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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Fiscal Year ended September 30, 1997
OR
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
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COMMISSION FILE NUMBER 000-28052
EN POINTE TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 75-2467002
(State or other jurisdiction (I.R.S. Employer
of Identification
incorporation or organization) No.)
100 NORTH SEPULVEDA BOULEVARD, 19TH FLOOR, EL SEGUNDO, CALIFORNIA 90245
(Address of principal executive offices)
Registrant's telephone number, including area code: (310) 725-5200
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Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
(Title of Class)
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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 _
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 voting stock held by non-affiliates of the
Registrant, based upon the closing sales price of the Common Stock as of
December 22,1997, was approximately $31,631,271.
The number of outstanding shares of the Registrant's Common Stock as of
December 22, 1997 was 5,855,040.
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DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF REGISTRANT'S PROXY STATEMENT FOR THE 1998 ANNUAL MEETING OF
STOCKHOLDERS (TO BE FILED WITH THE COMMISSION ON OR BEFORE JANUARY 28, 1998):
PART III, ITEMS 10-13.
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THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS RELATING
TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY, INCLUDING
BUT NOT LIMITED TO STATEMENTS CONTAINED IN "FACTORS WHICH MAY AFFECT FUTURE
OPERATING RESULTS," "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" AND "BUSINESS." READERS ARE CAUTIONED THAT
SUCH STATEMENTS, WHICH MAY BE IDENTIFIED BY WORDS INCLUDING "ANTICIPATES,"
"BELIEVES," "INTENDS," "ESTIMATES," "EXPECTS," AND SIMILAR EXPRESSIONS, ARE ONLY
PREDICTIONS OR ESTIMATIONS AND ARE SUBJECT TO KNOWN AND UNKNOWN RISKS AND
UNCERTAINTIES. IN EVALUATING SUCH STATEMENTS, READERS SHOULD CONSIDER THE
VARIOUS FACTORS IDENTIFIED IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING MATTERS
SET FORTH IN "FACTORS WHICH MAY AFFECT FUTURE OPERATING RESULTS," WHICH COULD
CAUSE ACTUAL EVENTS, PERFORMANCE OR RESULTS TO DIFFER MATERIALLY FROM THOSE
INDICATED BY SUCH STATEMENTS.
ITEM 1. BUSINESS
En Pointe Technologies, Inc. ("En Pointe" or the "Company") is a national
provider of information technology products and value-added services to large-
and medium-sized companies and government entities. The Company has developed an
innovative business model which capitalizes on the Company's proprietary
information systems and the extensive warehousing, purchasing and distribution
functions of selected national distributors of information technology products.
The Company's proprietary information systems, which include its EPIC software,
enable the Company to establish on-line communication links with its sales
representatives, selected distributors and certain customers that provide
pricing and availability information on a broad range of information technology
products from multiple sources. By leveraging its proprietary information
systems and distributor relationships, the Company is able to provide its
customers access to an extensive range of products at competitive prices without
the Company assuming the risks and costs associated with maintaining significant
product inventories.
INDUSTRY OVERVIEW
The markets for information technology products and services are expected to
continue to experience significant growth over the next few years. According to
DataQuest, Inc. ("DataQuest"), a leading industry publication, the U.S. market
for personal computers is expected to increase from $60.1 billion in 1996 to
$111.4 billion in 2000, representing a compound annual growth rate of 16.7%. In
addition, DataQuest expects the U.S. information technology services market to
increase from $56.0 billion in 1996 to $96.7 billion in 2000, representing a
compound annual growth rate of 14.7%. The Company believes that the leading
factors driving the growth in the markets for information technology products
and services are the continued transition to distributed computing technologies,
such as client/server, increased networking of personal computers into local
area networks ("LANs") and wide area networks ("WANs"), increased use of the
Internet and growing use of intranets in corporate environments.
Significant price competition and abbreviated product lifecycles have forced
information technology product manufacturers to pursue lower cost manufacturing,
assembly and distribution strategies. Additionally, certain product
manufacturers have elected to outsource the related configuration, installation
and maintenance of their products to third party providers. Wholesale
distributors, which inventory products from multiple vendors and sell to
resellers as well as corporate resellers, which sell directly to corporate end
users and provide related information technology services, have emerged as
direct beneficiaries of these trends by manufacturers.
The utilization of the information technology product distribution channel
and the continued efforts by manufacturers to improve their cost structure have
resulted in several changes in the marketplace. First, the wholesale distributor
market has experienced consolidation as the high fixed costs associated with
maintaining multiple warehouses and adequate inventory and the shift by
manufacturers from exclusive distribution partners to "open sourcing" have
forced a number of companies to align their businesses with financially stronger
partners. Second, the significant working capital required to carry large
in-stock product inventories and reductions in inventory price protection by
manufacturers have caused many resellers to adjust their current business
models. Due to the working capital required to maintain
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significant inventories, many corporate resellers often neither have the volume
nor range of products to fill customer demands. Third, several product
manufacturers have capitalized on their demand-driven operating model and direct
selling efforts to capture market share from other manufacturers and corporate
resellers.
In response to these changing market dynamics, the Company believes the
information technology product industry, and particularly corporate resellers,
will increasingly rely on electronic commerce to procure and deliver products
efficiently. The Company believes the ability to access product information
quickly and order and track products electronically, as well as to transact
business over the Internet, will provide a competitive advantage for corporate
resellers. Additionally, within the corporate reseller market, the Company
believes the ability to integrate electronically with end users and to provide
seamless access for product specifications, pricing, availability and order
tracking will enhance customer relationships and improve customer retention.
The decision-making process that organizations are confronted with when
planning, selecting and implementing information technology solutions is growing
more complex. Organizations must select from numerous product options with
shortening lifecycles. Organizations are continually faced with technology
obsolescence, and must design new networks and upgrade and migrate to new
systems. According to The Gartner Group, an information technology research
firm, the total cost of ownership of a personal computer over five years may be
as much as five times the initial capital expense. As a result, corporate
resellers are attempting to capitalize on their customer relationships initially
developed through product procurement in order to provide related value-added
services, including installation, pre- and post-sale technical support,
configuration and maintenance services, as well as higher-end service offerings,
including network and asset management, consulting and application development.
Furthermore, the Company believes a trend is emerging whereby the final
assembly of certain information technology products will be performed by third
parties including corporate resellers and distributors. In order to compete more
effectively and lower their costs, certain manufacturers have announced their
intention to reduce their own inventories and the inventories of their
distribution partners by implementing a build-to-order manufacturing process,
whereby final assembly will be performed by corporate resellers and distributors
as compared to the current build-to-forecast methodology employed by these
manufacturers.
THE EN POINTE BUSINESS MODEL
En Pointe's growth since its inception is attributable to its business
model, which features (i) a low cost overhead structure resulting from the
automation of many management and operating functions; (ii) sophisticated
proprietary information systems which enable En Pointe to provide enhanced
customer service; and (iii) reduced working capital requirements by leveraging
its limited inventory model and its Allied Distributor relationships.
The Company seeks to maintain a low-cost overhead structure through the
automation of many of its management and operating functions. En Pointe has
developed proprietary information systems to monitor sales, product returns,
profitability and accounts receivable at the sales representative, sales office
and customer levels. Additionally, the Company has integrated product purchasing
and customer invoicing into its information systems to expedite procurement and
billing. The Company believes that this level of automation allows it to operate
more efficiently and to provide its customers with competitive pricing and
quality service.
An integral component of the Company's business model is its ability to
access an extensive selection of information technology products stocked by a
number of distributors through its proprietary information systems, including
its EMS and EPIC software. These information systems make available to the
Company's sales representatives and certain of its customers product pricing and
availability of a broad range of information technology products, downloaded on
a daily basis, from certain large distributors of
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information technology products and services, including Ingram Micro Inc.
("Ingram Micro"), InaCom Corp. ("InaCom"), MicroAge, Inc. ("MicroAge"), Merisel
FAB, Inc. ("Merisel FAB"), Synnex Information Technologies, Inc. ("Synnex") and
Tech Data Corporation ("Tech Data") (the "Allied Distributors"). The information
provided by the Company's information systems allows the Company's sales
representatives to design each customer's order according to the particular
needs of that customer. If obtaining the best price for a particular product is
the customer's primary objective, the Company's information systems allow the
sales representative to identify which of the Allied Distributors can supply the
desired product at the best price. If immediate availability of products is the
customer's primary objective, then the Company's information systems can
indicate the availability of products from various Allied Distributors at
different warehouse locations across the country, and the order can be placed at
the Allied Distributor location which will enable the customer to receive the
desired products in the shortest time possible. Furthermore, the Company's
proprietary information systems allow the Company's customers to place a single
order which may include a number of different products from multiple
manufacturers or distributors. Each product ordered might ship overnight to a
desired configuration center or directly to the customer's location for delivery
to the end user. The Company's information systems can therefore reduce the
amount of unfulfilled customer orders and the need to backorder products.
The third element of the Company's business model is to reduce its working
capital requirements by leveraging its limited inventory model and utilizing the
extensive warehousing, purchasing and distribution functions of its Allied
Distributors. Since inception, the Company has been an innovator in using the
drop-shipping capabilities of the Allied Distributors to avoid many of the costs
and risks associated with maintaining inventory, which also enables the Company
to quickly adapt to changing demands. As product proliferation has occurred, the
Company's limited inventory model has given it a competitive advantage with
respect to price and availability on a broad range of products without the costs
and risks associated with carrying large amounts of inventory. The Company
believes its business model allows the Company to increase sales without a
significant capital investment in inventory.
PROPRIETARY INFORMATION SYSTEMS
The development and functionality of the Company's proprietary information
systems, including its EMS and EPIC software, has been an important factor in
the Company's success. These information systems provide online access to the
collective inventory and pricing information of the Allied Distributors for all
of the Company's sales offices, as well as for certain of the Company's
customers. These information systems are installed at the Company's sales
offices and can be installed, if desired, directly at a customer's facility.
These information systems enable the Company's sales representatives and
customers to access product pricing and availability information by manufacturer
part number or product description and provide detailed product specifications
for most major manufacturers. Customers can then enter orders on-line, check on
the status of their orders (including orders being configured directly by En
Pointe at its Memphis facility), access prior orders and serial numbers by
purchase order numbers, check on back-ordered products and verify FedEx and UPS
tracking and shipping numbers. The Company's systems can also provide the
customer with customized reports showing invoice, purchase order, cost, ship-to
address, serial numbers, dates, and totals of the products that such customer
has purchased from En Pointe.
