herein by reference.
(12) Filed on November 12, 1996 as an exhibit to the Quarterly Report
on Form 10-Q (No. 0-14371) and incorporated herein by reference.
(13) Filed on March 31, 1997 as an exhibit to the Annual Report on
Form 10-K (No. 0-14371) and incorporated herein by reference.
(14) Filed on April 9, 1997 as an exhibit to the 1997 Annual Meeting
Proxy Statement and incorporated herein by reference.
(15) Filed on March 31, 1998 as an exhibit to the Annual Report on
Form 10-K (No. 0-14371) and incorporated herein by reference.
(16) Filed on April 7, 1998 as an exhibit to the 1998 Annual Meeting
Proxy Statement and incorporated herein by reference.
(17) Filed on May 14, 1998 as an exhibit to the Quarterly Report on
Form 10-Q (No. 0-14371) and incorporated herein by reference.
(18) Filed on August 14, 1998 as an exhibit to the Quarterly Report
on Form 10-Q (No. 0-14371) and incorporated herein by reference.
(19) Filed on November 16, 1998 as an exhibit to the Quarterly Report
on Form 10-Q (No. 0-14371) and incorporated herein by reference.
20
Index to Consolidated Financial Statements
Independent Auditors' Report F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Stockholders' Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
Financial Statement Schedule
Schedule II Valuation and Qualifying Accounts F-22
Independent Auditors' Report
The Stockholders and Board of Directors
CompuCom Systems, Inc.:
We have audited the accompanying consolidated balance sheets of CompuCom
Systems, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the years in the three-year period ended December 31, 1998. In
connection with our audits of the consolidated financial statements, we also
have audited the financial statement schedule as listed in the accompanying
index. The consolidated financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on the consolidated financial statements and financial
statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of CompuCom
Systems, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1998 in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Dallas, Texas
February 10, 1999
F-2
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and 1997
(In thousands, except share amounts)
Assets 1998 1997
------ ---------- ----------
Current assets:
Cash $ 4,526 $ 4,456
Receivables, less allowance for doubtful accounts
of $3,507 in 1998 and $2,672 in 1997 262,380 177,141
Inventories 138,551 197,958
Deferred tax asset 6,718
Other 3,247 2,880
---------- ----------
Total current assets 415,422 382,435
Property and equipment:
Land, building and improvements 39,422 38,441
Furniture, fixtures and other equipment 57,703 41,338
Leasehold improvements 9,893 7,099
---------- ----------
107,018 86,878
Less accumulated depreciation and amortization (35,014) (23,519)
---------- ----------
Net property and equipment 72,004 63,359
Cost in excess of fair value of tangible net assets
purchased, less accumulated amortization 54,786 13,569
Other 3,277 3,227
---------- ----------
$545,489 $462,590
========== ==========
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities:
Accounts payable $160,524 $ 72,475
Accrued liabilities 89,218 71,791
Current portion of long-term debt 1,500 3,000
---------- ----------
Total current liabilities 251,242 147,266
Long-term debt 81,929 97,400
Deferred income taxes 1,378 7,198
Other 659 526
Stockholders' equity:
Series B preferred stock, $10 stated value. Authorized 3,000,000
Shares; issued and outstanding 1,500,000 shares. 15,000 15,000
Common stock, $.01 par value. Authorized 70,000,000 shares;
Issued and outstanding 47,441,820 shares in 1998
And 46,111,820 shares in 1997 474 461
Additional paid-in capital 70,380 66,094
Retained earnings 128,478 128,977
Notes receivable for sale of stock (4,051) (332)
---------- ----------
Total stockholders' equity 210,281 210,200
---------- ----------
$545,489 $462,590
========== ==========
See accompanying notes to consolidated financial statements.
F-3
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1998, 1997 and 1996
(In thousands, except per share amounts)
1998 1997 1996
----------- ----------- -----------
Revenue:
Product $ 1,980,578 $ 1,699,268 $ 1,816,504
Service 257,930 236,221 169,600
Other 15,957 14,313 9,087
----------- ----------- -----------
Total revenue 2,254,465 1,949,802 1,995,191
----------- ----------- -----------
Cost of revenue:
Product 1,786,851 1,523,034 1,635,653
Service 175,451 151,894 113,046
Other 8,203 7,329 5,529
----------- ----------- -----------
Total cost of revenue 1,970,505 1,682,257 1,754,228
----------- ----------- -----------
Gross margin 283,960 267,545 240,963
Operating expenses:
Selling 109,322 79,188 80,105
Service 54,940 49,563 39,876
General and administrative 67,928 59,539 55,580
Depreciation and amortization 15,923 11,274 8,760
Restructuring charges 16,437
----------- ----------- -----------
Total operating expenses 264,550 199,564 184,321
----------- ----------- -----------
Earnings from operations 19,410 67,981 56,642
Financing expenses (18,742) (14,947) (14,764)
Nonrecurring gains 5,624 8,738
----------- ----------- -----------
Earnings before income taxes 668 58,658 50,616
Income taxes 267 23,464 20,145
----------- ----------- -----------
Net earnings $ 401 $ 35,194 $ 30,471
=========== =========== ===========
Earnings/(loss) per common share:
Basic ($.01) $ .75 $ .66
Diluted ($.01) $ .71 $ .61
Average common shares outstanding:
Basic 46,346 45,686 44,616
Diluted 46,346 50,034 49,887
See accompanying notes to consolidated financial statements.
