ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceedings, other than ordinary routine litigation incidental to its business that management believes would not have a material adverse effect on its business, financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's authorized common stock consists of 51,000,000 shares of Common Stock, par value $.01 per share.
The Company's Common Stock has been publicly traded on the New York Stock Exchange under the symbol JIT since the Company's initial public offering on March 10, 1998. The following table sets forth the quarterly high and low sales prices for the indicated quarter of fiscal 1998:
QUARTER ENDED HIGH LOW ------------------- ---- --- March 31, 1998 (partial quarter commencing March 10, 1998)...................................... $14 $11 June 30, 1998......................................... 14 11/16 10 3/8 September 30, 1998................................... 12 3/4 5 1/2
There were approximately 172 shareholders of record (including brokerage firms and other nominees) of the Company's Common Stock as of December 15, 1998. The number of record holders does not bear any relationship to the number of beneficial owners of Common Stock.
The Company has never paid any cash dividends and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. The Company currently intends to retain earnings to support operations and finance expansion. In addition, the Company's existing credit facility prohibits the payment of dividends.
ORGANIZATION OF THE COMPANY
On November 18, 1997, and in connection with the initial formation of the Company, the Company sold 200,000, 125,000 and 125,000 shares of Common Stock of the Company to Messrs. Baldwin, Taten and Fontana, respectively, for $0.01 per share. As a result, the Company recorded non-recurring, non-cash compensation charges of $4.7 million in the fourth calendar quarter of 1997, representing the difference between the amount paid for the shares and the estimated initial public offering price, net of a 20% marketability discount. In February 1997, the Company also granted two consultants warrants to purchase an aggregate of 50,000 shares of Common Stock at $6.00 per share. In the first four months of 1997, the consultants provided business and legal consulting services for the Company in connection with its formation.
Simultaneously with the closing of its initial public offering, the Company acquired by merger all of the issued and outstanding capital stock of five businesses in separate transactions (the "Initial Acquisitions"): Alatec Products, Inc. (Alatec), AXS Solutions (AXS), Capitol Bolt & Supply, Inc. (Capitol), Maumee Industries, Inc. (Maumee), and Sales Systems, Limited (SSL) (collectively referred to as the "Founding Companies"), at which time each Founding Company became a wholly owned subsidiary of the Company. The aggregate consideration paid by the Company to acquire the Founding Companies consisted of (i) approximately $28.7 million in cash and (ii) 6,720,000 shares of Common Stock. In addition, certain indebtedness of the Founding Companies, which was personally guaranteed by Founding Company stockholders, was paid down in connection with the acquisitions.
In connection with the acquisitions of the Founding Companies, certain officers, directors and holders of more than 5% of the outstanding shares of the Company, together with trusts for which they act as trustees, received cash and shares of Common Stock of the Company as follows. These amounts do
not include any S-corporation distributions which were made by certain of the Founding Companies to their stockholders prior to the acquisition.
SHARES OF COMMON CASH STOCK --------- ---------- (IN THOUSANDS, EXCEPT SHARE DATA)
Donald B. List......... $12,666 2,969,493 Jack L. Fatica......... 3,423 1,081,003 Michael Black.......... 3,844 901,321 Benjamin E. Spence, Jr. 1,170 253,332 Mary E. McClure........ 661 179,470 ------- --------- Total............. $21,764 5,384,619 ======= =========
Pursuant to the agreements relating to the Founding Company acquisitions, all significant stockholders of each of the Founding Companies have agreed not to compete with the Company for a period of five years commencing on the date of closing of the acquisitions.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Pentacon Inc. was incorporated in March 1997. Simultaneously with the closing of the initial public offering of its common stock, on March 10, 1998, Pentacon acquired the Founding Companies. For financial reporting purposes, Alatec has been identified as the accounting acquiror. Accordingly, the historical financial statements of Alatec have become the historical financial statements of the Company. Since March 10, 1998, Pentacon has acquired in separate transactions (the "Subsequent Transactions" and, together with the Initial Acquisitions, the "Acquisitions") four additional businesses: Pace Products, Inc., D-Bolt Company, Inc., Texas International Aviation, Inc. and ASI Aerospace Group, Inc. The Companies acquired in the Acquisitions are referred to as the "Acquired Businesses."
ITEM 7
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
This discussion contains forward-looking statements that are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. Key factors that could cause actual results to differ materially from expectations include, but are not limited to; (1) estimates of costs or projected or anticipated changes to cost estimates relating to
entering new markets or expanding in existing markets; (2) changes in economic and industry conditions; (3) changes in regulatory requirements; (4) changes in interest rates; (5) levels of borrowings under the Company's Credit Facility; (6) accumulation of excess inventories by certain customers in the aerospace industry; and (7) volume or price adjustments with respect to sales to major customers. These and other risks and assumptions are described in the Company's reports that are available from the United States Securities and Exchange Commission.
RESULTS OF OPERATIONS
The pro forma financial information for the year ended September 30, 1998 and 1997 includes the results of Pentacon combined with the Founding Companies as if the Initial Acquisitions had occurred at the beginning of each year. The pro forma financial information includes the effects of (i) the Acquisitions (ii) the Offering (iii) certain reductions in salaries and benefits to the former owners of the Founding Companies to which they agreed prospectively (iv) certain reductions in lease expense paid to the former owners of the Founding Companies to which they agreed prospectively (v) elimination of non-recurring, non-cash compensation charges related to Common Stock issued to management (vi) amortization of goodwill resulting from the Acquisitions and (vii) advances under the Credit Facility including decreases in interest expense resulting from the repayment or refinancing of the Founding Companies' debt and (viii) adjustments to the provisions for federal and state income taxes. Acquisitions subsequent to the Offering are included in the pro forma financial information only for those periods subsequent to the dates of acquisition. The pro forma financial information may not be comparable to and may not be indicative of the Company's post-acquisition results of operations because the Founding Companies were not under common control or management.
PRO FORMA YEARS ENDED SEPTEMBER 30, 1998 AND 1997
The following table sets forth certain selected pro forma financial data as a percentage of pro forma revenues: PRO FORMA YEAR ENDED SEPTEMBER 30, ------------------------------------- 1998 1997 ------------------ ----------------- (DOLLAR AMOUNTS IN THOUSANDS) Revenues ............................... $187,059 100.0% $146,117 100.0% Cost of sales ......................... 122,621 65.6 96,659 66.2 -------- ----- -------- ----- Gross profit ........ 64,438 34.4 49,458 33.8
Operating expenses ..................... 44,524 23.8 35,470 24.3 Goodwill amortization .................. 1,733 0.9 1,496 1.0 -------- ----- -------- ----- Operating income .... $ 18,181 9.7 $ 12,492 8.5 ======== ===== ======== =====
REVENUES
Pro forma revenues increased 28.0%, or $41.0 million, to $187.1 million for the year ended September 30, 1998 from $146.1 million for the year ended September 30, 1997. The increase in pro forma revenues was attributable to internal revenue growth of the Founding Companies of $21.7 million, or 14.8%, with the remainder resulting from acquisitions during the year ended September 30, 1998. The increase in Founding Companies' pro forma revenues primarily resulted from increases in sales to existing customers in the industrial sector.
COST OF SALES
Pro forma cost of sales increased $25.9 million, or 26.8%, to $122.6 million for the year ended September 30, 1998 from $96.7 million for the year ended September 30, 1997. As a percentage of pro forma revenues, pro forma cost of sales decreased from 66.2% in the year ended September 30, 1997 to 65.6% in the year ended September 30, 1998. The decrease in pro forma cost of sales as a percentage of pro forma revenues was a result of a reduction in the percentage of pro forma cost of sales as a percentage of pro forma revenues at the Founding Companies due to the ability to implement selective price increases and improvements in product mix. This reduction was partially offset by higher pro forma cost of sales as a percentage of pro forma revenues experienced by companies acquired during the year ended September 30, 1998.
OPERATING EXPENSES
Pro forma operating expenses increased $9.0 million, or 25.4%, to $44.5 million for the year ended September 30, 1998 from $35.5 million for the year ended September 30, 1997. As a percentage of pro forma revenues, pro forma operating expenses decreased to 23.8% for the year ended September 30, 1998 from 24.3% for the year ended September 30, 1997. The decrease was attributable to lower pro forma operating expenses as a percentage of revenues for the companies acquired during the year ended September 30, 1998 partially offset by an increase in pro forma operating expenses as a percentage of revenues of the Founding Companies from 24.3% for the year ended September 30, 1997 to 24.8% for the year ended September 30, 1998. The Founding Companies' increase in pro forma operating expenses as a percentage of pro forma revenues was a result of increased commissions on international sales, increased professional fees incurred in connection with the purchase transaction and the costs of establishing a corporate office.
OPERATING INCOME
Due to the factors discussed above, pro forma operating income increased $5.7 million to $18.2 million for the year ended September 30, 1998 from $12.5 million for the year ended September 30, 1997. As a percentage of pro forma revenues, pro forma operating income increased to 9.7% for the year ended September 30, 1998 from 8.5% for the year ended September 30, 1997.