The Company is currently in the process of rolling out the latest version of
its EPIC software, EPIC 2.0, which it expects to have implemented by the end
June 1998. EPIC 2.0 will offer greater functionality than the current
applications and will allow the Company to strengthen its operational and
marketing capabilities. EPIC 2.0 uses a three-tiered architecture designed
around Microsoft's SQL client/ server technology. This architecture enables
rapid deployment and development of the software and permits easy access to the
inventory and pricing information of the Allied Distributors for the Company's
customers and sales representatives. EPIC 2.0 provides added functionality in
the areas of order tracking, real-time product pricing and availability,
transaction lifecycle management, Internet accessibility,
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enhanced query capabilities and enhanced security. The Company is designing
additional modules for payroll, commission and rebate tracking functionality.
In addition, the Company continues to focus on the development of other
value-added software applications which will improve customer accessibility to
the EPIC software as well as enhance its customer service capabilities. EPIC NET
and ReqBuilder are two recent developments which will add to the Company's
customer service capabilities. EPIC NET is a web-based front end to the EPIC
software that allows a customer to generate product quotes and orders remotely
from the customer's site via the Internet. ReqBuilder is a Company proprietary
application which will assist the Company's customers in standardizing and
streamlining their product procurement process over a web-accessible platform.
See "Factors Which May Affect Future Operating Results--Risks Associated With
Dependence on Proprietary Technology."
PRODUCTS AND VALUE-ADDED SERVICES
PRODUCTS
The majority of the Company's sales to date have been attributable to the
resale of information technology products. The Company currently makes available
to its customers an extensive selection of information technology products at
what it believes to be a competitive combination of price and availability. The
Company currently offers over 36,000 information technology products from over
700 manufacturers, including International Business Machines Corporation
("IBM"), Compaq Computer Corporation ("Compaq"), Hewlett Packard Company
("Hewlett Packard" or "HP"), Dell, Apple, Digital Equipment Corp. ("DEC"), 3Com
Corp. ("3Com"), Microsoft Corp. ("Microsoft"), Toshiba Corp., NEC Corp., Novell,
Inc. ("Novell"), Kingston Technology Corporation, Lexmark International Group,
Inc., Sony Corporation and Bay Networks, Inc. The Company is also certified as a
Microsoft Senior Partner. Products offered by the Company include desktop and
laptop computers, monitors, servers, memory, midrange systems, peripherals and
operating system and application software. Products manufactured by IBM, Compaq
and Hewlett Packard accounted for 34.3%, 18.2% and 16.9%, respectively, of the
Company's net sales in fiscal 1997.
VALUE-ADDED SERVICES
The Company believes it can provide value to its customers not only by
offering an extensive selection of information technology products from a
variety of manufacturers and distributors, but also by offering related
value-added services. The gross profit margin on the value-added services which
the Company currently offers are significantly higher than the gross profit
margin on the Company's information technology products reselling business. The
Company has traditionally provided many of these services via outsourcing
arrangements with third parties; however, in order to further promote the
value-added portion of its business, the Company is in the process of expanding
its internal service capabilities. The Company intends to expand upon its
offering of value-added services by focusing upon three different categories of
service: technical services; consulting services; and customer information
services. The Company intends to provide these services pursuant to both
services contracts as well as on a time and materials basis. The provision of
value-added services currently does not account for a material portion of the
Company's net sales.
The Company's technical services include installation, pre- and post-sale
technical support, network design, maintenance, product configuration, on-site
technical staffing and project roll-out. The Company currently offers its
customers configuration services at its Memphis, Tennessee facility or through
outsourcing arrangements with certain Allied Distributors. The ability to
configure product orders has become increasingly important to En Pointe's
targeted customer base, and in response to the increased demand for these
services, the Company is planning to open a new configuration center in Ontario,
California. This new facility is expected to provide the Company with a greater
configuration capacity, as well as enable the
5
Company to offer board-level repair and maintenance services. The Company's
project roll-out services generally involve the procurement of large volumes of
computer equipment with standard configurations delivered on a specific
timetable over a relatively short period of time. Roll-out projects may include
support capabilities such as project management, product scheduling, software
loading and testing, the coordination of shipments to multiple customer
locations and overall quality control.
The Company's consulting services currently include LAN/WAN integration,
asset management, mid-range systems consulting and special projects. The
Company's LAN/WAN integration services include consultation regarding
communication equipment requirements, configuring proposed solutions, systems
integration, installation and training. The Company's asset management services
consist of compiling and maintaining detailed information about a customer's
installed base of hardware and software assets, as well as all subsequent
service events related to those assets. The Company's mid-range system
consulting services involve the deployment and integration of RISC-based
platforms. To support these services, En Pointe personnel participate in
software solution provider certification and authorization programs. En Pointe
currently has attained the following nationwide certifications and designations:
Microsoft Windows NT Certified, 3Com NETBuilder II and LinkBuilder III GH
Authorized, DEC Alpha and IBM RS 6000/AIS. In addition, the Company is
authorized to provide HP 9000 and Sun Microsystems, Inc. products in selected
locations and to selected market segments.
Finally, the Company believes that its experience in designing and
developing its proprietary software systems provides the expertise necessary to
develop more advanced services, including application development and web site
development. The Company has recently entered into contracts to design and build
web sites for Mercury General Corporation and for the Los Angeles Department of
Airports. The Company has recently entered into a licensing agreement with
Shopping.com, an Internet shopping service, which plans to utilize the Company's
EPIC 2.0 software as the technology behind its Internet shopping venture.
CUSTOMERS
The Company's business model has allowed the Company to capture the business
of a number of large- and medium-sized corporate and government customers. The
Company's policy is to attract major customers by offering them "cost-plus"
pricing, whereby the Company prices information technology products at the
Company's cost plus a certain additional percentage negotiated with the
customer. Once the Company has been approved as a supplier to a customer, the
Company seeks to capture a significant portion of that customer's business,
which is typically spread over a number of resellers. The Company believes that
maintaining high customer satisfaction will enable the Company to more
effectively expand the range of value-added services it provides to include
sales of technical services, consulting services and customer information
services.
The entities listed below are illustrative of the wide range of customers
which have purchased information technology products and/or services from the
Company during fiscal 1997:
Chase Manhattan Bank Mercury General Corporation McGraw Hill
ARCO State of Georgia State of Texas
IBM State of Oregon State of Washington
State of California
Boeing Northrop Grumman Corp. (CMAS)
A substantial portion of the Company's net sales are derived under long-term
contracts, typically of at least one to two years' duration. However, these
contracts are usually non-exclusive agreements which are terminable upon 30
days' notice by either party. Purchases from customers are made pursuant to
individual purchase orders.
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In 1995, the Company was one of three resellers awarded a three-year
non-exclusive national contract with IBM to supply information technology
products to IBM, its wholly-owned subsidiaries, as well as certain operating
divisions and customers of IBM. For the fiscal years ended September 30, 1997,
1996 and 1995, net sales to IBM and certain IBM customers under the Company's
contract with IBM accounted for approximately 29.6%, 28.3% and 12.1%,
respectively, of the Company's net sales. IBM has extended the contract through
June 1998, at which time IBM will enter into new contracts (which the Company
believes will also include international sales) with one or more entities
bidding for this contract. The Company expects to bid for this contract.
However, no assurance can be made that the Company will be one of the entities
awarded this new contract. See "Factors Which May Affect Future Operating
Results--Risks Associated With Dependence on Relationships With IBM And Other
Large Customers."
SALES AND MARKETING
The Company currently employs approximately 232 sales representatives in 16
sales offices located throughout the U.S. (including its headquarters located in
El Segundo, California). The Company's sales efforts for most customers are
based in the regional sales offices, while certain of the Company's larger
customer relationships are maintained at the Company's headquarters. All of the
Company's sales representatives have access to the Company's proprietary
information systems. These systems allow the Company's sales representatives to
focus more on sales and less on the administrative tasks associated with
processing orders. Although the Company is highly reliant on its various
automated systems, the Company believes that high levels of personal interaction
with customers ensures the highest level of customer satisfaction. The Company
currently has sales offices in Irvine, Palo Alto, Sacramento, Denver, New York
City, Austin, Dallas, Portland, Salt Lake City, Seattle, Chicago, Atlanta,
Charlotte, Minneapolis and Memphis. The Company has adopted an entrepreneurial
approach with respect to its sales offices. Towards that end, sales office
personnel are usually given a high degree of autonomy, including limited pricing
authority. Each sales office also has profit and loss responsibility, with
compensation of sales office managers tied to the performance of their office.
The Company's practice is to hire experienced industry sales
representatives. Sales representatives are compensated based on the
profitability of their sales and their subsequent management of the account. The
Company typically will only guarantee the salary of a new sales representative
for several months, after which time all compensation to the sales
representative will come in the form of commissions. This compensation structure
has been very successful for the Company, as the most effective sales personnel
enjoy a high level of compensation relative to the industry average.
DISTRIBUTION
Many resellers of information technology products have assumed certain of
the functions of distributors, including stocking inventory, developing and
maintaining inventory control systems and establishing distribution systems. By
doing so, these resellers have incurred additional capital costs associated with
the warehousing of products, including the costs of leasing warehouse space,
maintaining inventory and tracking systems and employing personnel for stocking
and shipping duties. Furthermore, resellers which stock inventory risk
obsolescence costs, which the Company believes may be significant due to the
frequent product innovation and associated product obsolescence that
characterizes the information technology products market. The Company believes
that these overhead and "touch" costs require many resellers to incur expenses
which the Company expects more than offset the advantages of the lower purchase
prices that may be available to such resellers through their direct purchasing
relationships with manufacturers.
The Company's business model allows it to eliminate many overhead and
"touch" costs and risks. The Company has sought to take advantage of the
operational strengths of its Allied Distributors, who have developed extensive
warehousing, purchasing and distribution functions. As a result, En Pointe is
able to reduce its investment in product inventory and capital costs associated
with these "back office" functions and can accept lower gross profit margins
than many of its competitors and still remain profitable.