F-4
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended December 31, 1998, 1997 and 1996
(In thousands, except share amounts)
Preferred Stock Common Stock Additional Notes Total
-------------------- ------------------ Paid-in Retained Receivable for Stockholder
Shares Amount Shares Amount Capital Earnings Sale of Stock Equity
---------- -------- ---------- ------ ---------- -------- -------------- ----------
Balances at December 31, 1995 1,500,000 $15,000 44,100,732 $441 $57,788 $ 65,112 $138,341
Exercise of common stock warrants 71,666 1 107 108
Exercise of options 755,173 7 3,071 3,078
Preferred stock dividend (900) (900)
Net earnings 30,471 30,471
---------- -------- ---------- ------ ---------- -------- -------------- ----------
Balances at December 31, 1996 1,500,000 15,000 44,927,571 449 60,966 94,683 171,098
Exercise of options 1,184,249 12 5,128 5,140
Loans to officers for sale of stock (332) (332)
Preferred stock dividend (900) (900)
Net earnings 35,194 35,194
---------- -------- ---------- ------ ---------- -------- -------------- ----------
Balances at December 31, 1997 1,500,000 15,000 46,111,820 461 66,094 128,977 (332) 210,200
Exercise of options 1,330,000 13 4,286 4,299
Loans to officers for sale of stock (3,719) (3,719)
Preferred stock dividend (900) (900)
Net earnings 401 401
---------- -------- ---------- ------ ---------- -------- -------------- ----------
Balances at December 31, 1998 1,500,000 $15,000 47,441,820 $474 $70,380 $128,478 ($ 4,051) $210,281
========== ======== ========== ====== ========== ======== ============== ==========
See accompanying notes to consolidated financial statements.
F-5
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1998, 1997 and 1996
(In thousands)
1998 1997 1996
-------------- ------------- -------------
Cash flows from operating activities:
Net earnings $ 401 $ 35,194 $ 30,471
Adjustments to reconcile net earnings to net
cash provided by (used in) operating activities:
Depreciation and amortization 15,923 11,274 8,760
Deferred income taxes (3,711) 1,527 1,719
Restructuring charges 16,437
Nonrecurring gains (5,624) (8,738)
Changes in assets and liabilities:
Receivables (13,050) 207,397 (111,936)
Inventories 68,745 35,506 (36,933)
Other current assets 856 628 (1,357)
Accounts payable 23,950 (144,949) 28,244
Accrued liabilities and other (10,168) 12,970 8,715
-------------- ------------- -------------
Net cash provided by (used in) operating activities 99,383 153,923 (81,055)
-------------- ------------- -------------
Cash flows from investing activities:
Capital expenditures, net (14,330) (22,418) (42,135)
Business acquisitions, net of cash acquired (49,679) (6,479)
Proceeds from sale of building 1,960
Proceeds from sale of securities 2,724 11,368
-------------- ------------- -------------
Net cash (used in) investing activities (64,009) (17,734) (37,246)
-------------- ------------- -------------
Cash flows from financing activities:
Net bank credit facility and other borrowings (32,884) (139,961) 116,086
Issuance of common stock 1,480 4,808 3,186
Repayment of convertible debt (3,000)
Preferred stock dividend (900) (900) (900)
-------------- ------------- -------------
Net cash provided by (used in) financing activities (35,304) (136,053) 118,372
-------------- ------------- -------------
Net increase in cash 70 136 71
Cash at beginning of year 4,456 4,320 4,249
-------------- ------------- -------------
Cash at end of year $ 4,526 $ 4,456 $ 4,320
============== ============= =============
Supplemental disclosure of cash flow information
Income taxes paid $ 7,074 $ 16,078 $ 19,397
Interest paid 20,034 14,904 15,268
See accompanying notes to consolidated financial statements.
F-6
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Summary of Significant Accounting Policies
Description of Business
CompuCom Systems, Inc. and subsidiaries (the "Company") is a
leading provider of network integration services and computer products
for both large and medium-sized corporate customers, as well as state
and local governmental agencies. The Company's services include field
engineering, LAN/WAN projects, consulting, configuration, help desk,
asset tracking, and network management.
Principles of Consolidation
The consolidated financial statements include the accounts of
CompuCom Systems, Inc. and its subsidiaries. All significant
intercompany balances and transactions have been eliminated. Minority
interest expense for consolidated subsidiaries is reflected in
operating expense in the Consolidated Statements of Operations.
Minority interest liability is reflected in other long-term
liabilities in the Consolidated Balance Sheets.
Use of Estimates
The preparation of the consolidated financial statements in
accordance with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying
notes. Actual results could differ from those estimates.
Inventories
Inventories are stated at the lower of average cost or market.
The Company continually assesses the appropriateness of the inventory
valuations giving consideration to obsolete, slow-moving and
nonsalable inventory.
Property and Equipment
Property and equipment are stated at cost less accumulated
depreciation and amortization. Provision for depreciation and
amortization is based on the estimated useful lives of the assets
(building and leasehold improvements, 3 to 30 years; furniture and
equipment, 5 years) and is computed using the straight-line method.
Cost in Excess of Fair Value of Tangible Net Assets Purchased
Cost in excess of fair value of tangible net assets purchased
represents goodwill and customer lists and is amortized using the
straight-line method over a 5 to 20 year period. Accumulated
amortization at December 31, 1998 and 1997 was $17,140,000 and
$12,715,000, respectively.
Revenue Recognition
Product revenues are recognized upon shipment, with provisions
made for anticipated returns, which historically have been immaterial.
Service revenues are recognized when the service is rendered or
ratably if performed over a service contract period.
(continued)
F-7
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Vendor Programs
The Company receives volume incentives and rebates from certain
manufacturers related to sales of certain products which are recorded
as a reduction of cost of goods sold when earned. The Company also
receives manufacturer reimbursement for certain training, promotional
and marketing activities that offset the expenses incurred by the
Company.
Financing Expenses
Financing expenses consist of interest incurred on borrowings
under the Company's financing arrangements and discounts on the sale
of receivables.
Income Taxes
The Company uses the asset and liability method of accounting for
income taxes. Under this method, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases.