HISTORICAL PERIODS ENDED SEPTEMBER 30, 1998 AND 1997 AND DECEMBER 31, 1996
The historical financial information represents the information of Alatec prior to the Acquisitions and the Offering and the consolidated results of Pentacon subsequent to the Acquisitions and the Offering on March 10, 1998. The following table sets forth certain selected historical financial data as a percentage of historical revenues for the periods indicated:
YEAR ENDED NINE MONTHS YEAR ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, DECEMBER 31, 1998 1997 1996 ---------------- ----------------- ----------------- (DOLLAR AMOUNTS IN THOUSANDS) Revenues ............. $141,078 100.0% $ 42,296 100.0% $ 44,726 100.0% Cost of sales ........ 91,026 64.5 25,114 59.4 26,707 59.7 -------- ----- -------- ----- -------- ----- Gross profit...... 50,052 35.5 17,182 40.6 18,019 40.3
Operating expenses ... 36,524 25.9 11,664 27.6 12,818 28.7 Goodwill amortization 1,111 0.8 -- -- -- -- -------- ----- -------- ----- -------- ----- Operating income.. $ 12,417 8.8 $ 5,518 13.0 $ 5,201 11.6 ======== ===== ======== ===== ======== =====
HISTORICAL YEAR ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1997
REVENUES
Revenues increased $98.8 million, or 233.6% from $42.3 million for the nine months ended September 30, 1997 to $141.1 million for the year ended September 30, 1998. The increase in revenues primarily results from the Acquisitions and the Offering on March 10, 1998 and the acquisitions of other companies during the year ended September 30, 1998. (See Note 2 to the Financial Statements).
COST OF SALES
Cost of sales increased $65.9 million, or 262.5%, from $25.1 million for the nine months ended September 30, 1997 to $91.0 million for the year ended September 30, 1998. The increase in revenues primarily results from the Acquisitions and the Offering on March 10, 1998 and the acquisitions of other companies during the year ended September 30, 1998. (See Note 2 to the Financial Statements).
OPERATING EXPENSES
Operating expenses increased $24.8 million, or 212.0%, from $11.7 million for the nine months ended September 30, 1997 to $36.5 million for the year ended September 30, 1998. The increase in revenues primarily results from the Acquisitions and the Offering on March 10, 1998 and the acquisitions of other companies during the year ended September 30, 1998. (See Note 2 to the Financial Statements).
OPERATING INCOME
Operating income increased $6.9 million, or 125.5%, from $5.5 million for the nine months ended September 30, 1997 to $12.4 million for the year ended September 30, 1998 due to the factors noted above.
HISTORICAL NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES
Revenues increased $9.0 million, or 27.0%, from $33.3 million for the nine months ended September 30, 1996 to $42.3 million for the nine months ended September 30, 1997. Approximately $1.0 million of this increase was attributable to new customers and approximately $8.0 million was due to an increase in net sales to existing customers. Revenues for the year ended December 31, 1996 were $44.7 million compared to revenues for the nine months ended September 30, 1997 of $42.3 million.
COST OF SALES
As a percentage of revenues, cost of sales remained relatively constant at 59.4% in the nine months ended September 30, 1997 compare to 59.7% in the year ended December 31, 1996.
OPERATING EXPENSES
As a percentage of revenues, operating expenses decreased from 28.7% in the year ended December 31, 1996 to 27.6% in the nine months ended September 30, 1997. This percentage decrease was a result of the increase in revenues without a commensurate increase in administrative costs.
OPERATING INCOME
As a percentage of revenues, operating income increased from 11.6% in the year ended December 31, 1996 to 13.0% in the nine months ended September 30, 1997 as a result of the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
The Company used $18.7 million of net cash from operating activities during the year ended September 30, 1998, primarily for working capital requirements. Net cash used in investing activities was $102.1 million, $21.9 million of which represents the cash paid for the Founding Companies, net of cash acquired, and $77.0 million of which represents cash paid for acquisitions, net of cash acquired. Net cash provided by financing activities was $121.0 million for the year ended September 30, 1998 and primarily consisted of $50.8 million net proceeds of the Offering and $171.6 million of borrowings on long-term debt partially offset by $99.9 million repayment of long-term debt. At September 30, 1998, the Company had cash of $.8 million, working capital of $68.2 million and total debt of $149.9 million.
Effective September 3, 1998, the Company amended its credit agreement with NationsBank of Texas, N.A. (the "Credit Facility"). The Credit Facility provides the Company with a revolving line of credit of up to $175 million, which may be used for general corporate purposes, future acquisitions, capital expenditures and working capital. The Credit Facility is secured by Company stock and assets. Advances under the Credit Facility bear interest at the bank's designated variable rate plus margins ranging from 0 to 50 basis points, depending on the ratio of the Company's interest-bearing debt to its pro forma trailing earnings before interest, taxes, depreciation and amortization ("EBITDA") for the previous four quarters. At the Company's option, the loans may bear interest based on a designated London interbank offering rate plus a margin ranging from 75 to 212.5 basis points, depending on the same ratios. Commitment fees of 20 to 37.5 basis points per annum are payable on the unused portion of the line of credit, based on the same ratio. The Credit Facility contains a provision for standby letters of credit up to $5.0 million. The Credit Facility prohibits the payment of dividends by the Company, restricts the Company's incurring or assuming other indebtedness and requires the Company to comply with certain financial covenants including a minimum net worth and minimum fixed charge ratio. The Credit Facility will terminate and all amounts outstanding thereunder, if any, will be due and payable September 3, 2003. At September 30, 1998, the Company has approximately $5.8 million available under the Credit Facility.
The Credit Facility also contains provisions for quarterly reductions in the ratio of the Company's interest-bearing debt to its pro forma trailing EBITDA. Based upon the Company's projections of the ensuing year's pro forma trailing EBITDA, a portion of the borrowings under the Credit Facility has been classified as current liabilities.
In December 1998, the Company reached agreement in substance, subject to execution of appropriate documentation, with the lenders under the Credit Facility to amend certain provisions of the Credit Facility. The amendment would, among other things, adjust the step down reductions in the ratio of the Company's interest-bearing debt to pro forma EBITDA, reduce the line of credit to $150 million and to $130 million on March 1, 1999, increase the amount of subordinated debt permitted under the Credit Facility, shorten the term of the facility to three years, and increase the interest rate on the Company's LIBOR-based borrowings under the Credit Facility from LIBOR plus 212.5 basis points to LIBOR plus 300 basis points.
On March 10, 1998, the Company completed the Offering, which involved the sale by the Company of 5,980,000 shares of Common Stock at a price to the public of $10.00 per share, including 780,000 shares pursuant to an over-allotment option granted by the Company to the underwriters in connection with the Offering. The net proceeds to the Company from the Offering (after deducting
underwriting discounts, commissions and offering expenses) were approximately $50.8 million. Of this amount, $23.3 million was used to pay the cash portion of the purchase price relating to the Acquisitions of the Founding Companies with the remainder being used to pay certain indebtedness of the Founding Companies, make capital expenditures and fund working capital requirements.
The Company may require significant additional capital and/or debt. The Company intends to seek additional capital as necessary to fund its operating plans through one or more funding sources that may include borrowings under the Credit Facility or offerings of debt and/or equity securities of the Company. As noted above, the Company's Credit Facility anticipates certain reductions in the line of credit made available under the Credit Facility. Management is exploring alternatives to obtain additional capital and/or debt, or refinance all or a portion of its existing debt, in order to remain in compliance with these covenants. Although management believes that it will be able to obtain such additional capital or debt or will be able to refinance its existing debt, there can be no assurances that sufficient funds will be available to the Company at the time it is required or on terms acceptable to the Company. Failure of the Company to obtain such additional capital or debt, or to refinance its existing debt, would have a material and adverse effect on the Company.
On April 20, 1998, the Company's registration statement covering 3,350,000 additional shares of Common Stock for use in connection with future acquisitions was declared effective. During the year ended September 30, 1998, 1,134,010 shares of Common Stock were issued in connection with acquisitions (See Note 2 to the Financial Statements).
The Company currently operates in a decentralized information systems environment and uses a variety of software, computer systems and related technologies for accounting and reporting purposes and for revenue-generating activities. The Pentacon companies which primarily serve the aerospace industry are in the process of migrating to a common information system which will facilitate product ordering, pricing and reporting among the companies. The total expenditures for these information systems are expected to be approximately $3.0 million, the majority of which will be capitalized as computer hardware and software as it is installed and depreciated over the estimated useful life of the assets. Funding for these expenditures will come from operating cash flows and funding under the Company's Credit Facility as necessary.
SEASONALITY AND QUARTERLY FLUCTUATIONS
The Company experiences seasonal declines in the fourth calendar quarter due to declines in its customers' activities in that quarter. The Company's volume of business may be adversely affected by a decline in projects as a result of regional or national downturns in economic conditions. Quarterly results may also be materially affected by the timing of acquisitions and the timing and magnitude of acquisition assimilation costs. Accordingly, the operating results for any three-month period are not necessarily indicative of the results that may be achieved for any subsequent fiscal quarter or for a full fiscal year.
YEAR 2000
The Company is working to resolve the potential impact of the Year 2000 on the processing of date-sensitive information by the Company's computerized information systems and other infrastructure that contains embedded technology. The Year 2000 problem is the result of computer programs being written using two digits (rather than four) to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize a date using "00" as the Year 1900 rather than the Year 2000, which could result in miscalculations or system failures.
The Company believes that substantially all of its computerized information systems and other infrastructure that contains embedded technology are Year 2000 compliant or will be modified so as to become Year 2000 compliant by mid-1999. Based on preliminary information, costs of addressing potential problems are not currently expected to have a material adverse impact on the Company's financial position, results of operations or cash flows. However, if the Company, its customers or vendors are unable to resolve such processing issues in a timely manner, it could have a significant impact on the Company's ability to conduct its business and result in a material financial risk.
In addition, the Company is continually attempting to assess the level of Year 2000 preparedness of its key suppliers, distributors, customers and service providers. The Company has sent, and will continue to send, letters, questionnaires and surveys to its significant business partners inquiring about their Year 2000 efforts. If a significant supplier or customer of the Company fails to be Year 2000 compliant, the Company could suffer a material loss of business or incur material expenses.
As of September 30, 1998, the Company has spent $0.1 million in costs that are directly attributable to addressing Year 2000 issues. Management currently estimates that the Company will incur $0.3 million in additional costs during 1999 relating to Year 2000 issues. The Company expects that it will spend approximately $3.0 million to purchase software and hardware and on implementation expenses associated with the migration to a common information technology system in the company's Aerospace Group. The Company believes that these costs are not, for the most part, directly related to Year 2000 issues, but are required for the implementation of its new system in the Aerospace Group.