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One key feature of the Company's business model is the ability of the
Company to reliably deliver products purchased through the Company in a timely
fashion. The Company's information systems, which also serve as the Company's
ordering systems, allow the Company to place orders on a same-day basis. Most
orders for in-stock product are picked, staged and drop-shipped to the customer
from the Allied Distributor within 24 hours of receipt of order, and on the same
business day for orders received by 2 p.m. Pacific Time. The standard delivery
time is two to three business days. The configuration process will usually add a
maximum of three business days. After an order is entered, it is reviewed and
approved at the Company's headquarters and sent out electronically to the chosen
distributor. Once the order is shipped by the distributor, shipping information
is downloaded by the Company (usually done the day after the order is placed)
into its information systems. The Company will then use that information to
produce an invoice, which is sent to the customer. If a customer places an order
which cannot be filled by an individual distributor, then the Company will split
the order among multiple distributors.
Most of the Company's information technology product orders are currently
filled by the Allied Distributors. By choosing to rely on the "back office"
strengths of its Allied Distributors, the Company is also able to concentrate
on:
- SPECIFYING, RESEARCHING AND RECOMMENDING TECHNOLOGY. En Pointe's sales
representatives can use its proprietary information systems to assist its
customers in selecting the most appropriate technology to meet their
needs, as well as to determine the best combination of pricing and
availability of a wide variety of information technology products.
- COORDINATING AND OPTIMIZING PRODUCT DISTRIBUTION. Because En Pointe's
sales representatives have the ability to access the current inventory and
availability records of its Allied Distributors, these representatives are
able to determine which distributor can best supply the customer.
Furthermore, if any one distributor is unable to supply all of a
customer's needs, En Pointe is generally able to fill a customer's order
using multiple Allied Distributors. In order for En Pointe to facilitate
the distribution of information technology products to its customers, En
Pointe uses various carriers' (including FedEx and UPS) tracking software
and tracking numbers supplied by Allied Distributors to track customer
shipments.
En Pointe has been able to successfully implement its strategy due in large
part to the close relationships it has developed with the Allied Distributors.
The Company has been able to maintain these relationships due to several
factors, the most important of which is the volume of business that the Company
generates. This volume enables the Company to negotiate with its Allied
Distributors to receive discounts on certain products which the Company may pass
along to its customers. As the Company's sales have grown, it has been able to
take advantage of these discounts. In addition, many manufacturers make
discounts available from time to time to customers who place large-volume
orders. The Company seeks to participate in these discounts either directly
through agreements with the manufacturer, or indirectly as discounts are made
available to distributors, who in turn will pass a portion along to resellers.
See "Factors Which May Affect Future Operating Results--Risks Associated With
Dependence on Distributors And Manufacturers."
COMPETITION
The segment of the information technology industry in which the Company
operates is highly competitive. The Company competes with a large number and
wide variety of resellers of information technology products, including
traditional personal computer retailers, computer superstores, consumer
electronics and office supply superstores, mass merchandisers, corporate
resellers, value-added resellers, specialty retailers, distributors,
franchisers, mail-order and web-order companies, manufacturers and national
computer retailers which have commenced their own direct marketing operations to
end-users. Many of these companies compete principally on the basis of price and
may have lower costs than the Company which allow them to offer the same
products and services at a lower price. Many of the
8
Company's competitors are larger, have substantially greater financial,
technical, marketing and other resources and offer a broader range of
value-added services than does the Company. The Company competes with, among
others, CompuCom Systems, Inc. ("CompuCom"), Dell Computer Corporation ("Dell"),
Elcom International, Inc. ("Elcom"), Entex Information Services, Inc. ("Entex"),
InaCom Corp. ("InaCom"), MicroAge, Inc. ("MircoAge"), Vanstar Corp. ("Vanstar")
and CDW Computer Centers, Inc. ("CDW"). The Company expects to face additional
competition from new market entrants in the future.
Competitive factors include price, service and support, the variety of
products and value-added services offered, and marketing and sales capabilities.
While the Company believes that it competes successfully with respect to most,
if not all of these factors, there can be no assurance that it will continue to
do so in the future. The information technology industry has come to be
characterized by aggressive price cutting and the Company expects pricing
pressures will continue in the foreseeable future. In addition, the information
technology products industry is characterized by abrupt changes in technology
and associated inventory and product obsolescence, rapid changes in consumer
preferences, short product life cycles and evolving industry standards. The
Company will need to continue to provide competitive prices, superior product
selection and quick delivery response time in order to remain competitive. If
the Company were to fail to compete favorably with respect to any of these
factors, the Company's business, financial position, results of operations and
cash flows would be materially and adversely affected. See "--Industry Overview"
and "Factors Which May Affect Future Operating Results--Competition."
INTELLECTUAL PROPERTY
The Company's ability to effectively compete in its market will depend
significantly on its ability to protect its proprietary technology, especially
its rights in the EPIC software. The Company relies primarily upon trade secrecy
and confidentiality agreements to establish and protect its rights in its
proprietary technology. While the Company has a copyright on its EPIC 1.5
software, and has applied for a copyright on its EPIC 2.0 software, it does not
have any patents on any other proprietary technology which the Company believes
to be material to its future success, and insofar as the Company relies on trade
secrets and proprietary know-how to maintain its competitive position, there can
be no assurance that others may not independently develop similar or superior
technologies or gain access to the Company's trade secrets or know-how.
Furthermore, there can be no assurance that any confidentiality agreements
between the Company and its employees will provide meaningful protection of the
Company's proprietary information in the event of any unauthorized use or
disclosure of such proprietary information.
There can be no assurance that the Company will not become subject to claims
of infringement involving its information systems, or any other system,
including the Company's EPIC software. In addition, the Company may initiate
claims or litigation against third parties for infringement of the Company's
proprietary rights or to establish the validity of the Company's proprietary
rights. Any such claims could be time consuming, result in costly litigation or
lead the Company to enter into royalty or licensing agreements rather than
disputing the merits of such claims.
The Company conducts its business under the trademark and service mark "En
Pointe Technologies" as well as its logo. The Company has been issued
registrations for the mark "En Pointe" as well as its logo in the United States
and has pending registrations in Canada, Mexico and the European Community. The
Company does not believe that its operations are dependent upon any of its
trademarks or service marks. The Company also sells products and provides
services under various trademarks, service marks, and trade names to which
reference is made in this Annual Report on Form 10-K that are the property of
owners other than the Company. Such owners have reserved all rights with respect
to their respective trademarks, service marks, and trade names. See "Factors
Which May Affect Future Operating Results--Risks Associated With Dependence on
Proprietary Technology."
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EMPLOYEES
As of November 30, 1997, the Company employed approximately 434 individuals,
including approximately 232 sales representatives, 80 systems engineers and
service technicians and 122 in administration and finance. The Company believes
that its ability to recruit and retain highly skilled technical and other
management personnel will be critical to its ability to execute its business
model and growth strategy. None of the Company's employees are represented by a
labor union or are subject to a collective bargaining agreement. The Company
believes that its relations with its employees are good.
FACTORS WHICH MAY AFFECT FUTURE OPERATING RESULTS
IN ADDITION TO THE INFORMATION SET FORTH ELSEWHERE IN THIS ANNUAL REPORT ON
FORM 10-K, THE FOLLOWING FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING
THE COMPANY AND ITS BUSINESS.
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1993 AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934. IN LIGHT OF THE IMPORTANT FACTORS THAT CAN
MATERIALLY AFFECT RESULTS, INCLUDING THOSE SET FORTH IN THIS PARAGRAPH AND
BELOW, THE INCLUSION OF FORWARD-LOOKING INFORMATION HEREIN SHOULD NOT BE
REGARDED AS A REPRESENTATION BY THE COMPANY OR ANY OTHER PERSON THAT THE
OBJECTIVES OR PLANS FOR THE COMPANY WILL BE ACHIEVED. THE COMPANY MAY ENCOUNTER
COMPETITIVE, TECHNOLOGICAL, FINANCIAL AND BUSINESS CHALLENGES MAKING IT MORE
DIFFICULT THAN EXPECTED TO CONTINUE TO RESELL INFORMATION TECHNOLOGY PRODUCTS;
THE COMPANY MAY BE UNABLE TO RETAIN EXISTING KEY SALES, TECHNICAL AND MANAGEMENT
PERSONNEL; THERE MAY BE OTHER MATERIAL ADVERSE CHANGES IN THE INFORMATION
TECHNOLOGY INDUSTRY OR IN THE COMPANY'S OPERATIONS OR BUSINESS, AND ANY OR ALL
OF THESE FACTORS MAY AFFECT THE COMPANY'S ABILITY TO CONTINUE ITS CURRENT RATE
OF SALES GROWTH OR MAY RESULT IN LOWER SALES VOLUME THAN CURRENTLY EXPERIENCED.
CERTAIN IMPORTANT FACTORS AFFECTING THE FORWARD-LOOKING STATEMENTS MADE HEREIN
INCLUDE, BUT ARE NOT LIMITED TO (I) A SIGNIFICANT PORTION OF THE COMPANY'S SALES
CONTINUING TO BE TO CERTAIN LARGE CUSTOMERS, (II) CONTINUED DEPENDENCE BY THE
COMPANY ON CERTAIN ALLIED DISTRIBUTORS, (III) CONTINUED DOWNWARD PRICING
PRESSURES IN THE INFORMATION TECHNOLOGY MARKET, (IV) THE LACK OF PRIOR
EXPERIENCE OF THE COMPANY IN THE PROVISION OF VALUE-ADDED SERVICES AND (V) THE
DECISION BY THE COMPANY TO EXPAND ITS SALES FORCE INTO VARIOUS NEW GEOGRAPHIC
TERRITORIES. ASSUMPTIONS RELATING TO BUDGETING, MARKETING, AND OTHER MANAGEMENT
DECISIONS ARE SUBJECTIVE IN MANY RESPECTS AND THUS SUSCEPTIBLE TO
INTERPRETATIONS AND PERIODIC REVISIONS BASED ON ACTUAL EXPERIENCE AND BUSINESS
DEVELOPMENTS, THE IMPACT OF WHICH MAY CAUSE THE COMPANY TO ALTER ITS MARKETING,
CAPITAL EXPENDITURE OR OTHER BUDGETS, WHICH MAY IN TURN AFFECT THE COMPANY'S
BUSINESS, FINANCIAL POSITION, RESULTS OF OPERATIONS AND CASH FLOWS. THE READER
IS THEREFORE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS
CONTAINED HEREIN, WHICH SPEAK AS OF THE DATE OF THIS ANNUAL REPORT ON FORM 10-K.
