FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended September 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission file number: 0-28926 MLC Holdings, Inc. (Exact name of registrant as specified in its charter) Delaware 54-1817218 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 11150 Sunset Hills Rd., Suite 110, Reston, VA 20190-5321 (Address, including zip code, of principal offices) Registrant's telephone number, including area code: (703) 834-5710 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] The number of shares of Common Stock outstanding as of November 11, 1998, was 7,467,102.
MLC HOLDINGS, INC. AND SUBSIDIARIES <TABLE> <CAPTION> Part I. Financial Information: Item 1. Financial Statements: <S> <C> Condensed Consolidated Balance Sheets as of September 30, 1998 (Unaudited)and March 31, 1998 2 Condensed Consolidated Statements of Earnings, Three months ended September 30, 1998 (Unaudited) and 1997 (Unaudited) 3 Condensed Consolidated Statements of Earnings, Six months ended September 30, 1998 (Unaudited) and 1997 (Unaudited) 4 Condensed Consolidated Statements of Cash Flows, Six months ended September 30, 1998 (Unaudited) and 1997 (Unaudited) 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 9 Item 3. Quantitative and Qualitative Disclosures About Market Risk 17 Part II. Other Information: Item 1. Legal Proceedings 18 Item 2. Changes in Securities and Use of Proceeds 18 Item 3. Defaults Upon Senior Securities 18 Item 4. Submission of Matters to a Vote of Security Holders 18 Item 5. Other Information 18 Item 6. Exhibits and Reports on Form 8-K 19 Signatures 20 </TABLE>
<TABLE> <CAPTION> MLC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS As of As of September 30, 1998 March 31, 1998 (Unaudited) --------------------------------------------------- ASSETS <S> <C> <C> Cash and cash equivalents $ 5,223,316 $ 18,683,796 Accounts receivable 24,167,898 16,383,314 Other receivables 1,277,801 3,801,808 Employee advances 45,893 53,582 Inventories 6,234,888 1,213,734 Investment in direct financing and sales type leases - net 75,104,615 32,495,594 Investment in operating lease equipment - net 6,597,406 7,295,721 Property and equipment - net 1,407,566 1,131,512 Other assets 9,750,453 2,136,554 =================================================== TOTAL ASSETS $ 129,809,836 $ 83,195,615 =================================================== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Accounts payable - trade $ 8,050,299 $ 6,865,419 Accounts payable - equipment 28,123,867 21,283,582 Salaries and commissions payable 338,901 390,081 Accrued expenses and other liabilities 3,858,405 3,560,181 Recourse notes payable 31,879,007 13,037,365 Nonrecourse notes payable 24,738,407 13,027,676 Deferred taxes 1,487,000 1,487,000 Income tax payable 885,153 - --------------------------------------------------- Total Liabilities 99,361,039 59,651,304 COMMITMENTS AND CONTINGENCIES - - STOCKHOLDERS' EQUITY Preferred stock, $.01 par value; 2,000,000 shares authorized; none issued or outstanding - - Common stock, $.01 par value; 25,000,000 authorized; 6,355,991 and 6,071,505 issued and outstanding at September 30, 1998 and March 31, 1998, respectively 63,560 60,715 Additional paid-in capital 15,258,225 11,460,331 Retained earnings 15,127,012 12,023,265 --------------------------------------------------- Total Stockholders' Equity 30,448,797 23,544,311 =================================================== TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 129,809,836 $ 83,195,615 =================================================== See Notes to Condensed Consolidated Financial Statements. </TABLE>
<TABLE> <CAPTION> MLC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS Three Months Ended September 30, 1998 1997 (Unaudited) (Unaudited) -------------------------------------------- REVENUES <S> <C> <C> Sales of equipment $ 19,830,451 $ 10,360,696 Sales of leased equipment 11,648,919 12,046,271 -------------------------------------------- 31,479,370 22,406,967 Lease revenues 5,264,385 2,993,670 Fee and other income 1,257,340 1,468,285 -------------------------------------------- 6,521,725 4,461,955 -------------------------------------------- TOTAL REVENUES 38,001,095 26,868,922 -------------------------------------------- COSTS AND EXPENSES Cost of sales, equipment 16,724,750 8,104,931 Cost of sales, leased equipment 11,340,648 11,667,934 -------------------------------------------- 28,065,398 19,772,865 Direct lease costs 1,678,631 1,238,104 Professional and other fees 322,528 244,612 Salaries and benefits 3,033,226 2,399,029 General and administrative expenses 1,311,804 986,677 Interest and financing costs 856,089 509,480 Non-recurring acquisition costs - 183,453 -------------------------------------------- 7,202,278 5,561,355 -------------------------------------------- TOTAL COSTS AND EXPENSES 35,267,676 25,334,220 -------------------------------------------- EARNINGS BEFORE PROVISION FOR INCOME TAXES 2,733,419 1,534,702 -------------------------------------------- PROVISION