The Company is developing and evaluating contingency plans in the event that the Company has not completed all of its remediation plans in a timely manner or if third parties who provide goods or services to the Company fail to address their Year 2000 issues appropriately. These plans include identification of alternative suppliers and service providers, depletion of safety stocks of inventory and identification of important areas of record retention.
INFLATION
Inflation has not had a material impact on the Company's results of operations for the last three years.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to market risk exposure related to changes in interest rates on its credit facility, which includes revolving credit notes and term notes. These instruments carry interest at a pre-agreed upon percentage point spread from either the prime interest rate or LIBOR. Under its credit facility, the Company may, at its option, fix the interest rate for certain borrowings based on a spread over LIBOR for 30 days to 6 months. At September 30, 1998, the Company had $146.3 million outstanding under its Credit Facility. Based on this balance, an immediate change of one percent in the interest rate would cause a change in interest expense of approximately $1,463,000 on an annual basis. The Company's objective in maintaining these variable rate borrowings is the flexibility obtained regarding early repayment without penalties and lower overall cost as compared with fixed-rate borrowings.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders:
We have audited the accompanying consolidated balance sheets of Pentacon, Inc. as of September 30, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for the year ended September 30, 1998 and the nine months ended September 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pentacon, Inc. at September 30, 1998 and 1997, and the consolidated results of its operations and its cash flows for the year ended September 30, 1998 and the nine months ended September 30, 1997 in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Houston, Texas December 24, 1998
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors Alatec Products, Inc. Chatsworth, California
We have audited the accompanying consolidated statements of operations, stockholders' equity and cash flows of Alatec Products, Inc., for the year ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Alatec Products, Inc., for the year ended December 31, 1996 in conformity with generally accepted accounting principles.
As discussed in Note 1 to the Pentacon, Inc. financial statements, on March 10, 1998 Alatec Products, Inc. was acquired by Pentacon, Inc. For financial reporting purposes, Alatec Products, Inc. has been identified as the accounting acquiror and, therefore, the 1996 financial statements of Pentacon, Inc. represent the historical financial statements of Alatec Products, Inc.
McGLADREY & PULLEN, LLP
Pasadena, California November 21, 1997
PENTACON, INC. CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, ------------------- 1998 1997 -------- -------- (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
Cash and cash equivalents .......................... $ 835 $ 733 Accounts receivable ................................ 40,670 7,892 Inventories ........................................ 112,392 22,951 Deferred income taxes .............................. 4,430 1,420 Other current assets ............................... 923 -- -------- --------
Total current assets ........... 159,250 32,996 -------- -------- Property and equipment, net of accumulated depreciation ...................................... 7,077 1,578 Goodwill, net of accumulated amortization .......... 135,381 -- Deferred income taxes .............................. 670 65 Other assets ....................................... 2,013 272 -------- -------- Total assets ................... $304,391 $ 34,911 ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable ................................... $ 30,314 $ 7,521 Accrued expenses ................................... 7,281 1,362 Income taxes payable ............................... 1,988 3,594 Current maturities of long-term debt ............... 51,513 364 -------- -------- Total current liabilities ...... 91,096 12,841
Long-term debt, net of current maturities .......... 98,381 13,686 -------- -------- Total liabilities .............. 189,477 26,527 -------- -------- Commitments and contingencies
Preferred stock, $.01 par value, 10,000,000 shares authorized, no shares issued and outstanding in 1998 ............................... -- -- Common stock, $.01 par value, 51,000,000 shares authorized, 16,668,129 shares issued and outstanding in 1998 and $10 par value, 2,500,000 shares authorized, 145,000 shares issued and outstanding in 1997 ............. 167 1,450 Treasury stock ..................................... -- (2,690) Additional paid in capital ......................... 100,436 -- Retained earnings .................................. 14,311 9,624 -------- -------- Total stockholders' equity ....... 114,914 8,384 -------- -------- Total liabilities and stockholders' equity ......... $304,391 $ 34,911 ======== ========
The accompanying notes are an integral part of these statements.
PENTACON, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, 1998 1997 1996 ------------- ----------------- ------------ (IN THOUSANDS, EXCEPT SHARE DATA)
Revenues ......................... $ 141,078 $ 42,296 $ 44,726 Cost of sales .................... 91,026 25,114 26,707 --------- --------- --------- Gross profit ........... 50,052 17,182 18,019
Operating expenses ............... 36,524 11,664 12,818 Goodwill amortization ............ 1,111 -- -- --------- --------- ---------
Operating income ....... 12,417 5,518 5,201
Other (income) expense, net ...... (91) (26) (56) Interest expense ................. 2,448 1,015 1,118 --------- --------- ---------
Income before taxes .... 10,060 4,529 4,139 Income taxes ..................... 5,373 1,860 1,628 --------- --------- ---------
Net income ............. $ 4,687 $ 2,669 $ 2,511 ========= ========= =========
Net income per share: Basic .................. $ 0.45 $ 0.90 $ 0.85 Diluted ................ $ 0.45 $ 0.90 $ 0.85
The accompanying notes are an integral part of these statements.
PENTACON, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
(1) Net of the effects of acquisitions.
The accompanying notes are an integral part of these statements.
PENTACON, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)
The accompanying notes are an integral part of these statements.
PENTACON, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: Pentacon, Inc. ("Pentacon" or the "Company") was incorporated in March 1997. On March 10, 1998, Pentacon and separate wholly-owned subsidiaries acquired in separate transactions (the "Acquisitions"), simultaneously with the closing of its initial public offering (the "Offering") of its common stock (the "Common Stock"), five businesses: Alatec Products, Inc. (Alatec), AXS Solutions, Inc. (AXS), Capitol Bolt & Supply, Inc. (Capitol), Maumee Industries, Inc. (Maumee), and Sales Systems, Limited (SSL), collectively referred to as the "Founding Companies." The consideration for the Acquisitions of the Founding Companies consisted of a combination of cash and Common Stock. Because (i) the stockholders of the Founding Companies owned a majority of the outstanding shares of Common Stock following the Offering and the Acquisitions, and (ii) the stockholders of Alatec received the greatest number of shares of Common Stock among the stockholders of the Founding Companies, for financial statement presentation purposes, Alatec has been identified as the accounting acquiror. The Acquisitions of the remaining Founding Companies have been accounted for using the purchase method of accounting. Alatec's historical financial statements for all periods prior to March 10, 1998 are presented as the historical financial statements of the Company. Unless the context otherwise requires, all references herein to the Company include Pentacon and the Founding Companies. The allocations of the purchase price to the assets acquired and liabilities assumed of the Founding Companies has been initially assigned and recorded based on preliminary estimates of fair value and may be revised as additional information concerning the valuation of such assets and liabilities becomes available.
Pentacon distributes fasteners and other small parts and provides related inventory management services primarily to customers in the United States.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of Pentacon, Inc. and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
REVENUE RECOGNITION: Revenues are recognized upon shipment of products.
CASH EQUIVALENTS: Short-term investments purchased with original maturities of three months or less are considered cash equivalents.
INVENTORIES: Inventories consist of products held for resale and are stated at the lower of cost, determined using the first-in, first-out method, or market.
INCOME TAXES: The Company recognizes deferred tax assets and liabilities for expected future tax consequences of events that have been recognized in the financial statements or tax returns. Deferred tax assets and liabilities are determined based on the differences between the financial statements carrying amounts and the tax basis of assets and liabilities using enacted tax rates and laws in effect in the years in which the differences are expected to reverse.
PROPERTY AND EQUIPMENT: Property and equipment is stated at cost. Depreciation is provided over the estimated useful lives of the related assets using primarily the straight-line method. The amortization expense on assets acquired under capital leases is included with depreciation expense on owned assets.
GOODWILL: Goodwill is amortized over a period of 40 years. The carrying value of goodwill is reviewed if there are indications that the goodwill may be impaired. If this review indicates that the
goodwill will not be recoverable, as determined based on undiscounted cash flows over the remaining amortization periods, the carrying value of the goodwill will be reduced by the estimated shortfall in discounted cash flow.
USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK: The Company performs credit evaluations of its customers and generally does not require collateral. The Company maintains an allowance for doubtful accounts based upon the expected collectibility of all accounts receivable. The allowance for doubtful accounts and related activity were not material at and for the periods ended September 30, 1998 and 1997 and December 31, 1996. One customer accounted for approximately 12% of revenues for the year ended September 30, 1998. Accounts receivable balances related to this customer represented approximately 9% of total accounts receivable at September 30, 1998.
FAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying amounts of accounts receivable, prepaid expenses and accounts payable approximate fair values due to the short-term maturities of these instruments. The carrying value of the Company's debt facilities and capital lease obligations approximate fair value since the rates on such facilities are variable, based on current market or are at fixed rates currently available to the Company.
EXPORT SALES: The Company recorded export sales of $18,584,000, $9,434,000, and $8,875,000 in the year ended September 30, 1998, the nine months ended September 30, 1997 and the year ended December 31, 1996, respectively. The Company has export sales through its foreign sales corporation to Europe, the Far East, Canada, South America, Australia and Mexico, of which no country or region is individually significant.
COMMON STOCK BASED COMPENSATION: The Company follows the intrinsic value method of accounting for stock options and performance-based stock awards as prescribed by Accounting Principles Board Opinion No. 25 (APB 25), ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES.
RECENTLY ISSUED ACCOUNTING STANDARDS: In June 1997, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 130, REPORTING COMPREHENSIVE INCOME and Statement No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. These statements, which are effective for fiscal years beginning after December 15, 1997, expand and modify disclosures and, accordingly, will have no impact on the Company's net income or financial position.