RISKS ASSOCIATED WITH DEPENDENCE ON RELATIONSHIP WITH IBM AND OTHER LARGE
CUSTOMERS
For the years ended September 30, 1997, 1996 and 1995, net sales to IBM and
certain IBM customers under the Company's current contract with IBM accounted
for approximately 29.6%, 28.3% and 12.1%, respectively, of the Company's net
sales. The Company's contracts for the provision of products or services are
generally non-exclusive agreements which are terminable by either party upon 30
days notice. The loss of IBM or any other large customer, the failure of IBM or
any other large customer to pay its accounts receivable on a timely basis, or a
material reduction in the amount of purchases made by IBM or any other large
customer could have a material adverse effect on the Company's business,
financial position, results of operations and cash flows. The current contract
with IBM is due to expire in June 1998, at which time IBM will enter into new
contracts with certain resellers to supply it, and certain of its customers,
with products and services. Although the Company intends to bid for such
contract, there can be no assurance that the Company will be successful in
obtaining such contract. The inability of the Company to retain the current
contract or obtain the new contract would have a material adverse impact on the
Company's business, financial position, results of operations and cash flows.
See "Business--Customers."
10
RISKS ASSOCIATED WITH DEPENDENCE ON DISTRIBUTORS AND MANUFACTURERS
A key element of the Company's past success and future business strategy
involves the establishment of alliances with certain large distributors of
information technology products and services, including Ingram Micro, InaCom,
MicroAge, Merisel FAB, Synnex and Tech Data. These alliances enable the Company
to make available to its customers a wide selection of products without
subjecting the Company to many of the costs and risks associated with
maintaining large amounts of inventory. Products and services purchased from two
Allied Distributors, Ingram Micro and InaCom, accounted for 73.4% of the
Company's aggregate purchases in fiscal 1997. Certain Allied Distributors
provide the Company with substantial incentives in the form of allowances passed
through from manufacturers, discounts, credits and cooperative advertising,
which incentives directly affect the Company's operating income. There can be no
assurance that the Company will continue to receive such incentives in the
future and any reduction in the amount of these incentives could have a material
adverse effect on the Company's business, financial position, results of
operations and cash flows. Furthermore, the Company directly competes with
certain Allied Distributors for many of the same customers and therefore there
can be no assurance that any such Allied Distributor will not use its position
as a key supplier to the Company to pressure the Company from directly competing
with it. Substantially all of the Company's contracts with its Allied
Distributors are terminable by either party upon 30 days' notice or less and
several contain minimum purchase volume requirements as a condition to providing
discounts to the Company. The termination or interruption of the Company's
relationships with any of the Allied Distributors, modification of the terms or
discontinuance of agreements with any of the Allied Distributors, failure to
meet minimum purchase volume requirements, or the failure to establish a good
working relationship with any significant new distributor of information
technology products could materially adversely affect the Company's business,
financial position, results of operations and cash flows. See
"Business--Distribution."
Certain of the products offered by the Company are subject to manufacturer
allocations, which limit the number of units of such products available to the
Allied Distributors, which in turn may limit the number of units available to
the Company for resale to its customers. In addition, because certain products
offered by the Company are subject to manufacturer or distributor allocations,
which limit the number of units of such products available to the Company for
resale to its customers, there can be no assurance that the Company will be able
to offer popular new products or product enhancements to its customers in
sufficient quantity or in a timely manner to meet demand. In order to offer the
products of most manufacturers, the Company is required to obtain authorizations
from such manufacturers to act as a reseller of such products, which
authorizations may be terminated at the discretion of the manufacturers. There
can be no assurance that the Company will be able to obtain or maintain
authorizations to offer products, directly or indirectly, from new or existing
manufacturers. Termination of the Company's rights to act as a reseller of the
products of one or more significant manufacturers or the failure of the Company
to gain sufficient access to such new products or product enhancements could
have a material adverse effect on the Company's business, financial position,
results of operations and cash flows. See "Business-- Products and Value-Added
Services."
Recent changes in the information technology industry, especially pressure
on gross profit margins, has adversely affected a number of distributors of
information technology products, including certain Allied Distributors. There
can be no assurance that the continuing evolution of the information technology
industry will not further adversely affect the Company's distributors. Because
the Company's overall business strategy depends on the Company's relationships
with the Allied Distributors, the Company's business, financial position,
results of operations and cash flows would be materially adversely affected in
the event that distributors in general and Allied Distributors in particular
continue to suffer adverse consequences due to ongoing changes in the
information technology industry. There has recently been a consolidation trend
in the information technology industry, including consolidation among
distributors of information technology products. Because the Company's business
model is dependent upon the availability of a number of information technology
product distributors, any further consolidation would result in
11
fewer distributors available to supply products to the Company, which could have
a material adverse impact on the Company's business, financial position, results
of operations and cash flows. See "Business-- Industry Overview."
COMPETITION
The segment of the information technology industry in which the Company
operates is highly competitive. The Company competes with a large number and
wide variety of resellers of information technology products, including
traditional personal computer retailers, computer superstores, consumer
electronics and office supply superstores, mass merchandisers, corporate
resellers, value-added resellers, specialty retailers, distributors,
franchisers, mail-order and web-order companies, manufacturers and national
computer retailers which have commenced their own direct marketing operations to
end-users. Many of these companies compete principally on the basis of price and
may have lower costs than the Company which allow them to offer the same
products and services at a lower price. Many of the Company's competitors are
larger, have substantially greater financial, technical, marketing and other
resources and offer a broader range of value-added services than does the
Company. The Company competes with, among others, CompuCom, Dell, Elcom, Entex,
InaCom, MicroAge, Vanstar and CDW. The Company expects to face additional
competition from new market entrants in the future.
Competitive factors include price, service and support, the variety of
products and value-added services offered, and marketing and sales capabilities.
While the Company believes that it competes successfully with respect to most,
if not all of these factors, there can be no assurance that it will continue to
do so in the future. The information technology industry has come to be
characterized by aggressive price cutting and the Company expects pricing
pressures will continue in the foreseeable future. In addition, the information
technology products industry is characterized by abrupt changes in technology
and associated inventory and product obsolescence, rapid changes in consumer
preferences, short product life cycles and evolving industry standards. The
Company will need to continue to provide competitive prices, superior product
selection and quick delivery response time in order to remain competitive. If
the Company were to fail to compete favorably with respect to any of these
factors, the Company's business, financial position, results of operations and
cash flows would be materially and adversely affected. See "Business--Industry
Overview" and "--Competition."
RISKS ASSOCIATED WITH INDUSTRY EVOLUTION AND PRICE REDUCTIONS; CHANGING METHODS
OF DISTRIBUTION
The information technology industry is undergoing significant change. The
industry has become more accepting of large-volume, cost-effective channels of
distribution and accordingly such channels have proliferated. In addition, many
traditional computer resellers are consolidating operations and acquiring or
merging with other resellers in an effort to increase efficiency. This current
industry reconfiguration has resulted in increased pricing pressures. Decreasing
prices of information technology products requires the Company to sell a greater
number of products to achieve the same level of net sales and gross profit. The
continuation of such trend could make it more difficult for the Company to
continue to increase its net sales and earnings growth. In addition, it is
possible that the historically high rate of growth of the information technology
industry may slow at some point in the future, resulting in a material adverse
effect on the Company's business, financial position, results of operations and
cash flows. Furthermore, new methods of distributing and selling information
technology products, such as on-line shopping services and catalogs published on
CD-ROM, may emerge in the future. Hardware and software manufacturers have sold,
and may in the future intensify their efforts to sell, their products directly
to end-users. From time to time, certain vendors have instituted programs for
the direct sale of large orders of hardware and software to certain major
corporate customers. These types of programs may continue to be developed and
used by various vendors. While the Company attempts to anticipate and influence
current and future distribution trends, any of these distribution methods or
competitive programs, if successful, could have a material adverse effect on the
Company's business, financial position, results of operations and cash flows.
12
Recently, a trend has emerged whereby the final assembly of certain
information technology products is performed by resellers and distributors. In
order to compete more effectively and lower their costs, certain information
technology product manufacturers that rely on the wholesale distribution model
have announced their intention to reduce their own inventories and the
inventories of their resellers and distributors by implementing a
"build-to-order" manufacturing process. These major manufacturers have also
begun to develop programs whereby final assembly will be performed by resellers
and distributors ("channel assembly") as compared to the current
"build-to-forecast" methodology employed by these manufacturers. The Company has
not, to date, been authorized to participate in any announced build-to-order
manufacturing processes, and there can be no assurance that the Company will
ever be authorized to participate in any such process. The failure of the
Company to obtain any such authorization could have a material adverse effect on
the Company's business, financial position, results of operations and cash
flows. If the Company eventually participates in a "build-to-order" process, the
Company will have to make a significant capital investment in order to
successfully participate in such process. See "Business--Industry Overview."
RISKS ASSOCIATED WITH DEPENDENCE ON PROPRIETARY TECHNOLOGY
The Company's ability to effectively compete in its market will depend
significantly on its ability to protect its proprietary technology in general
and its EPIC software in particular. The Company relies primarily on trade
secrecy and confidentiality agreements in order to establish and protect its
rights in its proprietary technology. There can be no assurance that the
existing methods for protecting the Company's proprietary technology will be
successful in defending either the confidentiality of, or the unauthorized use
of, this technology, nor can any assurance be given that the Company will be
able to achieve or maintain a meaningful technological advantage. The Company
could incur substantial costs in seeking enforcement of its proprietary rights
against infringement or unauthorized use by others, or in defending itself
against similar claims by other holders of proprietary information. While the
Company has a copyright on its EPIC 1.5 software and has applied for a copyright
of its EPIC 2.0 software, it does not have any patents on other proprietary
technology which the Company believes to be material to the Company's future
success. Insofar as the Company relies on trade secrets and proprietary know-how
to maintain its competitive position, there can be no assurance that others may
not independently develop similar or superior technologies or gain access to the
Company's trade secrets or know-how. See "Business--Intellectual Property."
The Company may experience delays, complications or expenses in installing,
integrating and operating the EPIC software, especially its EPIC 2.0 upgrade, or
interruptions or disruptions in EPIC software operations, any of which could
have a material adverse effect on the Company's business, financial position,
results of operations and cash flows. The Company believes that its EPIC
software will require modification or improvement as the Company expands. Such
modification or improvement may require substantial expenditures to design and
implement and may interrupt the Company's operations, resulting in a material
adverse effect on the Company's business, financial position, results of
operations and cash flows. See "Business--Intellectual Property" and
"Business--Proprietary Information Systems."