Earnings Per Common Share
Basic earnings per common share is based on net earnings after
preferred stock dividend requirements, if any, and the weighted-
average number of common shares outstanding during each year. Diluted
earnings per common share assumes conversion of dilutive convertible
securities into common stock at the later of the beginning of the year
or date of issuance and includes the add-back of related interest
expense and/or dividends, as required. Diluted earnings per common
share also assumes the exercise of all options with an exercise price
below the average market price of the Company's stock for the year, at
the later of the beginning of the year or date of issuance, regardless
of whether the options are vested or not.
Financial Instruments
The Company's financial instruments, principally cash, accounts
receivable, accounts payable and accrued liabilities, are carried at
cost which approximates fair value due to the short-term maturity of
these instruments. As amounts outstanding under the Company's credit
agreements bear interest approximating current market rates, their
carrying amounts approximate fair value.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
of
The Company has adopted the provisions of Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed of." This Statement requires that long-lived
assets and certain identifiable intangibles be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to
be recognized is measured by the amount by which the carrying amount
of the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair
value less costs to sell.
(continued)
F-8
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Comprehensive Income
The Financial Accounting Standards Board issued Statement No.
130, "Reporting of Comprehensive Income", in June of 1997. This
Statement established standards for reporting and display of
comprehensive income and its components in a full set of general-
purpose financial statements. The Company adopted the provisions of
Statement 130 during 1998. For all periods presented, the Company's
comprehensive income is equal to the net earnings shown on the
Consolidated Statements of Operations.
Recent Accounting Pronouncements
The American Institute of Certified Public Accountants has issued
Statements of Position ("SOP") No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" and No. 98-
5, "Reporting on the Costs of Start-Up Activities." The new
accounting rules, which have been adopted, did not have a material
impact on the Company's results of operations.
Stock-Based Compensation
The Company accounts for stock options and stock-based awards
using the intrinsic-value method as outlined under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25") and related interpretations. In accordance with
Statement No. 123, "Accounting for Stock-Based Compensation," the
Company has disclosed pro forma net earnings and net earnings per
share as if the fair value method had been applied.
Reclassifications
Certain amounts in the 1997 consolidated financial statements
have been reclassified to conform to the 1998 presentation.
(2) Inventories
Inventory is comprised of product inventory and service parts. At
December 31, 1998 and 1997, total inventory was $138.6 million and $198.0
million, respectively, net of inventory reserves of $7.8 million and $9.9
million as of the same dates. Gross product inventory was $136.1 million
and $195.5 million at December 31, 1998 and 1997, respectively, and gross
service parts inventory as of the same dates was $10.3 million and $12.4
million.
(3) Nonrecurring gain on sale of building
During the fourth quarter of 1997, the Company sold its former
headquarters building, recognizing a nonrecurring after-tax gain of
approximately $2.4 million. As part of the sale, the Company accepted cash
of $2.0 million and a note receivable in the amount of $7.8 million.
Interest accrues on the note at an annual rate of 6.8%. The note is secured
by the Company's former headquarters building and was due and payable in
full on October 31, 1998, with accrued interest. In November of 1998, the
original note was modified such that accrued interest was paid through
November 30, 1998, and the maturity of the note was extended to March 30,
1999, to be payable in full with accrued interest from December 1998
through March 1999. The note receivable is included in receivables on the
Consolidated Balance Sheets.
(4) Restructuring Charge
On October 22, 1998 the Company's Board of Directors approved a
restructuring plan designed to reduce the Company's cost structure by
closing certain facilities and reducing the Company's workforce. As a
result, the Company recorded a restructuring charge in the fourth
quarter of 1998 in the amount of $16.4 million, primarily consisting of
costs associated with the closing of facilities and disposing of related
fixed assets as well as employee severance and benefits related to the
reduction in workforce. The entire $16.4 million charge is reflected as a
separate line of operating expense in the Company's Consolidated Statement
of Operations. Of the total amount expensed in the fourth quarter of 1998,
approximately $2.4 million was paid through December 31, 1998. The
following table provides a detail of the charges by category as well as the
amounts accrued as of December 31, 1998.
(continued)
F-9
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Amounts in thousands)
Expense in Accrual at
1998 12/31/98
----------- ----------
Lease termination costs $ 7,259 $ 6,415
Employee severance and related benefits 3,804 2,986
Disposal of assets, net of estimated proceeds 3,044 2,907
Other 2,330 1,780
----------- ----------
Total $ 16,437 $ 14,088
=========== ==========
The $14.1 million accrued at December 31, 1998 is reflected in accrued
liabilities on the Company's Consolidated Balance Sheet.
Severance is paid based on associates' years of service as well as
their level within the organization. The reduction in workforce included
457 associates, of which 2 were executive officers. The reduction in
workforce included associates from the following areas: sales, service, and
general and administrative.
The amount accrued at December 31, 1998 for lease termination costs is
the estimated cost for 65 facilities throughout the country to either
fulfill the Company's obligation under a signed lease contract, the net
expense expected to be incurred to sublet certain facilities, or the
estimated amount to be paid to terminate the lease contract before the end
of its term. The Company has consulted with a professional real estate firm
with knowledge of market rent rates in all applicable markets where the
Company has space. Assumptions have been used for market rent rates and the
estimated amount of time to sublet certain facilities. Payments, net of
proceeds derived from subleases, are being charged against the accrual as
incurred.
The amount accrued at December 31, 1998 for disposal of fixed assets
includes an estimate of proceeds to be received from the sale of those
assets. The assets primarily consist of furniture, fixtures, and computer
equipment. The Company is in the process of transferring the majority of
those assets to its headquarters in Dallas for ultimate disposition.
Other restructuring charges primarily include amounts such as the
write-off of leasehold improvements, estimated legal expense, estimated
costs to ship fixed assets to the Company's headquarters in Dallas, and
estimated commissions to be paid to the real estate firm for subleasing
activity.