FOR INCOME TAXES 1,093,368 411,820 -------------------------------------------- NET EARNINGS $ 1,640,051 $ 1,122,882 ============================================ NET EARNINGS PER COMMON SHARE - BASIC $ 0.26 $ 0.19 ============================================ NET EARNINGS PER COMMON SHARE - DILUTED $ 0.25 $ 0.18 ============================================ PRO FORMA NET EARNINGS (See Note 4) $ 1,640,051 $ 974,536 ============================================ PRO FORMA NET EARNINGS PER COMMON SHARE - BASIC $ 0.26 $ 0.16 ============================================ PRO FORMA NET EARNINGS PER COMMON SHARE - DILUTED $ 0.25 $ 0.16 ============================================ WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 6,348,603 6,069,551 WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 6,439,658 6,211,929 See Notes to Condensed Consolidated Financial Statements. </TABLE>
<TABLE> <CAPTION> MLC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS Six Months Ended September 30, 1998 1997 (Unaudited) (Unaudited) -------------------------------------------- REVENUES <S> <C> <C> Sales of equipment $ 30,104,885 $ 25,493,028 Sales of leased equipment 36,559,565 32,186,511 -------------------------------------------- 66,664,450 57,679,539 Lease revenues 10,249,472 6,516,239 Fee and other income 2,669,974 2,819,166 -------------------------------------------- 12,919,446 9,335,405 -------------------------------------------- TOTAL REVENUES 79,583,896 67,014,944 -------------------------------------------- COSTS AND EXPENSES Cost of sales, equipment 25,008,422 20,085,389 Cost of sales, leased equipment 36,153,714 31,579,951 -------------------------------------------- 61,162,136 51,665,340 Direct lease costs 3,670,459 2,628,859 Professional and other fees 519,493 440,874 Salaries and benefits 5,401,827 4,784,885 General and administrative expenses 2,299,675 2,154,786 Interest and financing costs 1,357,394 975,264 Non-recurring acquisition costs - 183,453 -------------------------------------------- 13,248,848 11,168,121 -------------------------------------------- TOTAL COSTS AND EXPENSES 74,410,984 62,833,461 -------------------------------------------- EARNINGS BEFORE PROVISION FOR INCOME TAXES 5,172,912 4,181,483 -------------------------------------------- PROVISION FOR INCOME TAXES 2,069,165 872,133 -------------------------------------------- NET EARNINGS $ 3,103,747 $ 3,309,350 ============================================ NET EARNINGS PER COMMON SHARE - BASIC $ 0.50 $ 0.55 ============================================ NET EARNINGS PER COMMON SHARE - DILUTED $ 0.49 $ 0.54 ============================================ PRO FORMA NET EARNINGS (See Note 4) $ 3,103,745 $ 2,696,089 ============================================ PRO FORMA NET EARNINGS PER COMMON SHARE - BASIC $ 0.50 $ 0.45 ============================================ PRO FORMA NET EARNINGS PER COMMON SHARE - DILUTED $ 0.49 $ 0.44 ============================================ WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 6,214,103 5,990,200 WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 6,346,548 6,106,753 See Notes to Condensed Consolidated Financial Statements. </TABLE>
<TABLE> <CAPTION> MLC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended September 30, 1998 1997 (Unaudited) (Unaudited) ------------------------------------- Cash Flows From Operating Activities: <S> <C> <C> Net earnings $ 3,103,747 $ 3,309,350 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 2,652,979 2,328,955 Provision for credit losses 500,000 (30,000) Gain on sale of operating lease equipment (3,689) (313,295) Adjustment of basis to fair market value of equipment and investments 268,506 231,000 Payments from lessees directly to lenders (563,025) (992,838) Compensation to outside directors - stock options - 12,109 Changes in assets and liabilities, net of effects of purchase acquisition: Accounts receivable (1,544,834) (4,613,259) Other receivables 2,524,007 (2,292,681) Employee advances 14,194 (25,806) Inventories (4,297,786) (351,452) Other assets (1,166,603) (429,216) Accounts payable - equipment 7,794,860 1,820,066 Accounts payable - trade (5,737,180) 1,435,326 Salaries and commissions payable, accrued expenses and other liabilities 687,224 55,238 ------------------------------------- Net cash provided by operating activities 4,232,400 143,497 ------------------------------------- Cash Flows From Investing Activities: Proceeds from sale of operating equipment 3,750 579,813 Purchase of operating lease equipment (1,678,067) (1,163,208) Increase in investment in direct financing and sales-type leases (46,697,227) (3,166,666) Purchases of property and equipment (281,398) (327,366) Cash used in acquisition, net of cash acquired (3,485,279) - Increase in other assets (437,809) (223,671) ------------------------------------- Net cash used in investing activities (52,576,030) (4,301,098) ------------------------------------- Cash Flows From Financing Activities: Borrowings: Nonrecourse 18,512,294 2,356,775 