In March 1998, the AICPA issued SOP 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE OBTAINED FOR INTERNAL USE. The SOP requires companies to capitalize qualifying computer software costs incurred during the application development stage. The SOP is effective for fiscal years beginning after December 15, 1998 and permits early adoption. The Company adopted the SOP in the quarter ended March 31, 1998. The adoption had no impact on net income as the Company's policy was materially consistent with the requirements of the SOP.
In April 1998, the AICPA issued SOP 98-5, ACCOUNTING FOR THE COSTS OF START-UP ACTIVITIES. The SOP requires that all costs of start-up activities be expensed as incurred. The SOP is effective for fiscal years beginning after December 15, 1998 and permits early adoption. The Company adopted this standard in the quarter ended September 30, 1998. The adoption had no impact on net income as the Company's policies were consistent with this standard.
In June 1998, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS No. 133"). SFAS No. 133 requires that all derivatives be recognized as assets and liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999 and early adoption is permitted. Because of the Company's minimal use of derivatives, management does not anticipate that the adoption of SFAS No. 133 will have a significant effect on net income or the financial position of the Company.
2. ACQUISITIONS
During the year ended September 30, 1998, the Company completed four acquisitions in addition to the acquisitions of the Founding Companies. In May 1998, the Company acquired Pace Products, Inc., a distributor of fasteners and other small parts which also provides inventory procurement and management services primarily to the telecommunications industry. In June 1998, the Company acquired D-Bolt Company Inc., a distributor of fasteners and other small parts primarily to the fabrication, construction and mining industries. In July 1998, the Company acquired Texas International Aviation, Inc., a distributor of fasteners and other small parts which provides inventory procurement and management services primarily to the aerospace industry. In September 1998, the Company acquired ASI Aerospace Group, Inc., a distributor of fasteners and other small parts which provides inventory procurement and management services primarily to the aerospace industry. The consideration paid consisted of an aggregate of 1,134,010 shares of Common Stock and approximately $77.0 million in cash. The acquisitions were accounted for using the purchase method of accounting and the results of operations of the acquired companies are included from the date of acquisition. The allocations of purchase price to the assets acquired and liabilities assumed has been initially assigned and recorded based on preliminary estimates of fair value and may be revised as additional information concerning the valuation of such assets and liabilities becomes available.
If all acquisitions completed during the year ended September 30, 1998, including the Founding Companies, were effective on the first day of the period being reported, the unaudited pro forma revenues, gross margin, operating income and net income would have been:
YEAR ENDED SEPTEMBER 30, -------------------------- 1998 1997 ------------ ----------- (IN THOUSANDS, EXCEPT SHARE DATA)
Revenues ........................ $ 283,794 $ 223,673 Gross margin .................... 94,981 73,021 Operating income ................ 31,835 20,129 Net income ...................... 11,240 4,450 Net income per share: Basic ...................... $ 0.67 $ 0.27 Diluted .................... $ 0.67 $ 0.27
3. PROPERTY AND EQUIPMENT AND GOODWILL
USEFUL SEPTEMBER 30, LIVES IN ----------------------- YEARS 1998 1997 -------- ---------- --------- (DOLLAR AMOUNTS IN THOUSANDS)
Buildings .......................... 10-40 $ 2,476 $ 1,637 Leasehold improvements ............. 6-39 1,078 208 Equipment .......................... 3-8 4,299 1,234 Furniture and fixtures ............. 5-7 1,198 327 Construction in progress ........... -- 402 -- ------- ------- 9,453 3,406
Less accumulated depreciation and amortization ............... (2,376) (1,828) ------- ------- $ 7,077 $ 1,578 ======= =======
SEPTEMBER 30, ------------------- 1998 1997 -------- ------ (DOLLAR AMOUNTS IN THOUSANDS)
Goodwill ................................................. $ 136,492 $ -- Less accumulated amortization ............................ (1,111) -- --------- ------ $ 135,381 $ -- ========= ======
4. CREDIT FACILITY, LONG-TERM DEBT AND LEASES
Effective September 3, 1998, the Company amended its credit agreement with NationsBank of Texas, N.A. (the "Credit Facility"). The Credit Facility provides the Company with a revolving line of credit of up to $175 million, which may be used for general corporate purposes, future acquisitions, capital expenditures and working capital. The Credit Facility is secured by Company stock and assets. Advances under the Credit Facility bear interest at the bank's designated variable rate plus margins ranging from 0 to 50 basis points, depending on the ratio of the Company's interest-bearing debt to its pro forma trailing earnings before interest, taxes, depreciation and amortization ("EBITDA") for the previous four quarters. At the Company's option, the loans may bear interest based on a designated London interbank offering rate plus a margin ranging from 75 to 212.5 basis points, depending on the same ratios. Commitment fees of 20 to 37.5 basis points per annum are payable on the unused portion of the line of credit, based on the same ratio. The Credit Facility contains a provision for standby letters of credit up to $5.0 million. The Credit Facility prohibits the payment of dividends by the Company, restricts the Company's incurring or assuming other indebtedness and requires the Company to comply with certain financial covenants including a minimum net worth and minimum fixed charge ratio. The Credit Facility will terminate and all amounts outstanding thereunder, if any, will be due and payable September 3, 2003. At September 30, 1998, the Company has approximately $5.8 million available under the Credit Facility.
The Credit Facility also contains provisions for quarterly reductions in the ratio of the Company's interest-bearing debt to its pro forma trailing EBITDA. Based upon the Company's projections of the ensuing year's pro forma trailing EBITDA, a portion of the borrowings under the Credit Facility has been classified as current liabilities.
In December 1998, the Company reached agreement in substance, subject to execution of appropriate documentation, with the lenders under the Credit Facility to amend certain provisions of the Credit Facility. The amendment would, among other things, adjust the step down reductions in the ratio of the Company's interest-bearing debt to pro forma EBITDA, reduce the line of credit to $150 million and to $130 million on March 1, 1999, increase the amount of subordinated debt permitted under the Credit Facility, shorten the term of the facility to three years, and increase the interest rate on the Company's LIBOR-based borrowings under the Credit Facility from LIBOR plus 212.5 basis points to LIBOR plus 300 basis points.
As noted above, the Company's Credit Facility anticipates certain reductions in the line of credit made available under the Credit Facility. Management is exploring alternatives to obtain additional capital and/or debt, or refinance all or a portion of its existing debt, in order to remain in compliance with these covenants. Although management believes that it will be able to obtain such additional capital or debt or will be able to refinance its existing debt, there can be no assurances that sufficient funds will be available to the Company at the time it is required or on terms acceptable to the Company. Failure of the Company to obtain such additional capital or debt, or to refinance its existing debt, would have a material and adverse effect on the Company.
Maturities of long-term debt (excluding capital leases) for the five years subsequent to September 30, 1998 are $51,326,000, $10,171,000, $10,171,000, $10,122,000, and $65,222,000.
The Company leases a portion of its buildings and equipment under noncancelable capital and operating leases. Future minimum lease payments under the capital and operating leases, together with
the present value of the net minimum lease payments, as of September 30, 1998 are as follows:
CAPITAL OPERATING LEASES LEASES TOTAL ----------- ----------- -------- (DOLLAR AMOUNTS IN THOUSANDS) FISCAL YEAR ENDING: 1999 ................................. 510 2,985 $3,495 2000 ................................. 494 2,652 3,146 2001 ................................. 490 2,353 2,843 2002 ................................. 421 1,997 2,418 2003 ................................. 378 1,582 1,960 Thereafter ........................... 2,375 6,365 8,740 ------ ------ ------ Total minimum lease payments ......... 4,668 17,934 22,602
Less amount representing interest .... 1,876 ------- Present value of net minimum lease payments .............. 2,792 Current maturities ................... 187 ------- Long-term portion .................... $ 2,605 =======
Total rental and interest expense under operating and capital leases for the year ended September 30, 1998, the nine months ended September 30, 1997, and the year ended December 31, 1996 was approximately $1,775,000, $640,000, and $778,000, respectively, including amounts to related parties of $807,000, $451,000, and $359,000, respectively. Total minimum lease payments include payments due to stockholders of $2,401,000 for capital leases and $7,082,000 for operating leases.
5. INCOME TAXES
The Company will file a consolidated federal income tax return which includes the operations of the Founding Companies for periods subsequent to the Acquisitions. The Founding Companies will file "short period" federal and state income tax returns through the date of the Acquisitions.
Deferred income taxes as reflected on the historical financial statements as of September 30, 1997 include the activity of the accounting acquiror only. Although deferred income taxes on the September 30, 1998 historical financial statements reflect the activity of the accounting acquiror for the entire year, the remaining Founding Companies are included for all periods subsequent to March 10, 1998, the date of the Acquisitions. Also reflected in deferred income taxes on the September 30, 1998 historical financial statements are the deferred income taxes acquired through various acquisitions during the year ended September 30, 1998 which were unrelated to the original Acquisitions.
If it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance to reduce the deferred tax assets reported is required based on the weight of evidence. After consideration of all the evidence, both positive and negative, no valuation allowance is necessary to reduce the deferred tax assets at September 30, 1998 as the Company believes it will realize the deferred tax assets principally through future earnings.