As the majority of the Company's restructuring charges in 1998 are
estimates and have not yet been paid, the actual amounts paid could differ
from those estimates. Any differences between the estimated amounts and
actual amounts paid will be reflected in operating expenses in future
periods.
(5) Segment Information
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which the Company has adopted in the current year. Statement
No. 131 requires the reporting of information about operating segments
determined by using the "management approach," as opposed to the "industry
approach" as was previously required.
(continued)
F-10
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The Company defines its operations as three distinct businesses sales
of computer products ("product"); services, which includes configuration,
network integration, and technology support and ClientLink. ClientLink, a
majority owned subsidiary of the Company, designs, develops, and implements
customized information technology solutions for organizations with mission-
critical business processing needs.
The Company measures segment earnings as operating earnings, defined
as income before restructuring charges, interest expense, and income taxes.
All significant intersegment activity has been eliminated. Business assets
are the owned or allocated assets used by each business. The majority of
revenue in the "Other" column is royalties the Company receives from
previously sold businesses and other miscellaneous revenue. The "Other"
column also includes all assets not specifically allocated to a segment.
For the Year Ended December 31, 1998
Operating Results Product Service ClientLink, Inc. Other Total
- ----------------- ------- ------- --------------- ----- -----
(in thousands)
Net revenues $1,980,478 $257,930 $15,182 $ 875 $2,254,465
Gross margin 193,727 82,479 6,906 848 283,960
Operating earnings 17,852 14,097 3,049 848 35,846
Total assets $ 339,778 $ 45,209 $ 3,007 $157,495 $ 545,489
For the Year Ended December 31, 1997
Operating Results Product Service ClientLink, Inc. Other Total
- ----------------- ------- ------- --------------- ----- -----
(in thousands)
Net revenues $1,699,268 $236,221 $13,492 $ 821 $1,949,802
Gross margin 176,234 84,327 6,361 623 267,545
Operating earnings 39,121 25,669 2,568 623 67,981
Total assets $ 323,970 $ 38,215 $ 6,449 $93,956 $ 462,590
For the Year Ended December 31, 1996
Operating Results Product Service ClientLink, Inc. Other Total
- ----------------- ------- ------- --------------- ----- -----
(in thousands)
Net revenues $1,816,504 $169,600 $8,528 $ 559 $1,995,191
Gross margin 180,851 56,554 2,999 559 240,963
Operating earnings 56,483 (1,797) 1,397 559 56,642
Total assets $ 542,970 $ 69,928 $2,758 $77,329 $ 692,985
(continued)
F-11
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(6) Financing Arrangements
The Company has financing arrangements which total $365 million,
consisting of a $175 million receivable securitization ("Securitization"),
a $165 million working capital facility ("Revolver"), and a $25 million
real estate loan ("Term Loan").
Under the Securitization, the Company has an agreement with a
financial institution that allows the Company to sell, at a discount, an
interest in a portion of its trade accounts receivable ("receivables") to a
commercial paper conduit sponsored by that financial institution. As
collections reduce receivables balances sold to the conduit, the Company
may sell interests in new receivables to bring the amount available up to
the maximum allowed. In accordance with SFAS No. 125 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," the Company has recorded this transaction as a sale of
accounts receivable. This sale is reflected as a reduction of accounts
receivable on the Consolidated Balance Sheets and is included in the net
cash provided by operating activities in the Consolidated Statement of Cash
Flows for 1997 when the original sale took place. The proceeds from the
sale of receivables were used to pay down long-term debt. The Company is
retained as servicer of the receivables; however, the cost of servicing is
not material. Discounts associated with the sale of receivables are based
on a designated commercial paper rate plus an agreed upon spread and
totaled $10.8 million and $4.7 million for 1998 and 1997, respectively.
Amounts outstanding as sold receivables were $173.6 million and $173.0
million at December 31, 1998 and December 31, 1997, respectively. The
designated commercial paper rate at December 31, 1998 was 4.95%. The
Securitization Facility expires April 15, 1999. The Company is currently
negotiating a replacement securitization facility and expects to execute
this agreement prior to April 15, 1999. For the month of February 1999, the
Company was out of compliance with one covenant ratio of its existing
Securitization Facility. The Company does not expect this violation to
negatively impact negotiations relative to the replacement securitization
facility or to negatively impact its liquidity.
The Revolver bears interest at a rate of LIBOR plus a spread which is
subject to adjustment based on certain performance criteria, and is secured
by certain assets of the Company, as defined. As of December 31, 1998, the
interest rate on the Revolver was LIBOR plus 137.5 basis points. The
Revolver is fully available subject to compliance with certain covenants
related to, among others, debt to capital, tangible net worth, asset and
fixed charge coverage ratios. On December 31, 1998, the Company was not in
compliance with certain financial covenants under the working capital
facility. However, the Company has received an amendment related to such
covenants from its lenders for periods up to and including April 15, 1999.
The Company is currently negotiating and expects to enter into a
replacement working capital facility prior to April 15, 1999. Terms of the
Revolver limit the amounts available for capital expenditures and
dividends. The amount outstanding under the Revolver at December 31, 1998
was $56.1 million. As of December 31, 1998, the effective interest rate on
the Revolver was 7.5%. The Revolver matures on November 2, 2002.
The Term Loan was used to finance the purchase of the Company's new
headquarters and operations campus. The amount outstanding under the Term
Loan at December 31, 1998 was $25.0 million. The Term Loan bears interest
at the same rate as the Revolver, and matures on November 2, 2002.
Principal maturities of the Term Loan at December 31, are as follows: 1999
- $1,500,000; 2000 - $4,000,000; 2001 - $8,000,000; 2002 - $11,500,000.
The Company's weighted-average interest rate on borrowings was
approximately 6.6%, 6.7% and 7.1%, in 1998, 1997 and 1996, respectively.
The Company capitalized interest costs of $1.0 million and $0.5
million in 1997 and 1996, respectively, as part of the refurbishment of its
corporate headquarters and operations campus. Construction was
substantially completed in 1997.