RISKS ASSOCIATED WITH POTENTIAL VARIABILITY IN QUARTERLY OPERATING RESULTS
The Company's quarterly net sales and operating results may vary
significantly as a result of a variety of factors, including: the demand for
information technology products and the Company's value-added services;
introduction of new hardware and software technologies; introduction of new
value-added services by the Company and its competitors; changes in
manufacturers' prices or price protection policies; changes in shipping rates;
disruption of warehousing or shipping channels; changes in the level of
operating expenses; the timing of major marketing or other service projects;
product supply shortages; inventory adjustments; changes in product mix; entry
into new geographic markets; the timing and integration of acquisitions or
investments; difficulty in managing margins; the loss of significant customer
13
contracts; the necessity to write-off a significant amount of accounts
receivable; and general competitive and economic conditions. In addition, a
substantial portion of the Company's net sales in each quarter results from
orders booked in such quarter. Accordingly, the Company believes that
period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
It is possible that in future periods, the Company's operating results may be
below the expectations of public market analysts and investors. In such event,
the market price of the Common Stock would likely be materially adversely
affected. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Quarterly Results."
RISKS ASSOCIATED WITH LOW MARGIN BUSINESS
The Company's historical growth in net income has been driven primarily by
net sales growth rather than increased profit margins. The Company's gross
profit margins are low compared to many other resellers of information
technology products. In fiscal 1997, the Company's gross profit margin was 9.0%.
Given the significant levels of competition that characterize the reseller
market, as well as the lower gross profit margins generated by the Company as a
result of its reliance on purchasing information technology products from its
Allied Distributors, it is unlikely that the Company will be able to
substantially increase gross profit margins in its core business of reselling
information technology products. Moreover, in order to attract and retain many
of its larger customers, the Company frequently must agree to volume discounts
and maximum allowable mark-ups that serve to limit the profitability of product
sales to such customers. Accordingly, to the extent that the Company's sales to
such customers increase, the Company's gross profit margins may be reduced, and
therefore any future increases in net income will have to be derived from
continued net sales growth, effective expansion into higher margin business
segments or a reduction in operating expenses as a percentage of net sales, none
of which can be assured. Furthermore, low gross profit margins increase the
sensitivity of the Company's business to increases in costs of financing,
because financing costs to carry a receivable can be relatively high compared to
the low dollar amount of gross profit on the sale underlying the receivable
itself. Low gross profit margins also increase the sensitivity of the business
to any increase in product returns and bad debt write-offs, as the impact
resulting from the inability to collect the full amount for products sold will
be relatively high compared to the low amount of gross profit on the sale of
such product. Any failure by the Company to increase or maintain its gross
profit margins and sales levels could have a material adverse effect on the
Company's business, financial position, results of operations and cash flows.
See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations."
RISKS ASSOCIATED WITH DEPENDENCE ON AVAILABILITY OF CREDIT; RISKS ASSOCIATED
WITH DEPENDENCE ON IBMCC
The Company's business requires significant capital to finance accounts
receivable and, to a lesser extent, product inventory. In order to obtain
necessary working capital, the Company relies primarily on lines of credit that
are collateralized by substantially all of the Company's assets. As a result,
the amount of credit available to the Company may be adversely affected by
numerous factors beyond the Company's control, such as delays in collection or
deterioration in the quality of the Company's accounts receivable, economic
trends in the information technology industry, interest rate fluctuations and
the lending policies of the Company's creditors. Any decrease or material
limitation on the amount of capital available to the Company under its lines of
credit and other financing arrangements will limit the ability of the Company to
fill existing sales orders or expand its sales levels and, therefore, would have
a material adverse effect on the Company's business, financial position, results
of operations and cash flows. In addition, any significant increases in interest
rates will increase the cost of financing to the Company and would have a
material adverse effect on the Company's business, financial position, results
of operations and cash flows. The Company is dependent on the availability of
accounts receivable financing on reasonable terms and at levels that are high
relative to its equity base in order to maintain and increase its sales. There
can be no assurance that such financing will continue to be available to the
Company in the future or available under
14
terms acceptable to the Company. The inability of the Company to have continuous
access to such financing at reasonable costs could materially adversely impact
the Company's business, financial position, results of operations and cash
flows. As of September 30, 1997, the Company had outstanding borrowings under
its credit facilities of $50.7 million out of a total availability under its
credit facilities of $81.0 million.
The Company has primarily funded its working capital requirements through a
$70.0 million Inventory and Working Capital Agreement (the "IBMCC Financing
Agreement") with IBM Credit Corporation ("IBMCC"). At September 30, 1997, the
outstanding principal balance under the IBMCC Financing Agreement was
approximately $44.7 million. Borrowings under the IBMCC Financing Agreement are
collateralized by certain assets of the Company, including accounts receivable,
inventory and equipment. The IBMCC Financing Agreement expires April 13, 1998.
IBMCC may terminate the IBMCC Financing Agreement at any time upon the
occurrence of, and subsequent failure to cure, an "Event of Default" (as such
term is defined in the IBMCC Financing Agreement). In the event of such
termination, the outstanding borrowings under the IBMCC Financing Agreement
become immediately due and payable in their entirety. The termination of the
IBMCC Financing Agreement and the subsequent inability of the Company to secure
a replacement credit facility on terms and conditions similar to those contained
in the IBMCC Financing Agreement could have a material adverse effect on the
Company's business, financial position, results of operations and cash flows.
See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
RISKS RELATED TO DEPENDENCE ON SENIOR MANAGEMENT AND OTHER KEY PERSONNEL
The Company believes that its success has been and will continue to be
dependent on the services and efforts of its existing senior management and
other key personnel. The loss of the services of one or more of any of the
Company's existing senior management and other key personnel would have a
material adverse effect on the Company's business, financial position, results
of operations and cash flows.
The Company's success and its plans for future growth also depend on its
ability to attract and retain highly skilled personnel in all areas of its
business, including application development, sales and technical services.
Competition for qualified personnel in the information technology industry is
intense, and although the Company believes that it has thus far been successful
in attracting and retaining qualified personnel for its business, the inability
to attract and retain qualified personnel in the future could have a material
adverse effect upon the Company's business, financial position, results of
operations and cash flows.
RISKS RELATED TO MANAGEMENT OF GROWTH
Since its inception, the Company has experienced rapid growth in net sales,
the number of its employees and branch offices, the amount of administrative
overhead and the type of services offered. This growth has and, if continued,
will continue to put strains on the Company's management, operational and
financial resources. To execute the Company's growth strategy, the Company
expects to require the addition of new management personnel, including
application development, sales and technical services personnel, and the
development of additional expertise by existing personnel. The Company's ability
to manage growth effectively will require it to continue to implement and
improve its operational, financial and sales systems (at both the national and
local level), to develop the skills of its managers and supervisors and to hire,
train, motivate, retain and effectively manage its employees. There can be no
assurance that the Company will be successful in managing any future expansion,
and the failure to do so could materially adversely affect the Company's
business, financial position, results of operations and cash flows.
The Company is currently in the process of upgrading its accounting software
system. The Company expects that such upgrade will utilize a considerable amount
of the Company's management resources. There can be no assurance that the
Company will be able to successfully implement such software system,
15
and such failure could have a material adverse impact on the Company's business,
financial position, results of operations and cash flows.
RISKS ASSOCIATED WITH EXPANDING SERVICES CAPABILITIES
The Company is expanding the nature and scope of its value-added services.
There can be no assurance that the value-added services business will be
successfully integrated with the Company's information technology products
reselling business or that the Company will be able to effectively compete in
this market. If the Company is unable to effectively provide value-added
services, it may be unable to effectively compete for the business of certain
large customers which require the provision of such services as a condition to
purchasing products from the Company. In addition, the Company will be subject
to risks commonly associated with a value-added services business, including
dependence on reputation, volatility of workload and dependence on ability to
recruit and retain qualified technical personnel. The expansion of the Company's
value-added services is expected to require a significant capital investment,
including a large increase in the number of technical employees. Also, a portion
of the Company's value-added services revenue may be derived from the
performance of services pursuant to fixed-price contracts. As a result, cost
overruns due to price increases, unanticipated problems, inefficient project
management or inaccurate estimation of costs could have a material adverse
effect on the Company's business, financial position, results of operations and
cash flows. See "Business--Products and Value-Added Services."
RISKS RELATED TO GEOGRAPHIC EXPANSION
The Company's growth has been and will continue to be driven, in part, by
sales generated through expansion into new geographic markets. The Company has
already opened sales offices in many of the metropolitan markets that the
Company believes offer the most potential for sales growth. Accordingly, to the
extent the Company attempts to open additional sales offices, there can be no
assurance that the new offices will experience the same success, if any,
experienced by the Company's existing sales offices. The failure of the Company
to expand or the failure by the Company to generate sufficient sales volumes in
new sales offices could have a material adverse effect on the Company's
business, financial position, results of operations and cash flows. The Company
generally incurs start-up expenses with respect to a new sales office for three
to six months after opening such sales office, and therefore, any increase in
the rate at which the Company opens new sales offices could have a material
adverse effect on the Company's business, financial position, results of
operations and cash flows.
RISKS ASSOCIATED WITH ACQUISITIONS AND INVESTMENTS IN COMPLEMENTARY BUSINESSES
One element of the Company's growth strategy may include expanding its
business through strategic acquisitions and investments in complementary
businesses. The Company has not had significant acquisition or investment
experience, and there can be no assurance that the Company will be able to
successfully identify suitable acquisition or investment candidates, complete
acquisitions or investments, or integrate acquired businesses into its
operations. Acquisitions and investments involve numerous risks, including
difficulties in the assimilation of the operations, services, products, vendor
agreements, and personnel of the acquired company, the diversion of management's
attention and other resources from other business concerns, entry into markets
in which the Company has little or no prior experience, and the potential loss
of key employees, customers, or contracts of the acquired company. Acquisition
and investments could also conflict with restrictions in the Company's
agreements with existing or future distributors or manufacturers. The Company is
unable to predict whether or when any prospective acquisition or investment
candidate will become available or the likelihood that any acquisition or
investment will be completed or successfully integrated. The Company's failure
to successfully manage any potential acquisitions or investments in
complementary businesses could have a material adverse effect on the Company's
business, financial position, results of operations and cash flows.