Components of income tax expense are as follows:
NINE MONTHS YEAR ENDED ENDED YEAR ENDED SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, 1998 1997 1996 ------------- -------------- ------------- (DOLLAR AMOUNTS IN THOUSANDS) Currently paid or payable: Federal................... $ 3,949 $ 1,496 $ 1,611 State..................... 1,531 360 389 -------- -------- -------- 5,480 1,856 2,000 Deferred: Federal................... (77) 3 (357) State..................... (30) 1 (15) -------- -------- -------- (107) 4 (372) -------- -------- -------- $ 5,373 $ 1,860 $ 1,628 ======== ======== =========
The net deferred tax assets (liabilities) consist of the following:
SEPTEMBER 30, ------------------------ 1998 1997 ----------- ---------- (DOLLAR AMOUNTS IN THOUSANDS) Deferred tax assets: Receivables allowance ........................ $ 276 $ 75 Inventory allowance .......................... 2,002 632 Accrued expenses ............................. 1,011 243 Uniform cost capitalization .................. 854 583 Property and equipment ....................... 670 198 Other ........................................ 608 -- ------- ------- 5,421 1,731 ------- -------
Deferred tax liabilities, other ................... (321) (246) ------- -------
$ 5,100 $ 1,485 ======= =======
Net deferred taxes consist of the following: Current assets ................................. $ 4,430 $ 1,420 Noncurrent assets .............................. 670 65 ------- ------- $ 5,100 $ 1,485 ======= =======
The Company's effective tax rate varied from the federal statutory tax rate during the year ended September 30, 1998, the nine months ended September 30, 1997 and the year ended December 31, 1996 as follows:
NINE MONTHS YEAR ENDED ENDED YEAR ENDED SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, 1998 1997 1996 ------------- -------------- ------------- Expected income tax rate ...... 34.0% 34.0% 34.0% International export sales partially exempt from federal income taxes (FSC benefit) ................ (1.4) (2.6) (4.4) State taxes, net of federal benefit ...................... 9.8 7.2 7.7 Nondeductible compensation .... 6.1 -- -- Adjustment to reflect IRS audit settlement ............. -- 0.2 6.0 Nondeductible goodwill ........ 3.8 -- -- Other nondeductible expenses .. 1.1 1.0 2.1 Other ......................... -- 1.3 (6.1) ---- ---- ---- Effective tax rate ............ 53.4% 41.1% 39.3% ==== ==== ====
6. COMMON STOCK
In March 1997, the Company granted stock purchase warrants that entitled certain venture capital investors to purchase 50,000 shares of the Company's common stock at a price of $6.00 per share through March 13, 2002. All of the warrant shares were vested at issuance.
In May 1997, Alatec's Board of Directors (the "Board") authorized an increase in the authorized shares of common stock from 2,500 shares to 2,500,000 shares. Concurrently, the Board approved a 1,000 for 1 stock-split.
On March 10, 1998, the Company completed the Offering, which involved the sale by the Company of 5,980,000 shares of Common Stock at a price to the public of $10.00 per share, including 780,000 shares pursuant to an over-allotment option granted by the Company to the underwriters in connection with the Offering. The net proceeds to the Company from the Offering (after deducting underwriting discounts, commissions and offering expenses) were approximately $50.8 million. Of this amount, $23.3 million was used to pay the cash portion of the purchase price relating to the Acquisitions of the Founding Companies with the remainder being used to pay certain indebtedness of the Founding Companies, make capital expenditures and fund working capital requirements.
On April 20, 1998, the Company's registration statement covering 3,350,000 additional shares of Common Stock for use in connection with future acquisitions was declared effective. During the year ended September 30, 1998, 1,134,010 shares of Common Stock were issued in connection with acquisitions (See Note 2).
7. EARNINGS PER SHARE
The periods ended prior to October 1, 1997 represent the results of operations of Alatec under its historical capital and income tax structure. Accordingly, the shares of Common Stock attributable to Alatec are presented to calculate earnings per share for these periods. The computation of net income per share for the year ended September 30, 1998 is based on the weighted average shares of Common Stock
outstanding as of September 30, 1998, which includes shares:
Issued in consideration for acquisition of Founding Companies . 6,720,000 Sold pursuant to the Offering and the over-allotment .......... 5,980,000 Issued to McFarland, Grossman Capital Ventures II, L.C ........ 2,295,000 Issued to management and directors ............................ 539,119 Issued in connection with acquisitions ........................ 1,134,010 ---------- 16,668,129 ==========
Basic and diluted net income per share is computed based on the following information:
NINE MONTHS YEAR ENDED ENDED YEAR ENDED SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, 1998 1997 1996 ------------- ------------- ------------ (AMOUNTS IN THOUSANDS) BASIC:
Net income ....................... $ 4,687 $ 2,669 $ 2,511 ======= ======= =======
Average Common shares ............ 10,335 2,969 2,969 ======= ======= ======= DILUTED:
Net income ....................... $ 4,687 $ 2,669 $ 2,511 ======= ======= =======
Average Common shares ............ 10,335 2,969 2,969
Common share equivalents: Warrants .................... 12 -- -- Options ..................... 27 -- -- ------- ------- ------- Total Common share equivalents .......... 39 -- -- ------- ------- -------
Average Common shares and Common share equivalents .... 10,374 2,969 2,969 ======= ======= =======
8. STOCK OPTION PLAN
The Board of Directors has adopted, and the stockholders of the Company have approved, the Pentacon, Inc. 1998 Stock Plan (the "1998 Stock Plan"). The aggregate amount of Common Stock with respect to which options or other awards may be granted may not exceed 1,700,000 shares. As of September 30, 1998, the Company had granted options and other awards for a total of 1,109,105 shares under the 1998 Stock Plan.
The 1998 Stock Plan is administered by the Compensation Committee, which is composed of non-employee directors (the "Committee"). Subject to the terms of the 1998 Stock Plan, the Committee generally determines to whom options will be granted and the terms and conditions of option grants. Options granted under the 1998 Stock Plan may be either non-qualified stock options, or may qualify as incentive stock options ("ISOs"), provided that the aggregate fair market value (determined at the time the ISO is granted) of the Common Stock with respect to which ISOs are exercisable for the first time by any
employee during any calendar year under all plans of the Company and any parent or subsidiary corporation shall not exceed $100,000. No employee or consultant may receive an option in any year to purchase more than 250,000 shares of Common Stock. The Committee determines the period over which options become exercisable, provided that all options become immediately exercisable upon death of the grantee or upon a change-in-control of the Company.
The 1998 Stock Plan also provides for automatic option grants to directors who are not otherwise employed by the Company or its subsidiaries. Upon commencement of service, a non-employee director will receive a non-qualified option to purchase 15,000 shares of Common Stock, and continuing non-employee directors annually will receive options to purchase 5,000 shares of Common Stock. Options granted to non-employee directors are immediately exercisable in full and have a term of ten years.
Upon exercise of a non-qualified option, the optionee generally will recognize ordinary income in the amount of the "option spread" (the difference between the market value of the option shares at the time of exercise and the exercise price), and the Company is generally entitled to a corresponding tax deduction (subject to certain withholding requirements). When an optionee sells shares issued upon the exercise of a non-qualified stock option, the optionee realizes a short-term or long-term gain or loss, depending on the length of the holding period, but the Company is not entitled to any tax deduction in connection with such sale.
The Company applies APB 25 in accounting for the Plan. Accordingly, no compensation cost has been recognized for its fixed stock option plan. Pro forma information regarding net income and earnings per common share is required by FAS 123 as if the Company had accounted for its employee stock options under the fair value method of that statement. The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing ("Black-Scholes") model with the following weighted average assumptions for 1998: (i) risk-free interest rate of 6.5%, (ii) a dividend yield of 0.0%, (iii) volatility factors of the historical market price of the Company's Common Stock of 49.8% and (iv) a weighted average expected life of 10 years.
The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosure, the estimated fair value of the options is amortized to expense over the vesting period of the stock options. Had compensation for the Company's stock-based compensation plan been determined based on the fair value at the grant dates for awards under the Plan consistent with the method of FAS 123, the Company's net income and earnings per common share would have been adjusted to the pro forma amounts indicated below:
NINE MONTHS YEAR ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, 1998 1997 ----------- -------------- (IN THOUSANDS, EXCEPT SHARE DATA) Net income As reported ................. $ 4,687 $ 2,669 ========== ============== Pro forma ................... $ 3,101 $ 2,669 ========== ============== Income per share As reported ................. $ 0.45 $ 0.90 ========== ============== Pro forma ................... $ 0.30 $ 0.90 ========== ==============
A summary of the status of the Company's fixed stock option plans for officers and employees as of September 30, 1998 and activity during the year is presented below:
WEIGHTED AVERAGE EXERCISE SHARES PRICE ----------- -----------
Outstanding at beginning of year ............. -- $ -- Granted ...................................... 1,117,180 10.24 Canceled ..................................... (8,075) 10.00 ---------- 1,109,105 $ 10.24 ==========
Common shares authorized ..................... 1,700,000 Outstanding options .......................... (1,109,105) Outstanding stock grants ..................... (4,119) ---------- Options available for grant at end of year ....................................... 586,776 ========== Weighted average fair value of options granted during the year .................... $ 7.15
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ------------------------------------------------------ ------------------------ WEIGHTED SHARES AVERAGE WEIGHTED SHARES WEIGHTED RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE EXERCISE AT CONTRACTUAL EXERCISE AT EXERCISE PRICES 9/30/98 LIFE PRICE 9/30/98 PRICE - ------------- ------------ ------------ ---------- ----------- ----------
$9.00-$12.44 1,109,105 9.5 $ 10.24 30,000 $ 10.00
9. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosures of cash flow information are as follows:
10. EMPLOYEE BENEFIT PLANS
The Company has a number of defined contribution plans which cover substantially all of the Company's full-time employees. Under certain plans, the Company may make discretionary contributions, match various percentages of participants' contributions or both. The Company contributed $411,000, $80,000 and $99,000 in matching contributions to the plans for the year ended September 30, 1998, the nine months ended September 30, 1997 and the year ended December 31, 1996, respectively. Additionally, the Company made discretionary contributions to certain plans of $10,000 and $300,000 for the year ended September 30, 1998 and the nine months that ended September 30, 1997, respectively.