Recourse 258,316 109,972 Repayments: Nonrecourse (2,650,333) (2,246,963) Recourse (80,011) (110,812) Distributions to shareholders of combined companies prior to business combination - (1,087,270) Proceeds from issuance of capital stock, net of expenses 177,931 - Proceeds from sale of stock 2,000,000 Proceeds from lines of credit 18,664,953 4,321,000 ------------------------------------- Net cash provided by financing activities 34,883,150 5,342,702 ------------------------------------- Net(Decrease)Increase in Cash and Cash Equivalents (13,460,480) 1,185,101 Cash and Cash Equivalents, Beginning of Period 18,683,796 6,654,209 ------------------------------------- Cash and Cash Equivalents, End of Period $ 5,223,316 $ 7,839,310 ===================================== Supplemental Disclosures of Cash Flow Information: Cash paid for interest $ 216,428 $ 206,266 ===================================== Cash paid for income taxes $ 324,446 $ 1,812,233 ===================================== See Notes To Condensed Consolidated Financial Statements. </TABLE>
MLC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The condensed consolidated balance sheet as of September 30, 1998, the condensed consolidated statements of earnings for the three months and six months ended September 30, 1998 and 1997, and the condensed consolidated statements of cash flows for the six months ended September 30, 1998 and 1997 have been prepared by the Company without audit. The quarterly financial information is submitted in response to the requirements of Form 10-Q and does not purport to be financial statements prepared in accordance with generally accepted accounting principles. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. They therefore do not include all disclosures which might be associated with such statements. In the opinion of management, the accompanying unaudited financial statements include all adjustments, consisting only of normal recurring accruals, necessary to present fairly the Company's financial position at September 30 and March 31, 1998, the results of operations for the three and six month periods ending September 30, 1998 and 1997, and the cash flows for the six month periods ended September 30, 1998 and 1997. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto for the year ended March 31, 1998 included in the Company's Annual Report on Form 10-K (No. 0-28926). 2. INVESTMENT IN DIRECT FINANCING AND SALES-TYPE LEASES <TABLE> <CAPTION> The Company's investment in direct financing and sales-type leases consists of the following components: September 30, March 31, 1998 1998 ------------------ ------------------ (In thousands) <S> <C> <C> Minimum lease payments $71,813 $ 29,968 Estimated unguaranteed residual value 12,133 7,084 Initial direct costs - net of amortization 1,391 760 Less: Unearned lease income (9,686) (5,270) Reserve for credit losses (546) (46) ================== ================== Investment in direct financing and sales type leases - net $75,105 $ 32,496 ================== ================== </TABLE>
3. INVESTMENT IN OPERATING LEASE EQUIPMENT <TABLE> <CAPTION> The components of the net investment in operating lease equipment are as follows: September 30, March 31, 1998 1998 ----------------- ------------------ (In thousands) <S> <C> <C> Cost of equipment under operating leases $15,403 $ 13,990 Initial direct costs 29 51 Accumulated depreciation and amortization (8,835) (6,745) ----------------- ------------------ Investment in operating leases - net $ 6,597 $ 7,296 ================= ================== </TABLE> 4. UNAUDITED PRO FORMA INCOME TAX INFORMATION The following unaudited pro forma income tax information is presented in accordance with Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes," as if the pooled companies, which were subchapter S corporations prior to their business combinations with the Company, had been subject to federal income taxes throughout the periods presented. <TABLE> <CAPTION> Three Months Ended Six Months Ended September 30, September 30, 1998 1997 1998 1997 (In thousands) ------------ -------------- ------------- --------------- Net earnings before pro forma adjustment <S> <C> <C> <C> <C> $ 1,640 $ 1,123 $ 3,104 $ 3,309 Additional provision for income tax - 148 - 613 ============ ============== ============= ============== Pro forma net income $ 1,640 $ 975 $ 3,104 $ 2,696 ============ ============== ============= =============== </TABLE> 5. NEW ACCOUNTING PRONOUNCEMENT Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standard ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for the reporting and presentation of comprehensive income and its components in financial statements by requiring minimum pension liability adjustments, unrealized gains or losses on available-for-sale securities and foreign currency translation adjustments, which prior to adoption were reported separately in shareholders' equity, to be included in other comprehensive earnings. The Company currently has no items of other comprehensive income to be reported.