16
RISKS ASSOCIATED WITH PLANNED INTERNATIONAL OPERATIONS
Although the Company to date has not generated significant net sales from
international operations, one of the elements of its growth strategy is to
expand internationally. There can be no assurance that the Company will be able
to successfully expand its international business. There are certain risks
inherent in doing business on an international level, such as remote management,
unexpected changes in regulatory requirements, export restrictions, tariffs and
other trade barriers, difficulties in staffing and managing foreign operations,
longer payment cycles, problems in collecting accounts receivable, political
instability, fluctuations in currency exchange rates, and potentially adverse
tax consequences, any of which could adversely impact the success of the
Company's international operations. There can be no assurance that one or more
of such factors will not have a material adverse effect on the Company's future
international operations and, consequently, on the Company's business, financial
position, results of operations and cash flows.
RISKS ASSOCIATED WITH BUSINESS INTERRUPTION; RISKS ASSOCIATED WITH DEPENDENCE ON
CENTRALIZED FUNCTIONS
The Company believes that its success to date has been, and future results
of operations will be, dependent in large part upon its ability to provide
prompt and efficient service to its customers. As a result, a substantial
disruption of the Company's day-to-day operations could have a material adverse
effect upon the Company's business, financial position, results of operations
and cash flows. In addition, the Company's success is largely dependent on the
accuracy, quality and utilization of the information generated by its
proprietary information systems, which are based in El Segundo, California.
Repairs, replacement, relocation or a substantial interruption in these systems
or in the Company's telephone or data communications systems, servers or power
could have a material adverse effect on the Company's business, financial
position, results of operations and cash flows. Although the Company has
business interruption insurance, an uninsurable loss could have a material
adverse effect on the Company's business, financial position, results of
operations and cash flows. The Company's current use of a single configuration
facility in Memphis also makes the Company more vulnerable to dramatic changes
in freight rates than a competitor with multiple, geographically dispersed
sites. Losses in excess of insurance coverage, an uninsurable loss, or change in
freight rates could have a material adverse effect on the Company's business,
financial position, results of operations and cash flows. See
"Business--Proprietary Information Systems."
RISKS ASSOCIATED WITH DEPENDENCE ON THIRD-PARTY SHIPPERS
The Company presently ships products from Memphis, Tennessee, and will be
shipping products from Ontario, California, by Federal Express Corporation
("FedEx") or United Parcel Service of America, Inc. ("UPS"), and the vast
majority of products that the Company sells are drop-shipped for the Company to
its customers by the Allied Distributors via these carriers. Changes in shipping
terms, or the inability of these third-party shippers to perform effectively
(whether as a result of mechanical failure, casualty loss, labor stoppage, other
disruption, or any other reason), could have a material adverse effect on the
Company's business, financial position, results of operations and cash flows.
There can be no assurance that the Company or others can maintain favorable
shipping terms or replace such shipping services on a timely or cost-effective
basis. See "Business--Distribution."
RISKS ASSOCIATED WITH PRODUCT RETURNS
As is typical of the information technology industry, the Company incurs
expenses as a result of the return of products by customers. Such returns may
result from defective goods, inadequate performance relative to customer
expectations, distributor shipping errors and other causes which are outside the
Company's control. Although the Company's distributors and manufacturers have
specific return policies that enable the Company to return certain products for
credit, to the extent that the Company's customers return products which are not
accepted for return by the distributor or manufacturer of such products, the
17
Company will be forced to bear the cost of such returns. Any significant
increase in the rate of product returns, coupled with the unwillingness by the
Company's distributors or manufacturers to accept goods for return, could have a
material adverse effect on the Company's business, financial position, results
of operations and cash flows.
RISKS ASSOCIATED WITH EXTENSIONS OF CREDIT
As a marketing enhancement, the Company offers unsecured and secured credit
terms for qualified customers. Historically, the Company has not experienced
losses from write-offs in excess of established reserves. While the Company
evaluates customers' qualifications for credit and closely monitors its
extensions of credit, defaults by customers in timely repayment of these
extensions of credit could have a material adverse effect on the Company's
business, financial position, results of operations and cash flows. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
RISKS ASSOCIATED WITH POTENTIAL INFLUENCE BY EXECUTIVE OFFICERS AND PRINCIPAL
STOCKHOLDERS
The directors, executive officers and principal stockholders of the Company
and their affiliates beneficially own, in the aggregate, approximately 53.4% of
the outstanding Common Stock. As a result, these stockholders acting together
will be able to exert considerable influence over the election of the Company's
directors and the outcome of most corporate actions requiring stockholder
approval, such as certain amendments to the Company's Certificate of
Incorporation. Additionally, the directors and executive officers have
significant influence over the policies and operations of the Company's
management and the conduct of the Company's business. Such concentration of
ownership may have the effect of delaying, deferring or preventing a change of
control of the Company and consequently could affect the market price of the
Common Stock.
POTENTIAL VOLATILITY OF STOCK PRICE
Factors such as the announcement of acquisitions by the Company or its
competitors, quarter to quarter variations in the Company's operating results,
changes in earnings estimates by analysts, governmental regulatory action,
general trends and market conditions in the information technology industry, as
well as other factors, may have a significant impact on the market price of the
Common Stock. Moreover, trading volumes in the Company's Common Stock have been
low historically and could exacerbate price fluctuations in the Common Stock.
Further, the stock market has recently and in other periods experienced extreme
price and volume fluctuations, which have particularly affected the market
prices of the equity securities of many companies and which have often been
unrelated to the operating performance of such companies. These broad market
fluctuations may materially and adversely affect the market price of the Common
Stock. See "Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters."
POTENTIAL EFFECT OF ANTI-TAKEOVER PROVISIONS
The Company's Board of Directors has the authority to issue up to 5,000,000
shares of preferred stock and to determine the price, rights, preferences,
qualifications, limitations and restrictions, including voting rights, of those
shares without any further vote or action by the stockholders. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any preferred stock that may be issued in the
future. The issuance of preferred stock, while providing desirable flexibility
in connection with possible acquisitions and other corporate purposes, could
have the effect of delaying or preventing a third party from acquiring a
majority of the outstanding voting stock of the Company. Further, Section 203 of
the General Corporation Law of Delaware prohibits the Company from engaging in
certain business combinations with interested stockholders. These provisions may
have the effect of delaying or preventing a change in control of the Company
without action by the stockholders, and therefore could adversely affect the
market price of the Common Stock.
18
RISKS ASSOCIATED WITH POTENTIAL "YEAR 2000" PROBLEMS OF THIRD PARTIES
It is possible that the currently installed computer systems, software
products or other business systems of the Company's distributors, manufacturers
or customers, working either alone or in conjunction with other software or
systems, will not accept input of, store, manipulate and output dates in the
year 2000 or thereafter without error or interruption (commonly know as the
"Year 2000 problem"). The Company's business systems, including its computer
systems, are not subject to the Year 2000 problem; however, the Company is
querying its distributors, manufacturers and customers as to their progress in
identifying and addressing problems that their computer systems may face in
correctly processing date information as the Year 2000 approaches and is
reached. However, there can be no assurance that the Company will identify all
such Year 2000 problems in the computer systems of its distributors,
manufacturers or customers in advance of their occurrence or that they will be
able to successfully rectify any problems that are discovered. The expenses of
the Company's efforts to identify and address such problems, or the expenses or
liabilities to which the Company may become subject as a result of such
problems, are not expected to have a material adverse effect on the Company's
business, financial position, results of operations or cash flows. In addition,
the purchasing patterns of existing and potential customers may be affected by
Year 2000 problems, which could cause fluctuations in the Company's sales
volumes.
ABSENCE OF DIVIDENDS
The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain all available funds
for use in the operation of its business, and does not intend to pay any cash
dividends in the foreseeable future. The payment of any future dividends will be
at the discretion of the Company's Board of Directors and will depend upon,
among other factors, future earnings, operations, capital requirements, the
general financial condition of the Company and general business conditions. The
Company's ability to pay cash dividends is currently restricted by certain of
the Company's credit facilities, and the terms of future credit facilities or
other agreements may contain similar restrictions. See "Item 5. Market for
Registrant's Common Equity and Related Stockholder Matters."
ITEM 2. PROPERTIES
The Company leases approximately 35,000 square feet of office space for its
headquarters in El Segundo, California, under a lease expiring in May 2001. The
Company also leases approximately 7,000 square feet of space for its
configuration facility in Memphis, Tennessee, under a lease expiring November
1999. The Company owns an approximately 126,000 square foot facility in Ontario,
California, which will primarily be used for configuration, board-level repair
and maintenance services. The Company expects this facility to be operational by
the end of June 1998. This facility is subject to a mortgage, the current
outstanding principal of which is $4.0 million.
19
The Company currently leases sixteen sales offices nationwide. The following
table identifies the Company's sales offices:
APPROXIMATE DATE
FACILITY OPENED
- -------------------------------------------------------------------------- ------------------
Corporate Headquarters and Sales Office:
El Segundo, California.................................................. April 1993
Configuration Facility:
Memphis, Tennessee...................................................... November 1994
Sales Offices:
Dallas, Texas........................................................... March 1993
Palo Alto, California................................................... April 1993
Seattle, Washington..................................................... June 1993
Portland, Oregon........................................................ July 1993
Austin, Texas........................................................... May 1994
New York, New York...................................................... July 1994
Denver, Colorado........................................................ August 1994
Salt Lake City, Utah.................................................... May 1996
Chicago, Illinois....................................................... July 1996
Sacramento, California.................................................. August 1996
Irvine, California...................................................... September 1996
Atlanta, Georgia........................................................ April 1997
Charlotte, North Carolina............................................... April 1997
Memphis, Tennessee...................................................... April 1997
Minneapolis, Minnesota.................................................. July 1997
Management believes the Company's headquarters, sales offices and
configuration facilities are adequate to support its current level of
operations.
ITEM 3. LEGAL PROCEEDINGS
The Company was named as a defendant in a lawsuit filed on August 8, 1997 in
the Superior Court in the County of Los Angeles, California. (Case No.
BC175991). The case name is CIC SYSTEMS, INC. V. EN POINTE TECHNOLOGIES, INC.,
ET AL., and the complaint alleges that the Company, along with one individual
defendant who was a former employee of the plaintiff, conspired to target and
persuade the plaintiff's sales personnel to leave plaintiff's employ and become
employed by the Company and further alleges that the individual defendants, all
of whom are former employees of the plaintiff, diverted to the Company sales and
customers of the plaintiff, made false and misleading statements regarding the
plaintiff, and misappropriated the plaintiff's trade secrets and proprietary
information, all on behalf of the Company. The plaintiff is seeking unspecified
damages as well as injunctive relief. The Company is currently unable to
estimate the loss in the event of an unfavorable outcome. However, before
consideration of any potential insurance recoveries, the Company believes that
the claims in the suit will not have a material adverse effect on the Company's
business, financial position, results of operations or cash flows. The Company
has maintained various liability insurance policies during the periods covering
the claims above. While such policies may limit coverage under certain
circumstances, the Company believes that it is adequately insured. Should the
Company not be successful in defending against such lawsuit or not be able to
claim compensation under its liability insurance policies, the Company's
business, financial position, results of operations and cash flows may be
adversely affected.