11. UNAUDITED QUARTERLY OPERATING RESULTS
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- (IN THOUSANDS, EXCEPT SHARE DATA) YEAR ENDED SEPTEMBER 30, 1998
Revenue ......................... 14,502 19,856 46,428 60,292 Gross profit .................... 5,947 7,469 16,048 20,588 Operating income ................ 530 171 4,727 6,989 Net income (loss) ............... 145 (91) 2,121 2,512 Basic earnings(loss) per share .......................... 0.03 (0.02) 0.13 0.15 Diluted earnings (loss) per share ...................... 0.03 (0.02) 0.13 0.15
YEAR ENDED SEPTEMBER 30, 1997
Revenue ......................... 11,458 12,776 14,334 15,186 Gross profit .................... 4,488 5,004 5,536 6,642 Operating income ................ 1,007 1,563 1,887 2,068 Net income ...................... 476 726 917 1,026 Basic earnings per share ........ 0.16 0.24 0.31 0.35 Diluted earnings per share ...... 0.16 0.24 0.31 0.35
12. COMMITMENTS AND CONTINGENCIES
The Company is involved in various legal proceedings that have arisen in the ordinary course of business. While it is not possible to predict the outcome of such proceedings with certainty, in the opinion of the Company, all such proceedings are either adequately covered by insurance or, if not so covered, should not ultimately result in any liability which would have a material adverse effect on the financial position, liquidity or results of operations of the Company.
13. RELATED PARTY TRANSACTIONS
NOTES PAYABLE: The Company had notes payable to stockholders of $2,687,000 at September 30, 1997. During the year ended September 30, 1998, the nine months ended September 30, 1997, and the year ended December 31, 1996, interest expense of $19,000, $50,000 and $69,000, respectively, was incurred on these notes (See Note 4).
RELATED PARTY PURCHASES: The Company purchased approximately $1,756,000, $1,100,000 and $1,386,000, in the year ended September 30, 1998, the nine months ended September 30, 1997 and the year ended December 31, 1996, respectively, from a supplier which is 50% owned by a shareholder.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth information concerning the Company's directors and executive officers:
NAME AGE POSITION ---- --- -------- Mark E. Baldwin......... 45 Chairman of the Board and Chief Executive Officer Jack L. Fatica.......... 54 President, Chief Operating Officer and Director Brian Fontana........... 41 Senior Vice President and Chief Financial Officer Bruce M. Taten.......... 43 Senior Vice President, Chief Administrative Officer, Corporate Secretary and General Counsel Robert M. Chiste........ 51 Director Cary M. Grossman........ 44 Director Donald B. List.......... 43 Director Mary E. McClure......... 58 Director Michael W. Peters....... 39 Director Benjamin E. Spence, Jr.. 45 Director Clayton K. Trier........ 46 Director
MARK E. BALDWIN became Chief Executive Officer of the Company in September 1997 and became Chairman of the Board in November 1997. Mr. Baldwin has been involved in the organization of the Company, the acquisition of the Founding Companies and the Company's initial public offering. From 1980 through August 1997, Mr. Baldwin was employed by Keystone International, Inc., a publicly traded manufacturer of industrial valves and controls, serving most recently as President of the Industrial Valves & Controls Group, a division with 17 manufacturing locations and multiple company-owned sales and distribution locations in 15 countries.
JACK L. FATICA became President, Chief Operating Officer and director of the Company in March 1998. Mr. Fatica has in excess of 30 years of experience in the fastener distribution business. He has been employed by AXS or its predecessors since 1967 and currently serves as its President.
BRIAN FONTANA became Senior Vice President and Chief Financial Officer of the Company in October 1997. From 1996 to 1997, Mr. Fontana served as Executive Vice President and Chief Financial Officer of Prime Service, Inc., one of the largest rental equipment companies in the United States. From 1990 to 1996, he was employed by National Convenience Stores Incorporated, most recently as Vice President and Chief Financial Officer. From 1985 to 1990, Mr. Fontana was employed by NationsBank as a Vice President of Corporate Banking and earlier by Allied Bank of Texas as Assistant Vice President.
BRUCE M. TATEN became Senior Vice President, Chief Administrative Officer, General Counsel and Corporate Secretary of the Company in October 1997. From 1993 to 1997, Mr. Taten was employed by Keystone International, Inc. most recently as Vice President and General Counsel. From 1988 to 1993, Mr. Taten practiced law at Sutherland Asbill & Brennan, a law firm based in Atlanta, Georgia. From 1983 to 1986, Mr. Taten practiced law with the New York firm of Simpson, Thacher & Bartlett. Mr. Taten is a C.P.A. and an attorney.
ROBERT M. CHISTE became a director of the Company in March 1998. Mr. Chiste was President, Industrial Services Group, of Philip Services Corp. from August 1997 to June 1998. He served as Vice Chairman of Allwaste, Inc. ("Allwaste"), a provider of industrial and environmental services, from May 1997 through July 1997, President and Chief Executive Officer of Allwaste from November 1994 through July 1997 and a director of Allwaste from January 1995 through August 1997. Philip Services Corp. acquired Allwaste effective July 31, 1997. Mr. Chiste served as Chief Executive Officer and President of America National Power, Inc., a successor company of Transco Energy Ventures Company, from its creation in 1986 until August 1994. During the same period he served as Senior Vice President of Transco Energy Company. From 1980 to 1986, Mr. Chiste served in various executive roles with Enron Oil & Gas and its predecessor companies. Mr. Chiste also serves as a director of Franklin Credit Management Corp., a New York-based financial services company, and of Innovative Valve Technology, Inc.
CARY M. GROSSMAN has been a director of the Company since March 1997. Mr. Grossman co-founded McFarland, Grossman & Company, Inc. ("MGCO"), an investment banking firm in 1991, and serves as its Chief Executive Officer. MGCO formed the Company in 1997 and sponsored the Company through its initial public offering. From 1977 until 1991, Mr. Grossman was engaged in the practice of public accounting. Mr. Grossman is a C.P.A.
DONALD B. LIST became a director of the Company in March 1998. Mr. List has over 20 years of experience in the fastener and distribution business and has served as President of Alatec since 1981.
MARY E. MCCLURE became a director of the Company in March 1998. Ms. McClure co-founded Capitol Bolt & Supply, Inc. in 1966 and has served as Capitol's President since 1981. Ms. McClure has served as Chairman of the Southwest Fastener Association and as Chairman/President of the National Fastener Distributor Association. Ms. McClure has also been inducted into the Fastener Hall of Fame.
MICHAEL W. PETERS became a director of the Company in March 1998. Mr. Peters has over 11 years of experience in the fastener and distribution business. He joined Maumee Industries, Inc. in 1986 and has served as its Chief Executive Officer since July 1995.
BENJAMIN E. SPENCE, JR. became a director of the Company in March 1998. Mr. Spence has over 22 years of experience in the fastener and distribution business and has served as President of Sales Systems, Limited since 1986.
CLAYTON K. TRIER became a director of the Company in March 1998. Mr. Trier is a private investor. In 1993, he was a founder of U.S. Delivery Systems, Inc. ("U.S. Delivery"), a company created to consolidate the highly fragmented local delivery industry, and Mr. Trier served as Chairman and Chief Executive Officer of U.S. Delivery from its inception until April 1997. In March 1996, U.S. Delivery, an NYSE-listed company at that time, was acquired by Corporate Express, Inc., a large publicly owned office products company, and Mr. Trier served as a director of Corporate Express, Inc. from the acquisition date until January 1997. From 1991 to 1993, Mr. Trier was President of Trier & Partners, Inc., a consulting firm. From 1987 through 1990, Mr. Trier served as President and Co-Chief Executive Officer of Allwaste, a provider of industrial and environmental services listed on the NYSE. From 1974 to 1987, Mr. Trier was at the international accounting firm of Arthur Andersen & Co., in which he was a partner from 1983 to 1987.
Directors are elected at each annual meeting of stockholders. The Board of Directors is divided into three classes of directors, with directors serving staggered three-year terms, expiring at the annual meeting of stockholders for fiscal years 1999, 2000 and 2001, respectively. At each annual meeting of stockholders, one class of directors will be elected for a full term of three years to succeed to that class of directors whose terms are expiring. Messrs. List's, Fatica's and Chiste's terms expire in 2001; Messrs. Spence's, Peters' and Trier's terms expire in 2000 and Ms. McClure's, Mr. Baldwin's and Mr. Grossman's terms expire in 1999. Mr. Grossman is the director elected by the holders of the Restricted Common Stock. The Company has agreed to nominate each of the Directors from the Founding Companies for re-election upon any expiration of their terms occurring prior to March, 2003. All officers serve at the discretion of the Board of Directors, subject to the terms of their respective employment agreements. See "--Employment Agreements."
The Board of Directors has established an Audit Committee, a Compensation Committee and a Committee on Director Affairs. The Audit Committee recommends the appointment of auditors and oversees the accounting and audit functions of the Company. The Compensation Committee determines executive officers' and key employees' salaries and bonuses and administers the Pentacon, Inc. 1998 Stock Plan. Messrs. Chiste and Trier serve as members of the Company's Compensation Committee and Messrs. Chiste, Trier and Grossman comprise the Company's Audit Committee. The Committee on Director Affairs administers the Company's corporate governance program, recommends individuals to serve on the Company's Board of Directors, and reviews transactions between the Company and its directors to ensure fairness. Messrs. Trier, Grossman, Fatica and Baldwin serve as members of the Committee on Director Affairs.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
DIRECTORS' COMPENSATION
Directors who are employees of the Company do not receive additional compensation for serving as directors. Each director who is not an employee of the Company receives an annual fee of $16,000 paid in equal quarterly amounts. Directors of the Company are reimbursed for out-of-pocket expenses incurred in attending meetings of the Board of Directors or committees thereof, and for other expenses incurred in their capacity as directors of the Company. Each non-employee director will receive stock options to purchase 15,000 shares of Common Stock upon election to the Board of Directors and an annual grant of 5,000 options. See "--1998 Stock Plan." In March 1998 Messrs. Chiste and Trier each purchased 10,000 shares of Common Stock at $10.00 per share and the Company granted each of Messrs. Chiste and Trier 10,000 shares of Common Stock pursuant to restricted stock grants under the 1998 Stock Plan.