6. BUSINESS COMBINATION On July 1, 1998, the Company, through a new wholly owned subsidiary, MLC Network Solutions of Virginia, Inc., issued 263,478 common shares, valued at $3,622,822, and cash of $3,622,836 for all the outstanding common shares of PC Plus, Inc., a value-added reseller of PC's , related network equipment and software products and provider of various support services to its customers from its facility in Reston, Virginia. Subsequent to the acquisition, MLC Network Solutions of Virginia, Inc. changed its name to PC Plus, Inc. This business combination has been accounted for using the purchase method of accounting, and accordingly, the results of operations of PC Plus, Inc. have been included in the Company's consolidated financial statements from July 1, 1998. The Company's other assets include goodwill calculated as the excess of the purchase price over the fair value of the net identifiable assets acquired of $6,045,330, and is being amortized on a straight-line basis over 27.5 years. The following unaudited pro forma financial information presents the combined results of operations of PC Plus, Inc. as if the acquisition had occurred as of the beginning of the six months ended September 30, 1998 and 1997, after giving effect to certain adjustments, including amortization of goodwill. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and PC Plus, Inc. constituted a single entity during such periods. Six Months Ended September 30, (in thousands) 1998 1997 -------------- -------------- Total Revenues 91,522 82,083 Net Earnings 3,323 3,735 Net Earnings per Common Share - Basic .52 .60 Net Earnings per Common Share - Diluted .51 .59
7. OTHER DEVELOPMENT One of the Company's equipment sales and lease customers has filed for voluntary bankruptcy protection. Allegheny Health, Education & Research Foundation ("AHERF") is a Pittsburgh based not-for-profit entity that owns multiple hospitals, the largest of which include Hahnemann University Hospital, St. Christopher's Hospital for Children, Medical College of Pennsylvania and Graduate Hospital, all of which are located in Philadelphia, Pennsylvania. On July 21, 1998, AHERF, and some but not all of its operating subsidiaries filed for bankruptcy and agreed to sell its eight Philadelphia-area hospitals to Vanguard Health Systems, Inc., a Tennessee based for-profit company, subject to court approval. Since then, the bankruptcy court held an auction and Tenet Healthcare, Inc. acquired AHERF's assets. As of September 30, 1998, the Company's net book value of leases to AHERF is approximately $1,983,000 and receivable balance is approximately $481,000. The Company believes that the fair market value of the equipment may be below its current balances, and, depending on the assumption or rejection of the leases by the Bankruptcy Trustee and the creditor status and ultimate repayment schedule of other claims, upon disposal of the equipment and disposition of its claims, the Company could incur a loss with respect to its current balances. The amount and timing of such losses cannot be accurately estimated by the Company at this time due to the recent filing and unknown status of many of its claims. On September 21, 1998, the bankruptcy court issued an order requiring AHERF to make lease payments to the Company. The Company is vigorously pursuing all available remedies in bankruptcy court. The Company believes that as of September 30, 1998, its reserves are adequate to provide for the potential loss resulting from this customer. 8. PRIVATE PLACEMENT OF EQUITY SUBSEQUENT TO QUARTER END On October 23, 1998, the Company issued 1,111,111 shares of unregistered common stock to a single investor in a private placement for cash consideration of $10,000,000 (per share price of $9.00). The investor also received a warrant to purchase an additional 1,099,909 shares of common stock at an exercise price of $11.00 per share. The warrant expires December 31, 2001.