(continued)
F-12
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(7) Accrued Liabilities
-------------------
Accrued liabilities consist of the following as of December 31:
(Amounts in thousands)
1998 1997
-------- --------
Accrued payroll and payroll taxes $21,754 $22,848
Accrued cost of software and licenses 18,903 16,805
Accrued restructuring charges 14,088
Accrued sales tax payable 7,812 8,448
Other 26,661 23,690
-------- --------
Total $89,218 $71,791
======== ========
(8) Income Taxes
------------
The provision for income taxes is comprised of the following (in
thousands):
1998 1997 1996
------- ------- -------
Current:
Federal $ 3,271 $19,422 $16,826
State 707 2,211 1,600
Deferred, primarily federal (3,711) 1,831 1,719
------- ------- -------
$ 267 $23,464 $20,145
======= ======= =======
Total income tax expense differed from the amounts computed by applying the
U.S. Federal income tax rate of 34% in 1998 and 35% in 1997 and 1996 to
earnings before income taxes as a result of the following (in thousands):
1998 1997 1996
--------- -------- ---------
Computed "expected" tax expense 227 20,530 17,716
State taxes, net of U.S. Federal
income tax benefit (848) 1,989 1,547
Other, net 888 945 882
--------- -------- ---------
Actual income tax provision 267 23,464 20,145
========= ======== =========
Effective tax rate 40.0% 40.0% 39.8%
========= ======== =========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31 are presented below (in thousands).
(continued)
F-13
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1998 1997
-------- --------
Deferred tax assets:
Net operating loss and credit carryforwards $ 7,564
Inventories, principally due to reserves and additional
costs inventoried for tax purposes 640 746
Accounts receivable, principally due to allowance for
doubtful accounts 1,228 935
Restructuring accrual 4,931
Other accrued expenses 4,123 2,227
------- --------
Deferred tax assets 18,486 3,908
------- --------
Deferred tax liabilities:
Intangible assets 1,767 166
Accelerated depreciation 3,575 3,949
Section 481a adjustment 1,966
Other 5,838 6,991
------- --------
Deferred tax liabilities 13,146 11,106
------- --------
Net deferred tax asset/(liabilit) $ 5,340 ($ 7,198)
======= ========
The Company has available net operating loss carryforwards, resulting
from acquisitions, totaling approximately $21 million, which expire in the
years 2007 to 2012. The Company also has available alternative minimum tax
credit carryforwards of approximately $300,000, which may be carried
forward indefinitely. The utilization of these pre-acquisition tax loss
carryforwards and tax credits is limited to approximately $2.0 million each
year under Internal Revenue Code section 382.
(9) Preferred Stock
---------------
The Company has authorized three million shares of Series B Cumulative
Convertible Preferred Stock ("Series B Shares"), stated value $10. In
1994, Safeguard Scientifics, Inc. ("Safeguard"), purchased from the Company
$20 million (2,000,000 shares) of its Series B Shares. The Series B Shares
are convertible into shares of Common Stock based on a conversion price of
$6.77 per share subject to anti-dilutive adjustments. The Series B Shares
are entitled to a 6% per annum cumulative dividend payable out of legally
available funds. The Series B Shares are entitled to one vote for each
share of Common Stock into which such Series B Shares may be converted,
except that in the election of directors (as long as Safeguard owns at
least 40% of the Company's then outstanding voting securities, excluding
the Series B Shares), the Series B Shares will be entitled to five votes
for each share of Common Stock into which the Series B Shares may be
converted. Safeguard has up to a 60% voting interest as a result of its
ownership of the Series B Shares.
(10) Stock-Based Compensation
------------------------
The Company maintains four stock option plans covering certain key
employees and outside directors. The 1983 Stock Option Plan ("1983 Plan")
and the 1984 Non-Qualified Stock Option Plan ("1984 Plan") expired by their
terms in May 1993 and January 1994, respectively, and therefore no new
grants can be awarded out of those plans. All eligible option grants have
been made from the Stock Option Plan for Directors ("Directors Plan"),
although not all options have been exercised. Under the Directors Plan,
nonemployee directors were initially granted 10,000 options upon election
to the Board, with subsequent service grants awarded in accordance with
formulas based upon years of service. Options under the Directors Plan vest
25% each year and expire after 10 years. The Company adopted a 1993 Stock
Option Plan ("1993 Plan") under which the Company may grant qualified or
nonqualified stock options to eligible employees and outside directors.
The 1993 Plan was amended in 1995 and 1997 to increase the number of shares
available. To the extent allowable, all grants are incentive stock
options. All options granted under the plans to date have an exercise
price equal to the market price of the Company's stock on the date of
grant. Generally, options vest 20-25% each year and expire after 10 years
under the 1983 Plan, the 1984 Plan, and the 1993 Plan. After May 1996, all
options granted to nonemployee directors have been issued from the 1993
Plan.
(continued)
F-14
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
On October 22, 1998, the Company's Board of Directors approved a
measure enabling all employees who had been previously granted stock
options, with the exception of executive officers, the opportunity to
reprice the exercise price of their respective options to the Company's
stock price as of that date, which was $3.1875 per share. In exchange for
the repricing of options, those employees agreed to forfeit the ability to
exercise the options for one year, or until October 22, 1999. All vesting
was kept intact. As a result, a total of 1.51 million options with a
weighted average exercise price of $6.76 per share were repriced to $3.1875
per share. The Company accounted for this repricing as a cancellation of
old options and an issuance of new options.
On October 22, 1998, the Company's Board of Directors approved a stock
option grant agreement for 500,000 shares to a director and officer of the
Company. The option price is equal to the fair market value of the
Company's stock on the date of grant. Exercisability of the options was
immediate, although vesting occurs at 25% per year. All 500,000 options
were exercised on December 23, 1998. These options were issued outside of
the 1993 Plan.