The Company was named, along with Bob Din, as a defendant in a lawsuit filed
April 29, 1997 in the Superior Court for the County of Los Angeles (Case No.
BC170234). The case name for this filing is NOVAQUEST INFOSYSTEMS, ET AL. V. EN
POINTE TECHNOLOGIES, INC., ET AL., and the complaint alleges that the
20
Company and Bob Din knowingly accepted trade secret information owned by the
plaintiffs and furthermore alleges that the Company interfered with the
plaintiffs' prospective economic advantage. The plaintiff is seeking unspecified
damages as well as injunctive relief. The Company is currently unable to
estimate the loss in the event of an unfavorable outcome. However, before
consideration of any potential insurance recoveries, the Company believes that
the claims in the suit will not have a material adverse effect on the Company's
business, financial position, results of operations or cash flows. The Company
has maintained various liability insurance policies during the periods covering
the claims above. While such policies may limit coverage under certain
circumstances, the Company believes that it is adequately insured. Should the
Company not be successful in defending against such lawsuit or not be able to
claim compensation under its liability insurance policies, the Company's
business, financial position, results of operations and cash flows may be
adversely affected.
The Company does not believe that any of the aforementioned claims have
merit, and intends to defend itself against all such claims.
The Company is also subject to other legal proceedings and claims that arise
in the normal course of business. While the outcome of these proceedings and
claims cannot be predicted with certainty, management does not believe that the
outcome of any of these matters will have a material adverse effect on the
Company's business, financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year ended September 30, 1997.
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is quoted on the Nasdaq National Market under the
symbol "ENPT." The following table sets forth, for the period indicated, the
high and low sale prices for the Common Stock as reported by the Nasdaq National
Market.
RANGE OF SALES
PRICES
------------------
HIGH LOW
------- -------
Fiscal 1996
Third quarter (from May 8, 1996)......................................... $13 1/8 $ 8 3/4
Fourth quarter........................................................... 11 1/4 8 1/4
Fiscal 1997
First quarter............................................................ $15 $ 9 1/8
Second quarter........................................................... 13 5/8 8 1/2
Third quarter............................................................ 11 1/4 8 3/8
Fourth quarter........................................................... 24 1/2 8 7/8
Fiscal 1998
First quarter (through December 22, 1997)................................ $23 1/2 $ 8 5/8
On December 22, 1997, the closing sale price for the Common Stock on the
Nasdaq National Market was $10.50 per share. As of December 22, 1997, there were
44 stockholders of record of the Common Stock.
The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain all available funds
for use in the operation of its business, and does not intend to pay any cash
dividends in the foreseeable future. The payment of any future dividends will be
at the discretion of the Company's Board of Directors and will depend upon,
among other factors, future earnings, operations, capital requirements, the
general financial condition of the Company and general business conditions. The
Company's ability to pay cash dividends is restricted by certain of the
Company's credit facilities, and the terms of future credit facilities or other
agreements may contain similar restrictions. See "Item 1. Business: Factors
Which May Affect Future Operating Results--Absence of Dividends."
22
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below as of September 30, 1996 and
1997 and for each of the years in the three year-period ended September 30, 1997
have been derived from the Company's Financial Statements and the related notes
thereto that have been audited by Coopers & Lybrand L.L.P., independent
accountants, which financial statements and report thereon are included
elsewhere in this Annual Report on Form 10-K.
The data set forth below should be read in conjunction with "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements of the Company and the Notes thereto
included elsewhere in this Annual Report on Form 10-K.
FISCAL YEAR ENDED SEPTEMBER 30,
---------------------------------------------------------
1993(1) 1994 1995 1996 1997
--------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net sales............................................. $ 19,327 $ 109,987 $ 200,797 $ 345,093 $ 491,358
Cost of sales......................................... 17,288 101,057 184,761 316,165 447,276
--------- ---------- ---------- ---------- ----------
Gross profit........................................ 2,039 8,930 16,036 28,928 44,082
Operating expenses:
Selling and marketing expenses...................... 1,277 5,493 9,307 15,253 22,339
General and administrative expenses................. 688 2,159 3,755 5,948 10,905
Litigation settlement and defense, net.............. -- -- -- 525 --
--------- ---------- ---------- ---------- ----------
Operating income.................................. 74 1,278 2,974 7,202 10,838
Interest expense...................................... 192 1,121 1,843 1,673 1,239
Other income, net..................................... (77) (159) (61) (116) (194)
--------- ---------- ---------- ---------- ----------
Income (loss) before income taxes................. (41) 316 1,192 5,645 9,793
Provision (benefit) for income taxes.................. (21) 129 489 2,315 3,962
--------- ---------- ---------- ---------- ----------
Net income (loss)................................. $ (20) $ 187 $ 703 $ 3,330 $ 5,831
--------- ---------- ---------- ---------- ----------
--------- ---------- ---------- ---------- ----------
Net income (loss) per share:
Primary............................................. $ (0.01) $ 0.06 $ 0.21 $ 0.77 $ 1.00
--------- ---------- ---------- ---------- ----------
--------- ---------- ---------- ---------- ----------
Fully diluted....................................... $ (0.01) $ 0.06 $ 0.21 $ 0.77 $ 0.95
--------- ---------- ---------- ---------- ----------
--------- ---------- ---------- ---------- ----------
Weighted average shares and share equivalents
outstanding (2):
Primary............................................. 2,137 3,197 3,410 4,302 5,811
--------- ---------- ---------- ---------- ----------
--------- ---------- ---------- ---------- ----------
Fully diluted....................................... 2,137 3,197 3,410 4,302 6,155
--------- ---------- ---------- ---------- ----------
--------- ---------- ---------- ---------- ----------
AS OF SEPTEMBER 30,
---------------------------------------------------------
1993 1994 1995 1996 1997
--------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
BALANCE SHEET DATA:
Working capital....................................... $ 290 $ 1,377 $ 2,286 $ 18,338 $ 24,753
Total assets.......................................... 9,784 24,462 36,792 64,923 90,862
Borrowings under line of credit and current portion of
notes payable....................................... 7,843 19,084 29,202 36,668 50,890
Notes payable......................................... 666 1,940 1,733 284 463
Stockholders' equity (deficit)........................ (11) 189 1,832 20,875 28,319
- ------------------------
(1) Fiscal 1993 consisted of approximately eight months from the Company's
inception on January 25, 1993.
(2) See Note 1 of Notes to Financial Statements.
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
THE FOLLOWING DISCUSSION AND ANALYSIS OF THE COMPANY'S FINANCIAL CONDITION
AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL
STATEMENTS AND THE NOTES THERETO INCLUDED ELSEWHERE IN THIS ANNUAL REPORT ON
FORM 10-K.
OVERVIEW
The Company was incorporated in January 1993 and commenced operations in
March 1993 as a reseller of information technology products. The Company began
emphasizing its value-added offerings to its customers in fiscal 1997.
Value-added services accounted for 1.6% of the Company's net sales in fiscal
1997. The gross profit margins on the value-added services which the Company
currently offers are significantly higher than the gross profit margins on the
Company's information technology products reselling business.
The Company's net sales have increased from $110.0 million in fiscal 1994
(the Company's first full year of operations) to $491.4 million in fiscal 1997,
representing a compound annual growth rate of 64.7%. The growth in net sales has
principally been driven by sales to new customers and increased sales to
existing customers as well as geographic expansion through the opening of
additional sales offices. The Company's gross profit margins have expanded from
8.1% in fiscal 1994 to 9.0% in fiscal 1997, principally due to increased
purchasing volume resulting in better purchasing terms, a shift to higher-margin
product sales, and sales of higher-margin value-added services. The Company's
operating income increased from $1.3 million in fiscal 1994 to $10.8 million in
fiscal 1997, representing a compound annual growth rate of 103.9%. The growth in
operating income has been principally driven by increased sales and gross profit
margins and a decline in general and administrative expenses, excluding software
development costs, as a percentage of net sales.
Product revenues are recognized upon shipment and satisfaction of
significant vendor obligations, if any. Service revenues are recognized based on
contractual hourly rates as services are rendered or upon completion of
specified contract services. Net sales consist of product and service revenues,
less discounts. Cost of sales include product and service costs and current and
estimated allowances for returns of products not accepted by the Company's
distributors or manufacturers, less any incentive credits.
Because the Company's business model involves the resale of information
technology products held in inventory by certain distributors, the Company does
not maintain significant amounts of inventory on hand for resale. The Company
typically does not place an order for product purchases from distributors until
it has received a customer purchase order. Inventory is then drop-shipped by the
distributor to either the customer or the Company's configuration center in
Memphis, Tennessee. The distributor typically ships products within 24 hours
following receipt of a purchase order and, consequently, substantially all of
the Company's net sales in any quarter result from orders received in that
quarter. Although the Company maintains little, if any, inventory in stock for
resale, it records as inventory the merchandise being configured and products
purchased from distributors, but not yet shipped to customers.
Because the Company does not experience significant differences for tax and
financial reporting purposes, the Company's effective tax rate has not varied
significantly from the statutory rate in the past, and the Company does not
anticipate that its effective tax rate will vary significantly from the
statutory rate in the future.