Item 2. Management's Discussion and Analysis of RESULTS OF OPERATIONS, Financial Condition The following discussion and analysis of results of operations and financial condition of the Company should be read in conjunction with the Consolidated Financial Statements and the related Notes thereto included elsewhere in this report. "SAFE HARBOR" STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The statements contained in this Report which are not historical facts may be deemed to contain forward-looking statements with respect to events, the occurrence of which involve risks and uncertainties, including, without limitation, demand and competition for the Company's lease financing services and the products to be leased by the Company, the continued availability to the Company of adequate financing, the ability of the Company to recover its investment in equipment through re-marketing, the ability of the Company to manage its growth, and other risks or uncertainties detailed in the Company's Securities and Exchange Commission filings. The Company's results of operations are susceptible to fluctuations for a number of reasons, including, without limitation, differences between estimated residual values and actual amounts realized related to the equipment the Company leases. Operating results could also fluctuate as a result of the sale by the Company of equipment in its lease portfolio prior to the expiration of the lease term to the lessee or to a third party. Such sales of leased equipment prior to the expiration of the lease term may have the effect of increasing revenues and net earnings during the period in which the sale occurs, and reducing revenues and net earnings otherwise expected in subsequent periods. RESULTS OF OPERATIONS - Three and Six Months Ended September 30, 1998 (Unaudited) Compared to Three and Six Months Ended September 30, 1997 (Unaudited) The following discussion and analysis of the Company's results of operations should be read in conjunction with the accompanying unaudited condensed consolidated financial statements for the three and six month periods ended September 30, 1998 and 1997. Total revenues generated by the Company during the three month period ended September 30, 1998 were $38,001,095, compared to revenues of $26,868,922 during the comparable period in the prior fiscal year, an increase of 41.4%. During the six month period ended September 30, total revenues were $79,583,896 and $67,014,944 in 1998 and 1997, respectively, an increase of 18.8%. The Company's revenues are composed of sales and other revenue, and may vary considerably from period to period (See "POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS"). Sales revenue, which includes sales of equipment and sales of leased equipment, increased 40.5% to $31,479,370 during the three month period ended September 30, 1998, as compared to $22,406,967 in the corresponding period in the prior fiscal year. For the six month period ended September 30 1998, sales increased 15.6% to $66,664,450 over the corresponding period in the prior year. During the three months ended September 30, 1998 and 1997, sales to MLC/CLC, LLC, an institutional equity partner of the Company, accounted for 100% of sales of leased equipment for both periods. During the six month periods ended September 30, sales to MLC/CLC LLC accounted for 100% and 86.1% of 1998 and 1997 sales of leased equipment, respectively. Sales to the Company's equity joint ventures require the consent of the relevant joint venture partner. While management expects the continued availability of equity financing through this joint venture, if such consent is withheld, or financing from this entity otherwise becomes unavailable, it could have a material adverse effect upon the Company's business, financial condition, results of operations and cash flows until other equity financing arrangements are secured.
Sales of equipment, both new and used, are generated through the Company's equipment brokerage and re-marketing activities, and through its valued added reseller ("VAR") subsidiaries. Sales of equipment increased during the three month period (91.4%) $9,469,755 compared to the corresponding period in the prior fiscal year. For the fiscal year to date through September 30, equipment sales increased 18.09% to $30,104,885. On a pro forma basis, had PC Plus, Inc.'s equipment sales been included throughout the periods presented, equipment sales would have increased 5.0% and 4.1% during the three and six month periods ended September 30, 1998, as compared to the comparable periods in the prior fiscal year. The Company's brokerage and re-marketing activities accounted for 3.6% and 18.0% of equipment sales during the three month period in 1998 and 1997, respectively. During the six month periods ended September 30, brokerage and re-marketing activities accounted for 4.1% and 15.8% of 1998 and 1997 sales, respectively. Brokerage and re-marketing revenue can vary significantly from period to period, depending on the volume and timing of transactions, and the availability of equipment for sale. Sales of