At December 31, 1998, the Company has reserved approximately 4.4
million shares of its common stock for issuance under its stock option
plans.
In 1998, the Company created the CompuCom Systems, Inc. Employee Stock
Purchase Plan ("ESPP"). The ESPP provides eligible Company employees the
opportunity to purchase common stock of the Company through accumulated
payroll deductions. Participation in the ESPP is for periods of six
months, beginning on January 1 and July 1 of each year. The first such
period was July 1 (i.e., "the enrollment date") through December 31, 1998
(i.e., "the exercise date"). The exercise price, as defined, for each six
month period, is equal to the lower of 85% of the fair market value, as
defined, of the Company's stock price on the enrollment date or 85% of the
fair market value of the Company's stock price on the exercise date. Once
the shares have been purchased, each employee has the option of keeping
their shares or selling them at any time. For the six-month period July 1
through December 31, 1998, approximately 338 employees participated in the
ESPP resulting in the issuance of approximately 193,000 shares of the
Company's common stock at $2.975. A total of 1.0 million shares were
authorized for issuance under the ESPP.
The Company applies APB 25 and related interpretations in
accounting for its various fixed stock option plans and its stock purchase
plan. Had compensation cost been recognized consistent with SFAS No. 123,
the Company's net earnings and earnings per share would have been reduced
to the pro forma amounts indicated below:
(In thousands, except per share amounts) 1998 1997 1996
--------- --------- --------
Net earnings/(loss) As reported $ 401 $35,194 $30,471
Pro forma $ (2,161) $34,639 $29,409
Basic earnings/(loss) per share As reported $ (.01) $ .75 $ .66
Pro forma $ (.07) $ .74 $ .65
Diluted earnings/(loss) per share As reported $ (.01) $ .71 $ .61
Pro forma $ (.07) $ .69 $ .60
The per share weighted-average value of stock options issued by
the Company during 1998, 1997 and 1996 was $2.14, $4.20, and $4.91,
respectively, on the dates of grant using the Black Scholes option-pricing
model. The Company used the following weighted-average assumptions to
determine the fair value of stock options granted:
1998 1997 1996
----------- ------------ ------------
Dividend yield 0% 0% 0%
Expected volatility 59% 63% 64%
Average expected option life 5 years 5 years 5 years
Risk-free interest rate 4.4% to 5.8% 5.9% to 6.8% 5.8% to 6.5%
The fair value of the employees' purchase rights, which was estimated
using the Black Scholes model with the following assumptions for 1998: dividend
yield of 0%, an expected life of 6 months, expected volatility of 59%, and a
risk-free interest rate of 5.3%, granted in 1998 was $4.32.
Pro forma net earnings reflect only options granted subsequent to
January 1, 1995. Therefore, the full impact of calculating compensation
cost for stock options under SFAS No. 123 is not reflected in the pro forma
net earnings amounts presented above because compensation cost is reflected
over the options' vesting period and compensation cost for options granted
prior to January 1, 1995 is not considered.
(continued)
F-15
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Option activity under the Company's plans is summarized below:
1998 1997 1996
---------------------------- ---------------------------- ------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------------------------- ---------------------------- -------------------------
(In thousands) (In thousands) (In thousands)
Outstanding at beginning of year 4,009 $5.51 4,021 $3.96 4,278 $2.81
Granted 3,458 3.91 1,642 7.07 845 8.28
Exercised (1,330) 3.17 (1,225) 2.39 (761) 1.90
Canceled (2,143) 6.89 (429) 5.82 (341) 5.82
------------ ----------- ------------
Outstanding at end of year 3,994 $4.16 4,009 $5.51 4,021 $3.96
============ =========== ============
Options exercisable at year-end 1,225 $3.97 1,343 $3.40 1,970 $2.40
Shares available for future grant 436 1,190 1,483
The Company plans to ask its shareholders to approve an increase in
the number of authorized shares under the 1993 Plan by 3 million shares at its
May 13, 1999 annual shareholders' meeting.
The following summarizes information about the Company's stock options
outstanding at December 31, 1998:
Options Outstanding Options Exercisable
------------------------------------------------------------- ------------------------------------
Weighted- Weighted- Weighted-
Range of Average Average Average
Exercise Number Remaining Exercise Number Exercise
Prices Outstanding Contractual Life Price Exercisable Price
- --------------------------- ----------------- ------------------- --------------- ---------------- ---------------
(In thousands) (years) (In thousands)
$ 1.00 - $ 1.25 308 1.0 $ 1.24 308 $ 1.24
2.25 - 3.19 2,411 8.5 3.17 472 3.08
3.50 - 4.75 242 5.9 3.72 101 3.86
5.50 - 8.13 982 7.9 7.30 319 7.43
8.63 - 12.50 51 8.0 10.36 25 10.36
-------------- -------------
$ 1.00 - $ 12.50 3,994 7.6 $ 4.16 1,225 $ 3.97
============== =============
(11) Business Combinations
---------------------
During 1998, the Company consummated three business combinations. The
total consideration given for these business combinations was approximately
$49 million in cash. In addition, the Company assumed liabilities of
approximately $95 million, in aggregate. The business combinations were
accounted for as purchases and accordingly the consolidated financial
statements reflect the operations of the acquired entities since the
respective acquisition dates. The Company has not completed the final
allocation of the purchase price for these acquisitions. Therefore, the
amount of goodwill recorded could be adjusted once the allocation is
finalized.
(continued)
F-16
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following unaudited pro forma financial information presents the
combined results of operations as if the acquisitions had occurred as of
the beginning of 1998 and 1997, after giving effect to certain adjustments,
including amortization of goodwill, increased interest expense on debt
related to the acquisitions, and related income tax effects (amounts in
thousands, except per share data). The pro forma results do not
necessarily represent results which would have occurred if the acquisition
had taken place on the basis assumed above, nor are they indicative of the
results of future combined operations.