24
RESULTS OF OPERATIONS
The following table sets forth certain financial data as a percentage of net
sales for the periods indicated:
FISCAL YEAR ENDED SEPTEMBER 30,
-------------------------------------
1995 1996 1997
----------- ----------- -----------
Net sales..................................................... 100.0% 100.0% 100.0%
Cost of sales................................................. 92.0 91.6 91.0
----- ----- -----
Gross profit................................................ 8.0 8.4 9.0
Selling and marketing expenses................................ 4.6 4.4 4.6
General and administrative expenses........................... 1.9 1.7 2.2
Litigation settlement and defense, net........................ 0.0 0.2 0.0
----- ----- -----
Operating income............................................ 1.5 2.1 2.2
Interest expense.............................................. 0.9 0.5 0.2
Other income, net............................................. 0.0 0.0 0.0
----- ----- -----
Income before income taxes.................................. 0.6 1.6 2.0
Provision for income taxes.................................... 0.2 0.6 0.8
----- ----- -----
Net income.................................................. 0.4% 1.0% 1.2%
----- ----- -----
----- ----- -----
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1997 AND 1996
NET SALES. Net sales increased $146.3 million, or 42.4%, to $491.4 million
in fiscal 1997 from $345.1 million in fiscal 1996. The increase in net sales was
attributable to sales to new customers, increased sales to existing customers
and increased sales of value-added services. The Company opened four sales
offices in fiscal 1997, which contributed $10.6 million in net sales. Net sales
under the IBM contract increased $47.9 million in fiscal 1997 to $145.5 million
and accounted for 29.6% of net sales in fiscal 1997 compared with 28.3% of net
sales in fiscal 1996.
GROSS PROFIT. Gross profit increased $15.2 million, or 52.4%, to $44.1
million in fiscal 1997 from $28.9 million in fiscal 1996, and increased as a
percentage of net sales to 9.0% in fiscal 1997 from 8.4% in fiscal 1996. The
improvement in gross profit margin was primarily attributable to increased
purchasing volume resulting in better purchasing terms, a shift to higher-margin
product sales and sales of higher-margin value-added services.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased
$7.1 million, or 46.5%, to $22.3 million in fiscal 1997 from $15.3 million in
fiscal 1996, primarily as a result of increased sales volume. As a percentage of
net sales, selling and marketing expenses increased to 4.6% in fiscal 1997 from
4.4% in fiscal 1996, primarily due to the hiring of additional personnel and the
opening of four sales branch offices.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $5.0 million, or 83.3%, to $10.9 million in fiscal 1997 from $5.9
million in fiscal 1996. A significant factor contributing to the increase in
general and administrative expenses was an increase in software development
costs which increased to $2.3 million in fiscal 1997 from $0.3 million in fiscal
1996. In addition, the Company hired additional personnel to support the
increase in sales volume and other administrative duties. As a percentage of net
sales, general and administrative expenses increased to 2.2% in fiscal 1997 from
1.7% in fiscal 1996.
LITIGATION SETTLEMENT AND DEFENSE, NET. In April 1996, the Company entered
into a settlement agreement with a former employee relating to claims with
respect to the Company's use of certain proprietary software programs originally
developed by the employee prior to his employment with the Company (the
"Settlement"). As consideration for entering into the Settlement, the Company
agreed to pay the former employee installment payments totaling $1,225,000. The
remaining unpaid balance under
25
the Settlement as of September 30, 1997 and 1996 was $287,511 and $447,512,
respectively. In August 1996, the Company entered into a separate settlement
agreement with its insurance carrier whereby the insurance carrier reimbursed
the Company for all amounts paid by the Company pursuant to the Settlement, as
well as for certain legal expenses incurred by the Company in connection with
the Settlement and underlying claims. In fiscal 1996, the Company expensed
$524,913 in litigation and settlement defense costs, net of insurance
recoveries.
OPERATING INCOME. Operating income increased $3.6 million, or 50.5%, to
$10.8 million in fiscal 1997 from $7.2 million in fiscal 1996, primarily as a
result of increased sales volume accompanied by improved gross profit margins.
As a percentage of net sales, operating income improved to 2.2% in fiscal 1997
from 2.1% in fiscal 1996.
INTEREST EXPENSE. Interest expense decreased $434,000, or 25.9%, to $1.2
million in fiscal 1997 from $1.7 million in fiscal 1996. The decrease in
interest expense was primarily due to improved borrowing rates following the
Company's May 1996 initial public offering that resulted in the weighted average
interest rate declining from 10.8% in fiscal 1996 to 8.2% in fiscal 1997.
NET INCOME. Net income increased $2.5 million, or 75.1%, to $5.8 million in
fiscal 1997 from $3.3 million in fiscal 1996. The increase in net income
resulted primarily from the 42.4% increase in net sales and the related 52.4%
increase in gross profit, as well as the reduction in interest expense. As a
percentage of net sales, net income improved to 1.2% in fiscal 1997 from 1.0% in
fiscal 1996.
COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1996 AND 1995
NET SALES. Net sales increased $144.3 million, or 71.9%, to $345.1 million
in fiscal 1996 from $200.8 million in fiscal 1995. The increase in net sales was
attributable to sales to new customers and increased sales to existing
customers. The Company opened two sales offices in fiscal 1996, which
contributed $3.2 million in net sales. Net sales under the IBM contract
increased $73.6 million in fiscal 1996 to $97.6 million and accounted for 28.3%
of net sales in fiscal 1996 compared with 12.1% for fiscal 1995.
GROSS PROFIT. Gross profit increased $12.9 million, or 80.4%, to $28.9
million in fiscal 1996 compared to $16.0 million in fiscal 1995, and increased
as a percentage of net sales to 8.4% in fiscal 1996 from 8.0% in fiscal 1995.
The improvement in gross profit margin was primarily due to increased purchasing
volume resulting in better purchasing terms.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses increased
$5.9 million, or 63.9%, to $15.3 million in fiscal 1996 from $9.3 million in
fiscal 1995, primarily as a result of increased sales volume. As a percentage of
net sales, however, selling and marketing expenses decreased slightly to 4.4% in
fiscal 1996 from 4.6% in fiscal 1995, primarily due to fixed costs being spread
over a higher sales volume and a lower commission rate paid on sales to
high-volume customers.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $2.2 million, or 58.4%, to $5.9 million in fiscal 1996 from $3.8
million in fiscal 1995, primarily as a result of the hiring of additional
personnel to support the increase in sales volume and other administrative
activities. As a percentage of net sales, general and administrative expenses
decreased slightly to 1.7% in fiscal 1996 from 1.9% in fiscal 1995.
OPERATING INCOME. Operating income increased $4.2 million, or 142.2%, to
$7.2 million in fiscal 1996 from $3.0 million in fiscal 1995, primarily as a
result of increased sales volume, improved gross profit margins and a reduction
in operating expenses as a percentage of net sales. As a percentage of net
sales, operating income increased to 2.1% in fiscal 1996 from 1.5% in fiscal
1995. Excluding the net litigation and settlement and defense charge, operating
income would have been $7.7 million in fiscal 1996, or 2.2% of net sales.
INTEREST EXPENSE. Interest expense decreased $170,000, or 9.2%, to $1.7
million in fiscal 1996 from $1.8 million in fiscal 1995. The decrease in
interest expense was primarily due to applying $14.7 million of the net proceeds
from the Company's initial public offering to pay down the line of credit.
Offsetting that reduction in debt were increased borrowings to support accounts
receivable growth of $24.1 million.
26
NET INCOME. Net income increased $2.6 million, or 373.5%, to $3.3 million
in fiscal 1996 from $703,000 in fiscal 1995. The increase in net income resulted
primarily from the 71.9% increase in net sales, the related 80.4% increase in
gross profit and the reduction in operating expenses as a percentage of net
sales. As a percentage of net sales, net income improved to 1.0% in fiscal 1996
from 0.4% in fiscal 1995. Excluding the litigation and settlement charge, net
income would have been $3.6 million in fiscal 1996, or 1.1% of net sales.
QUARTERLY FINANCIAL RESULTS
The following tables sets forth certain unaudited quarterly financial data
and such data expressed as a percentage of net sales. The information has been
derived from the Company's unaudited financial statements that, in the opinion
of management, reflect all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of such quarterly information.
The operating results for any quarter are not necessarily indicative of the
results to be expected for any future period
QUARTER ENDED
FISCAL 1996
--------------------------------------------------------------
DEC. 31, 1995 MAR. 31, 1996 JUNE 30, 1996 SEPT. 30, 1996
------------- ------------- ------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net sales.............................................. $77,016 $79,893 $88,938 $99,246
Cost of sales.......................................... 70,955 73,254 81,465 90,491
------------- ------------- ------------- -------
Gross profit......................................... 6,061 6,639 7,473 8,755
Selling and marketing expenses......................... 3,304 3,271 4,033 4,647
General and administrative expenses.................... 851 1,182 1,730 2,184
Litigation settlement and defense, net................. 134 458 576 (644)
------------- ------------- ------------- -------
Operating income..................................... 1,772 1,728 1,134 2,568
Interest expense....................................... 579 562 350 181
Other income, net...................................... (27) (22) (33) (34)
------------- ------------- ------------- -------
Income before income taxes........................... 1,220 1,188 817 2,421
Provision for income taxes............................. 518 505 358 935
------------- ------------- ------------- -------
Net income........................................... $ 702 $ 683 $ 459 $ 1,486
------------- ------------- ------------- -------
------------- ------------- ------------- -------
Fully diluted net income per share................... $ 0.21 $ 0.20 $ 0.10 $ 0.26
------------- ------------- ------------- -------
------------- ------------- ------------- -------
Fully diluted weighted average shares and share
equivalents outstanding............................ 3,391 3,391 4,756 5,715
------------- ------------- ------------- -------
------------- ------------- ------------- -------
FISCAL 1997
--------------------------------------------------------------
DEC. 31, 1996 MAR. 31, 1997 JUNE 30, 1997 SEPT. 30, 1997
------------- ------------- ------------- --------------
Net sales.............................................. $111,666 $116,595 $128,400 $134,697
Cost of sales.......................................... 101,810 106,974 116,671 121,820
------------- ------------- ------------- --------------
Gross profit......................................... 9,856 9,621 11,729 12,877
Selling and marketing expenses......................... 5,383 4,778 5,737 6,442
General and administrative expenses.................... 2,141 2,340 3,194 3,231
Litigation settlement and defense, net................. -- -- -- --
------------- ------------- ------------- --------------
Operating income..................................... 2,332 2,503 2,798 3,204
Interest expense....................................... 332 283 311 312
Other income, net...................................... (57) (71) (44) (21)
------------- ------------- ------------- --------------
Income before income taxes........................... 2,057 2,291 2,531 2,913
Provision for income taxes............................. 870 967 1,070 1,054
------------- ------------- ------------- --------------
Net income........................................... $ 1,187 $ 1,324 $ 1,461 $ 1,859
------------- ------------- ------------- --------------
------------- ------------- ------------- --------------
Fully diluted net income per share................... $ 0.21 $ 0.23 $ 0.25 $ 0.30
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Fully diluted weighted average shares and share
equivalents outstanding............................ 5,784 5,817 5,784 6,191
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