equipment through the Company's VAR subsidiaries accounted for the remaining portion of equipment sales. The Company realized a gross margin on sales of equipment of 15.7% and 16.9% for the three and six month periods ended September 30, 1998, respectively, as compared to a gross margin of 21.8% and 21.2% realized on sales of equipment generated during the three and six months periods, respectively, in the prior fiscal year. This decrease in net margin percentage can be attributed to the Company's July 1, 1998 acquisition of PC Plus, Inc., who has a concentration of higher volume customers with lower gross margin percentages. The Company's gross margin on sales of equipment can be effected by the mix and volume of products sold. The gross margin generated on sales of leased equipment represent the sale of the equity portion of equipment placed under lease and can vary significantly depending on the nature, and timing of the sale, as well as the timing of any debt funding recognized in accordance with SFAS No. 125. For example, a lower margin or a loss on the equity portion of a transaction is often offset by higher lease earnings and/or a higher gain on the debt funding recognized under SFAS No. 125. Additionally, leases which have been debt funded prior to their equity sale will result in a lower sales and cost of sale figure, but the net earnings from the transaction will be the same as had the deal been debt funded subsequent to the sale of the equity. During the three month period ended September 30, 1998, the Company recognized a gross margin of $308,271 on equity sales of $11,648,919, as compared to a gross margin of $378,337 on equity sales of $12,046,271 during the same period in the prior fiscal year. For the fiscal year to date through September 30, 1998, the Company recognized a gross margin of $405,851 on equity sales of $36,559,565, as compared to a gross margin of $606,560 on equity sales of $32,186,511 during the same period in the prior fiscal year. The Company's lease revenues increased 75.9% to $5,264,385 for the three-month period ended September 30, 1998, compared with the corresponding period in the prior fiscal year. For the fiscal year to date through September 30, lease revenues increased 57.2% to $10,249,472 for the 1998 period compared to the same period in 1997. This increase consists of increased lease earnings and rental revenues reflecting a higher average investment in direct financing and sales-type leases. The investment in direct financing and sales-type leases at September 30, 1998 and March 31, 1998 were $75,104,615 and $32,495,594, respectively. The September 30, 1998 balance represents an increase of $42,609,021 or 131.1% over the balance as of March 31, 1998. In addition, lease revenue includes the gain or loss on the sale of certain financial assets, as required under the provisions of Financial Accounting Standard No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," ("SFAS No. 125") which was effective beginning January 1, 1997. During the three and six month periods ending September 30, 1998, fewer of the Company's debt funding transactions qualified for gain on sale treatment prescribed under SFAS No. 125 as compared to the comparable periods in the prior fiscal year. For the three and six months ended September 30, 1998, fee and other income decreased 14.4% and 5.3%, respectively, over the comparable period in the prior fiscal year. This decrease is attributable to decreases in revenues from adjunct services and fees, including broker fees, support fees, warranty reimbursements, and learning center revenues generated by the Company's VAR subsidiaries. Included in the Company's fee and other income are earnings from certain transactions which are in the Company's normal course of business but there is no guarantee that future transactions of the same nature, size or profitability will occur. The Company's ability to consumate such transactions, and the timing thereof, may depend largely upon factors outside the direct control of management. The earnings from these types of transactions in a particular period may not be indicative of the earnings that can be expected in future periods. The Company's direct lease costs increased 35.6% and 39.6% during the three and six month periods ended September 30, 1998 as compared to the same periods in the prior fiscal year. Although the largest component of direct lease costs is depreciation on operating lease equipment, the increase is primarily attributable to an increase in the allowance for doubtful accounts due to the increased business volume of leases and retained lease portfolio, increased amortization of initial direct costs. Salaries and benefits expenses increased 26.4% during the three month period ended September 30, 1998 over the same period in the prior year. For the fiscal year to date through September 30, 1998, salaries and benefits had increased 12.9% over the prior year. These increases reflect both the higher commission expenses in the value added reseller businesses the increased number of personnel employed by the Company.