1998 1997
------------ ------------
Revenue $ 2,444,935 $ 2,520,886
============ ============
Net earnings (loss) $ (4,280) $ 21,989
============ ============
Diluted earnings (loss) per share $ (0.11) $ .44
=========== ============
(12) Related Party Transactions
--------------------------
The Company founded PC Service Source, Inc. ("PCSS") in 1990, then
known as PC Parts Express, Inc. In January 1994, the Company sold the
majority of its interest in PCSS in exchange for cash, a secured note
receivable ("secured note"), and warrants to purchase additional PCSS
common stock. In April 1994, the Company participated in an initial public
offering of PCSS common stock. During the second quarter of 1996, the
Company participated in a secondary stock offering of PCSS resulting in a
nonrecurring after-tax gain on the sale of securities of $5.2 million.
Concurrent with the secondary offering, the Company exercised warrants for
250,000 shares of PCSS common stock at an exercise price of $2.25, selling
those shares in conjunction with the secondary offering. During the third
quarter of 1997, the Company received early payment of the secured note,
thus recognizing a previously deferred nonrecurring after-tax gain of $1.0
million.
In 1994, the Company loaned an officer and director of the Company
$1,181,250 evidenced by a term note receivable. The proceeds of the loan
were used to purchase shares of the Company's common stock. Interest on the
note accrues at the rate of 6% per annum and is payable at maturity. Terms
of the note were amended in February 1999 such that principal on the note
is due on October 22, 2001. The outstanding balance of the note at December
31, 1998 was $900,000, which is included in notes receivable from the sale
of stock on the Consolidated Balance Sheets.
In 1997, the Company loaned an officer and director of the Company
$661,251 evidenced by a term note receivable. Interest on the note accrues
at the rate of 6.25% per annum and is payable annually on June 17. A
portion of the loan proceeds was used to exercise stock options. This
portion of the loan is included in notes receivable from the sale of stock,
while the remainder of the loan is included in Other Assets on the
Consolidated Balance Sheets at December 31, 1998. Principal on the note is
due on June 17, 2000. This officer is no longer employed by the Company.
In 1998, the Company loaned an officer and director of the Company
$796,875 evidenced by a term note receivable. Interest on the note accrues
at the rate of 4.33% per annum and is payable upon maturity of the note.
The loan proceeds were used to exercise stock options and is included in
notes receivable from the sale of stock on the Consolidated Balance Sheets
at December 31, 1998. Principal on the note is due on December 31, 2001.
In 1998, the Company loaned an officer and director of the Company
$2,021,875 evidenced by a term note receivable. Interest on the note
accrues at the rate of 5.1% per annum and is payable at maturity. The loan
proceeds were used to exercise stock options and is included in notes
receivable from the sale of stock on the Consolidated Balance Sheets at
December 31, 1998. Principal on the note is due on October 22, 2001.
Each of the loans for the exercise of stock options are full recourse
loans. In addition, the Company has retained physical possession of the
resulting stock certificates.
(continued)
F-17
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Safeguard owns approximately 50% of the Company's outstanding common
stock as of December 31, 1998. The Company pays Safeguard a fee for
providing certain administrative, legal and financial services to the
Company. General and administrative expenses include fees paid to
Safeguard of $600,000 in 1998, 1997 and 1996.
(13) Earnings Per Share
------------------
In 1997, the Company adopted the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings Per Share." This
statement supersedes APB Opinion No. 15, "Earnings Per Share" and replaces
the presentation of primary earnings per share ("EPS") and fully diluted
EPS with a presentation of basic EPS and diluted EPS. SFAS No. 128 also
requires a reconciliation of the numerators and denominators of the basic
and diluted per share computations as follows (in thousands, except per
share amounts):
Year ended December 31, 1998
--------------------------------------
Income Shares
(Numerator) (Denominator) EPS
----------- --------------- -----
Net earnings $ 401
Less: Preferred stock dividends (900)
Basic EPS
---------
Income available to common shareholders (499) 46,346 ($ .01)
--------- ---------
Diluted EPS
-----------
Income available + assumed conversions (499) 46,346 ($ .01)
========= ========= =========
Year ended December 31, 1997
--------------------------------------
Income Shares
(Numerator) (Denominator) EPS
----------- --------------- -----
Net earnings $35,194
Less: Preferred stock dividends (900)
Basic EPS
---------
Income available to common shareholders 34,294 45,686 $.75
Effect of dilutive securities
-----------------------------
Stock options 1,745
Convertible preferred stock 900 2,216
Convertible debt 92 387
--------- ---------
Diluted EPS
-----------
Income available + assumed conversions 35,286 50,034 $.71
========= ========= ========
(continued)
F-18
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Year ended December 31, 1997
--------------------------------------
Income Shares
(Numerator) (Denominator) EPS
----------- --------------- -----
Net earnings $30,471
Less: Preferred stock dividends (900)
Basic EPS
---------
Income available to common shareholders 29,571 44,616 $.66
Effect of dilutive securities
-----------------------------
Stock options 2,668
Convertible preferred stock 900 2,216
Convertible debt 92 387
-------- -------
Diluted EPS
-----------
Income available + assumed conversions 30,563 49,887 $.61
========= ========= ========
The Company has excluded 4,239,001 shares from its calculations of diluted
earnings per share in 1998 as they are considered anti-dilutive. This
represents all of the Company's weighted average options outstanding for
the year, since the numerator used in calculating earnings per share is a
negative amount. The Company has excluded 150,325 and 35,281 shares from
its calculations of diluted earnings per share in 1997 and 1996,
respectively, as they are considered anti-dilutive.