EXECUTIVE COMPENSATION
The following table sets forth certain compensation information for the Chief Executive Officer of the Company and three additional most highly compensated executive officers (the "Named Executive Officers") for the fiscal year ended September 30, 1998. The Company was incorporated in March 1997 but did not conduct any business operations until the acquisitions in March 1998. As a result, none of the
Named Executive Officers received any compensation from the Company prior to March 1998.
(1) Messrs. Baldwin's, Fatica's, Taten's and Fontana's salaries are based on annual salaries of $150,000. (2) The Company commenced operations in March 1998. No amounts were paid prior to that time.
STOCK OPTIONS
The following table reflects certain information regarding stock options granted to the Named Executive Officers during the fiscal year ended September 30, 1998.
OPTION GRANTS IN FISCAL 1998
The following table reflects certain information concerning the number of unexercised options held by the Named Executive Officers and the value of such officers' unexercised options as of
September 30, 1998. No options were exercised by the Named Executive Officers during the year ended September 30, 1998.
YEAR END 1998 OPTION VALUES
VALUE OF NUMBER OF "IN-THE-MONEY" UNEXERCISED OPTIONS AT OPTIONS AT SEPTEMBER 30, 1998 SEPTEMBER 30, 1998 --------------------------- --------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ------------ ------------- ----------- -------------
Mark E. Baldwin..... - 185,000 - - Jack L. Fatica...... - - - - Bruce M. Taten...... - 100,000 - - Brian Fontana....... - 85,000 - -
(1) Options are "in-the-money" if the closing market price of the Company's Common Stock exceeds the exercise price of the options. The exercise price of the options granted to Messrs. Baldwin, Taten and Fontana is $10.00 per share. The unexercised options for Messrs. Baldwin, Taten and Fontana have no value since the exercise price exceeds the closing market price of the Company's Common Stock on September 30, 1998.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with each executive officer of the Company that prohibit such officers from disclosing the Company's confidential information and trade secrets and generally restrict these individuals from competing with the Company for a period of two years after the termination of their respective employment agreements. Messrs. Baldwin's and Fatica's employment agreements have an initial term of five years. The agreements for Messrs. Taten and Fontana have an initial term of three years. All of the employment agreements are terminable by the Company for "good cause" upon ten days' written notice and without "cause" or for "good reason" by the officer upon thirty days' written notice. All employment agreements provide that if the officer's employment is terminated by the Company without "good cause," such officer will be entitled to receive a lump-sum severance payment at the effective time of termination.
All of the employment agreements contain certain provisions concerning a change-in-control of the Company, including the following: (i) in the event that the executive is not notified by the acquiring company that it will assume the Company's obligations under the employment agreement at least five days in advance of the transaction giving rise to the change-in-control, the change-in-control will be deemed a termination of the employment agreement by the Company without "cause," and the provisions of the employment agreement governing the same will apply, except that the severance amount otherwise payable shall be tripled and the provisions which restrict competition with the Company shall not apply; and (ii) in any change-in-control situation, such officer may elect to terminate his employment by giving ten days' written notice prior to the anticipated closing of the transaction giving rise to the change-in-control, which will be deemed a termination of the employment agreement by the Company without "cause," and the provisions of the employment agreement governing the same will apply, except that the severance amount otherwise payable shall be doubled and the time period during which such officer is restricted from competing with the Company will be eliminated. The change-of-control provisions in the employment agreements may discourage bids to acquire the Company or reduce the amount an acquiror is willing to pay for the Company.
1998 STOCK PLAN
The Board of Directors has adopted, and the stockholders of the Company have approved, the Pentacon, Inc. 1998 Stock Plan (the "1998 Stock Plan"). The purpose of the 1998 Stock Plan is to provide directors, officers, key employees and certain other persons who will be instrumental in the success of the Company or its subsidiaries with additional incentives by increasing their proprietary interest in the Company. The aggregate amount of Common Stock with respect to which options or other awards may be granted may not exceed 1,700,000 shares (subject to adjustment to reflect stock splits). As of September 30, 1998, the Company had granted options and other awards for a total of 1,113,224 shares under the 1998 Stock Plan.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to beneficial ownership of the Company's Common Stock as of October 31, 1998, by (i) all persons known to the Company to be the beneficial owner of 5% or more thereof, (ii) each director, (iii) each executive officer and (iv) all officers and directors as a group. Unless otherwise indicated, the address of each such person is c/o Pentacon, Inc., 10375 Richmond Avenue, Suite 700, Houston, Texas 77042. All persons listed have sole voting and investment power with respect to their shares unless otherwise indicated.
BENEFICIALLY SHARES OWNED OWNED NUMBER PERCENT -------------- ----------- Donald B. List (1) ............ 2,979,493 17.9 Jack L. Fatica (2) ............ 1,043,220 6.3 Generations Family Limited Partnership (3) ............. 901,321 5.4 Cary M. Grossman (4) .......... 358,615 2.2 Michael W. Peters ............. 300,441 1.8 Benjamin E. Spence, Jr ........ 253,332 1.5 Mark E. Baldwin ............... 207,100 1.2 Mary E. McClure ............... 184,470 1.1 Brian Fontana ................. 133,000 * Bruce Taten ................... 132,000 * Clayton K. Trier (6) (7) ...... 45,000 * Robert M. Chiste (6) .......... 20,000 * All officers and directors as a group (14 persons) .......... 5,735,476 34.4
* Less than one percent.
(1) Includes an aggregate of 76,248 shares held by three trusts for the benefit of Mr. List's minor children. Mr. List disclaims any beneficial ownership of the shares owned by the trusts.
(2) Includes 92,782 shares of Common Stock owned by the Jason P. Fatica Trust and 92,782 shares of Common Stock owned by the Ryan A. Fatica Trust of which Mr. Fatica is co-trustee.
(3) Represents shares owned by the Generations Family Limited Partnership of which Mr. Michael Black is General Partner. The Partnership address is 4648 Craftsbury Circle, Fort Wayne, Indiana, 46818.
(4) Consists of 152,000 shares owned directly by Mr. Grossman; and 193,304 shares owned by a family limited partnership of which Mr. Grossman is a general partner; 12,875 shares owned by McFarland, Grossman & Company, Inc., and 436 shares owned by Mr. Grossman's children. Mr. Grossman disclaims beneficial ownership of shares held by the family limited partnership, McFarland, Grossman & Company, and his children.
(5) Includes 84,243 shares of Common Stock owned by the Earl Milton McClure, Jr. Residuary Trust of which Ms. McClure is trustee.
(6) Includes 10,000 shares granted as a restricted stock grant under the 1998 Stock Plan.
(7) Includes 2,000 shares of Common Stock owned by the KKT Trust and 2,000 shares of Common Stock owned by the JCT Trust of which Mr. Trier is trustee.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
TRANSACTIONS INVOLVING CERTAIN OFFICERS, DIRECTORS AND STOCKHOLDERS
LEASES OF REAL PROPERTY
Alatec leases its facilities located in Chatsworth, California from Mr. List, who became a director of the Company in March 1998. The leases provide for a total annual rent of $462,840 with the terms of the leases expiring in March 2012. Alatec shall also pay taxes and utilities on the leased premises. The rent will be adjusted in accordance with the Consumer Price Index ("CPI"), subject to a minimum of 4% and a maximum of 8%. [In addition, Alatec leases its warehouse in Fremont, California from FDR Properties, an entity controlled and partially owned by Mr. List. This lease expires August 31, 2003 and provides for an annual rent of $126,000. Alatec shall also pay taxes and utilities on those premises.] The Company leases from the List Family Trust an office and warehouse in Chatsworth, California. The lease provides for an annual rental of $170,832 and terminates in October 2012. Alatec also pays utilities and taxes on the premises. The Company believes that the rent for each of these properties does not exceed fair market value.
AXS leases certain real property located in Erie, Pennsylvania from JFJ Realty Company, an entity owned in part by Jack Fatica. Jack Fatica became an officer and director of the Company in March 1998. The lease for the property runs through August 2006 and provides for an annual rent of $240,000 through August 30, 2001. Beginning September 1, 2001, the rent shall be adjusted to fair market value as determined on February 1, 2001. Furthermore, AXS shall pay taxes and utilities on the leased premises. In addition, AXS leases certain real property located in Niles, Illinois from the Joseph Hoyt Residual Trust and the Hoyt Family Residual Trust, in which Mr. Hoyt has an economic and beneficial interest. The lease on this property will expire August 30, 2006, and provides for an annual rent of $157,500 through August 31, 2001. Beginning September 1, 2001, the rental shall be adjusted to fair market value as determined on February 1, 2001. Furthermore, AXS pays utilities and taxes on the leased premises. The Company believes that the rent for these properties does not exceed fair market value.
SSL leases certain real properties located in Chester, South Carolina from Chester Associates, LLC, an entity owned in part by Mr. Spence. Mr. Spence became a director of the Company in March 1998. One facility in Chester, South Carolina is leased for an initial five year term expiring December 31, 2002, with an option to extend the lease for an additional five year term. The annual rent for the first year of this lease is $61,250. The rent shall increase each subsequent year of the lease based on the CPI, not to increase more than 4%. SSL shall be responsible for utilities. Also, certain warehouse space in South Carolina is leased to SSL. This warehouse is leased for an initial five year term expiring December 31, 2002, with an option to extend for an additional five year term. The annual rent for the first year of this
lease is $55,000, with subsequent rental rates to increase per the CPI, not to exceed 4% in any one year. SSL is responsible for utilities. The Company believes that the rent for these properties does not exceed fair market value.