(14) Leases
------
The Company has noncancelable operating leases for facilities and
equipment, which expire at various dates from 1999 to 2004. Total rental
expense for operating leases was $11.2 million, $8.9 million and $10.4
million in 1998, 1997 and 1996, respectively. Future minimum lease
payments under noncancelable operating leases as of December 31, 1998 are:
$8.8 million - 1999; $6.7 million - 2000; $4.0 million - 2001; $2.0 million
- 2002; $1.6 million - 2003; and $.6 million thereafter. These future
minimum lease payments include obligations under leases that are being
abandoned as part of the restructuring (the "Restructuring Leases"). The
future minimum lease payments of the Restructuring Leases are $4.7 million
1999; $3.5 million 2000; $2.0 million 2001; $1.3 million 2002; and $1.0
million 2003.
(15) Savings Plan
------------
The Company has a defined contribution plan (401(k) Matched Savings
Plan)("the Plan") covering substantially all employees who have completed
at least six months of qualifying service. Participants may contribute to
the Plan an amount between 1% and 10% of their eligible compensation. The
Company matches 50% of each participant's qualifying contribution up to 4%
of compensation, and an additional 25% of the next 2% of the participant's
qualifying contributions. The Company modified the Plan in 1998 to allow
for the Company's matching payments to be made to each participating
employees account at the end of each calendar quarter, as opposed to the
end of the year as before. Amounts expensed relating to the Plan were $2.4
million, $1.6 million and $1.5 million in 1998, 1997 and 1996,
respectively.
(continued)
F-19
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(16) Quarterly Financial Data (Unaudited)
------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------------ ------------ ------------ ------------
(in thousands, except per share amounts)
1998
---------
Revenue:
Product $376,778 $530,495 $531,640 $ 541,665
Service 57,128 63,127 67,488 70,187
Other 3,846 3,935 4,202 3,974
------------ ------------ ------------ ------------
Net revenue 437,752 597,557 603,330 615,826
Gross margin:
Product $ 43,880 $ 50,528 $ 49,586 $ 49,733
Service 18,370 19,755 21,772 22,582
Other 1,915 1,871 2,126 1,842
------------ ------------ ------------ ------------
Total gross margin 64,165 72,154 73,484 74,157
Net earnings/(loss) $ 3,843 $ 4,286 $ 1,063 ($ 8,791) *
Earnings/(loss) per common share:
Basic .08 .09 .02 (.19) *
Diluted .08 .09 .02 (.19) *
* Includes Restructuring charges related to reorganization of $9.9
million or ($.21) per share (Basic and Diluted)
(continued)
F-20
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------------ ------------ ------------ ------------
(in thousands, except per share amounts)
1997
---------
Revenue:
Product $375,605 $428,353 $437,089 $458,221
Service 53,728 59,715 60,513 62,265
Other 2,556 3,152 3,902 4,703
------------ ------------ ------------ ------------
Net revenue 431,889 491,220 501,504 525,189
Gross
margin:
Product $ 38,932 $ 41,099 $ 44,023 $ 52,180
Service 19,362 22,144 21,972 20,849
Other 1,184 1,719 2,129 1,952
Total gross margin 59,478 64,962 68,124 74,981
------------ ------------ ------------ ------------
Net earnings $ 4,872 $ 7,980 $ 9,462 * $ 12,880 **
Earnings per common share:
Basic .10 .17 .20 * .28 **
Diluted .10 .16 .19 * .26 **
* Includes nonrecurring gain on prepayment of secured note
related to sale of subsidiary in 1994 of $1.0 million or
$.02 per share (Basic and Diluted)
** Includes nonrecurring gain on sale of Company's former
headquarters of $2.4 million (Basic - $.06 per share,
Diluted -$.05 per share )
Earnings per common share calculations are based on the weighted-average
number of shares outstanding in each period. Therefore, the sum of the
quarters may not necessarily equal the year-to-date earnings per common
share.
(17) Contingencies
-------------
The Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse
effect on the Company's consolidated financial position or results of
operations, taken as a whole.
F-21
COMPUCOM SYSTEMS, INC. AND SUBSIDIARIES
Schedule II
Valuation and Qualifying Accounts
Years ended December 31, 1998, 1997 and 1996
(In thousands)
Balance at Charged to Balance at
Beginning of Costs and End of
Description Period Expenses Deductions Period
- ------------------------------- -------------- -------------- -------------- --------------
Trade receivables-
Allowance for doubtfulaccounts
1996 $2,234 900 860 $2,274
1997 $2,274 2,114 1,716 $2,672
1998 $2,672 1,856 1,021 $3,507
Inventory reserves
1996 $9,524 15,529 16,119 $8,934
1997 $8,934 14,844 13,854 $9,924
1998 $9,924 14,204 16,326 $7,802
F-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.
CompuCom Systems, Inc.
By: /s/ M. Lazane Smith
-----------------------
M. Lazane Smith
Senior Vice President, Finance and Chief Financial
Officer (Chief Accounting Officer)
Dated: March 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
is signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
Dated: March 29, 1999
/s/ Warren V. Musser /s/ Delbert W. Johnson
- ------------------------ -------------------------
Warren V. Musser Delbert W. Johnson
Chairman of the Board and Director Director
/s/ Edward R. Anderson /s/ John D. Loewenberg
- ------------------------ ------------------------
Edward R. Anderson John D. Loewenberg
President and Chief Executive Director
Officer and Director
/s/ Harry Wallaesa /s/ Thomas C. Lynch
- ---------------------- ---------------------
Harry Wallaesa Thomas C. Lynch
Director Chief Operating Officer
and Director
/s/ Michael J. Emmi /s/ John C. Maxwell III
- ------------------------- --------------------------
Michael J. Emmi John C. Maxwell, III
Director Director
/s/ Richard F. Ford /s/ Edward N. Patrone
- ---------------------- -------------------------
Richard F. Ford Edward N. Patrone
Director Director
/s/ Anthony J. Paoni
- ---------------------
Anthony J. Paoni
Director