OTHER TRANSACTIONS
Mr. List owns approximately 50% of a supplier from which the Company purchased approximately $1.8 million of products during the fiscal year ended September 30, 1998. The Company believes all such purchases have been at fair market prices. The Company anticipates continuing to purchase products from the supplier in the future so long as the prices and terms remain competitive with those of alternative suppliers.
In March 1998 Mr. Fatica acquired certain life insurance policies from AXS for the cash surrender value of the policy.
Mr. Grossman is a principal in McFarland, Grossman & Company ("MG&C"), an investment banking and advisory firm. The Company engaged the services of an employee of MG&C from March 10, 1998 until July 10, 1998 to assist the Company with the development of its mergers and acquisition activities until the Company could employ an individual to assume that function. Pursuant to this agreement, the Company paid MG&C fees in the amount of $300,000 during the fiscal year ended September 30, 1998. The Company also paid MG&C fees in the amount of $600,000 for the fiscal year ended September 30, 1998 in connection with the placement of the Company's initial credit facility. The Company has entered into an indemnity agreement with certain principals of MG&C in connection with the initial public offering and the conduct of audit procedures at certain of the Founding Companies.
All of the directors of Pentacon, other than Messrs. Grossman, Chiste and Trier, are employees of Pentacon or one of its subsidiaries and as such receive employment-based consideration and benefits from the Company.
COMPANY POLICY
Any future transactions with directors, officers, employees or affiliates of the Company are anticipated to be minimal and must be approved in advance by a majority of disinterested members of the Board of Directors.
PART IV
ITEM 14.
ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS
Reports of Independent Auditors
Consolidated Balance Sheets as of September 30, 1998 and 1997
Consolidated Statements of Operations for the Year Ended December 31, 1996, the nine months ended September 30, 1997 and the Year Ended September 30, 1998.
Consolidated Statements of Cash Flows for the Year Ended December 31, 1996, the nine months ended September 30, 1997 and the Year Ended September 30, 1998.
Consolidated Statements of Changes in Stockholders Equity for the Year Ended December 31, 1996, the nine months ended September 30, 1997 and the Year Ended
September 30, 1998.
Notes to Consolidated Financial Statements
(A)(2) FINANCIAL STATEMENT SCHEDULES
Financial statement schedules are not included in this Form 10-K Annual Report because they are not applicable or the required information is shown in the financial statements or notes thereto.
(A)(3) EXHIBITS
2.1 Lock-Up Agreement between the Company and Michael Black dated March 10, 1998 (incorporated herein by reference to Exhibit 2.1 of the Company's Form SC 13D). 2.2 Lock-Up Agreement between the Company and Donald List dated March 10, 1998 (incorporated herein by reference to Exhibit 2.1 of the Company's Form SC 13D). 2.3 Lock-Up Agreement between the Company and Jack Fatica dated March 10, 1998 (incorporated herein by reference to Exhibit 2.1 of the Company's Form SC 13D). 2.4 Bylaws of the Registrant, as amended (incorporated herein by reference to Exhibit 2.1 of the Company's Form 8-A12B). 2.5 Plan of Merger and Stock Purchase Agreement dated as of August 14, 1998 among Pentacon, Inc., Pentacon Aerospace Acquisition, Inc., West Coast Aero Products Holding Corp. and the common stockholders of West Coast and Steve Riggs and Joel Jacks (incorporated herein by reference to Exhibit 2.1 of the Company's Form 8-K filed September 18, 1998). 2.6 Agreement and Plan of Merger dated as of July 17, 1998 among Pentacon, Inc., TIA Acquisition Corp., Texas International Aviation, Inc. and James B. Cassels, James W. Cassels, Frances Cassels, Gregory S. Cassels, the James Boyakin Cassels Trust, The Gregory Scott Cassels Trust, and Merritt B. Horrell (incorporated herein by reference to Exhibit 2. 1 of the Company's Form 8-K filed July 31, 1998). 3.1 Second Amended and Restated Certificate of Incorporation (incorporated herein by reference to Exhibit 3.1 of Registration Statement No. 333-49809). 3.2 Bylaws (incorporated herein by reference to Exhibit 3.2 of Registration Statement No. 333-49809). 4.1 Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit (incorporated herein by reference to Exhibit 3.1 of Amendment No. 5 of the Company's Form S-1 (No. 333-41383)). 4.2 Pentacon, Inc. 1998 Stock Option Plan (incorporated by reference to Exhibit 10.4 of Amendment No. 1 of the Company's Form S-1 (No. 333-41383)). 10.1 Agreement and Plan of Organization respecting Alatec, Inc. dated as of December 1, 1997 (incorporated herein by reference to Exhibit 10.1 of Registration Statement No. 333-49809). 10.2 Pentacon, Inc. 1998 Stock Plan (incorporated herein by reference to Exhibit 10.1 of Registration Statement No. 333-49809). 10.3 Agreement and Plan of Organization respecting Alatec Products, Inc. dated as of December 1, 1997 (incorporated herein by reference to Exhibit 10.1 of Registration Statement No. 333-41383). 10.4 Form of Waiver of Termination Rights and Schedule of Signatories (incorporated herein by reference to Exhibit 10.11 of Registration Statement No. 333-49809). 10.5 Form of Waiver and Schedule of Signatories (incorporated herein by reference to Exhibit 10.1 of Registration Statement No. 333-49809). 10.6 Form of Recontribution Agreement and Schedule of Signatories (incorporated herein by reference to Exhibit 10.13 of Registration Statement No. 333-49809). 10.7 Employment Agreement with James Jackson (incorporated herein by reference to
Exhibit 10.14 of Registration Statement No. 333-49809). 10.8 Agreement and Plan of Organization respecting AXS Solutions, Inc. dated as of December 1, 1997 (incorporated herein by reference to Exhibit 10.2 of Registration Statement No. 333-49809). 10.9 Agreement and Plan or Organization respecting Capitol Bolt & Supply, Inc. dated as of December 1, 1997 (incorporated herein by reference to Exhibit 10.3 of Registration Statement No. 333-49809). 10.10 Agreement and Plan of Organization respecting Maumee Industries, Inc. dated as of December 1, 1997 (incorporated herein by reference to Exhibit 10.4 of Registration Statement No. 333-49809). 10.11 Agreement and Plan of Organization respecting Sales Systems Limited dated as of December 1, 1997 (incorporated herein by reference to Exhibit 10.5 of Registration Statement No. 333-49809). 10.12 Employment Agreement with Mark Baldwin (incorporated herein by reference to Exhibit 10.6 of Registration Statement No. 333-49809). 10.13 Employment Agreement with Bruce Taten (incorporated herein by reference to Exhibit 10.7 of Registration Statement No. 333-49809). 10.14 Employment Agreement with Brian Fontana (incorporated herein by reference to Exhibit 10.8 of Registration Statement No. 333-49809). 10.15 Form of Officer and Director Indemnification Agreement (incorporated herein by reference to Exhibit 10.9 of Registration Statement No. 333-49809). 10.16* Amended and Restated Credit Agreement with NationsBank. 21.1* Subsidiaries of the Registrant 23.1* Consent of Ernst & Young LLP 23.2* Consent of McGladrey & Pullen, LLP 27.1* Financial Data Schedule 99.1 Press Release, dated August 17, 1998 (incorporated herein by reference to Exhibit 99.1 of the Company's Form 8-K filed August 24, 1998). 99.2 Press Release, dated May 26, 1998 (incorporated herein by reference to Exhibit 99.1 of the Company's Form 8-K filed September 18, 1998).
* Filed herewith.
(B) REPORTS ON FORM 8-K
The Company filed a report on Form 8-K dated July 31, 1998 announcing that it had consummated the acquisition of Texas International Aviation, Inc.
The Company filed a report on Form 8-K dated August 24, 1998 which included a copy of a press release announcing that it had signed a definitive agreement to acquire ASI Aerospace Group, Inc.
The Company filed a report on Form 8-K dated September 18, 1998 announcing that it had consummated the acquisition of ASI Aerospace Group, Inc.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PENTACON, INC.
Dated: December 29, 1998 By:/s/ MARK E. BALDWIN ----------------------- Chairman of the Board & Chief Executive Officer
The undersigned directors and officers of Pentacon Inc. hereby constitute and appoint Brian Fontana and Bruce M. Taten, and each of them, with full power to act without the other and with full power of substitution and resubstitution, our true and lawful attorneys-in-fact and agents, for him and in his name, place, and stead, in any and all capacities, to sign on his behalf any and all amendments to this Annual Report, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Commission granting unto said attorney-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises as fully as to all intents and purposes as he or she might or could do in person, and hereby ratify and confirm that all such attorneys-in-fact or agents, or any of them, or their substitutes shall lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
NAME CAPACITY DATE
Chairman of the Board December 29, 1998 /s/ MARK E. BALDWIN and Chief Executive - ---------------------------------- Officer(Principal Executive Officer)
Vice President and December 29, 1998 /s/ BRIAN FONTANA Chief Financial Officer - ---------------------------------- (Principal Financial and Accounting Officer)
/s/ DONALD B. LIST Director December 29, 1998 - ----------------------------------
/s/ MARY E. McCLURE Director December 29, 1998 - ----------------------------------
/s/ MICHAEL W. PETERS Director December 29, 1998 - ----------------------------------
/s/ BENJAMIN E. SPENCE, JR. Director December 29, 1998 - ----------------------------------
/s/ ROBERT M. CHISTE Director December 29, 1998 - ----------------------------------
/s/ CLAYTON K. TRIER Director December 29, 1998 - ----------------------------------
/s/ CARY M. GROSSMAN Director December 29, 1998 - ----------------------------------