Interest and financing costs incurred by the Company for the three and six months ended September 30, 1998 amounted to $856,089 and $1,357,394 respectively, and relate to interest costs on the Company's lines of credit and notes payable. Payment for interest costs on the majority of non-recourse and certain recourse notes are typically remitted directly to the lender by the lessee. The increase in interest and financing costs are primarily due to the Company's increased utilization of its operating lines of credit during the three and six month periods in the current fiscal year as compared to the prior fiscal year. The Company's provision for income taxes increased to $1,093,368 for the three months ended September 30, 1998 from $411,820 for the three months ended September 30, 1997, reflecting effective income tax rates of 40.0% and 26.8%, respectively. For the six months ended September 30, 1998, the Company's provision for income tax was $2,069,165, as compared to $872,133 during the comparable period in the prior year, reflecting effective income tax rates of 40.0% and 20.9%, respectively. The low effective income tax rate for September 30, 1997 was primarily due to the inclusion of the net earnings of businesses acquired by the Company, which prior to their combination with the Company had elected subchapter S corporation status, and as such, were not previously subject to federal income tax. Pro forma tax expense, adjusted as if the Company's subsidiaries which were previously subchapter S corporations had been subject to income tax for the three and six months ended September 30, 1997, would have increased the expense by approximately $148,000 and $613,000. The foregoing resulted in a 68.3% and 15.1% increase in net earnings for the three and six month periods ended September 30, 1998, respectively, as compared to the same periods in the prior fiscal year after taking into consideration the pro forma tax expense. Notwithstanding pro forma tax adjustments, net earnings increased 46.1% and decreased 6.2% for the three and six month periods ended September 30, 1998 as compared to the same periods in the prior fiscal year. Basic and fully diluted earnings per common share were $.26 and $.25, respectively, for the three months ended September 30, 1998, as compared to $.19 and .18, respectively, for the three months ended September 30, 1997, based on weighted average common shares outstanding of 6,348,603 and 6,439,658, respectively, for 1998, and 6,069,551 and 6,211,929, respectively, for 1997. For the fiscal year to date through September 30, 1998, the Company's basic and fully diluted earnings per common share were $.50 and $.49, respectively, as compared to $.55 and $.54, respectively, for the same period in 1997, based on weighted average common shares outstanding of 6,214,103 and 6,346,548, respectively, for 1998, and 5,990,200 and 6,106,753, respectively, for 1997. LIQUIDITY AND CAPITAL RESOURCES During the six month period ended September 30, 1998, the Company generated cash flows from operations of $4,232,400, and used cash flows from investing activities of $52,576,030. Cash flows generated by financing activities amounted to $34,883,150 during the same period. The net effect of these cash flows was to decrease cash and cash equivalents by $13,460,480 during the six month period. During the same period, the Company's total assets increased $46,614,221, or 56.0%, primarily the result of increases in direct financing leases and the acquisition of PC Plus, Inc., a wholly owned subsidiary, on July 1, 1998. The Company's net investment in operating lease equipment decreased during the period, as the decrease in book value, primarily due to depreciation, outpaced new investment in operating lease equipment. The financing necessary to support the Company's leasing activities has principally been provided from non-recourse and recourse borrowings. Historically, the Company has obtained recourse and non-recourse borrowings from money centers, regional banks, insurance companies, finance companies and financial intermediaries. The Company's "Accounts payable - equipment" represents equipment costs that have been placed on a lease schedule, but for which the Company has not yet paid. The balance of unpaid equipment cost can vary depending on vendor terms and the timing of lease originations. As of September 30, 1998, the Company had $28,123,867 of unpaid equipment cost, as compared to $21,283,582 at March 31, 1998. Prior to the permanent financing of its leases, interim financing has been obtained through short-term, secured, recourse facilities. On June 5, 1997, the Company entered into the First Union Facility with First Union National Bank, N.A., which is available through December 19, 1998, and bears interest at LIBOR+110 basis points, or, at the Company's option, Prime minus one percent. On June 30, 1998, the Company's First Union Facility was increased to a maximum limit of $35 million. Availability under the revolving lines of credit may be limited by the asset value of equipment purchased by the Company and may be further limited by certain covenants and terms and conditions of the facilities. As of September 30, 1998, the Company had an outstanding balance of $30,500,000 on the First Union Facility. The First Union facility is made to MLC Group, Inc., and guaranteed by MLC Holdings, Inc. In addition, MLC Holdings, Inc. has guaranteed the lines of credit made to the Company's recently acquired subsidiaries. The Company expects to renew the First Union Facility at a reasonable rate when it expires on December 19, 1998.
The Company's subsidiaries, MLC Network Solutions, Inc. and MLC Integrated, Inc., and it's recently acquired subsidiary, PC Plus, Inc., have separate credit sources to finance their working capital requirements for inventories and accounts receivable. Their traditional business as value-added resellers of PC's and related network equipment and software products is financed through agreements known as "floor planning" financing where interest expense for the first thirty to forty days is charged to the supplier/distributor but not the reseller. These floor plan liabilities are recorded under accounts payable as they are normally repaid within the thirty to forty day time frame and represent an assigned accounts payable originally generated with the supplier/distributor. If the thirty to forty day obligation is not timely liquidated, interest is then assessed at stated contractual rates. As of September 30, 1998, MLC Network Solutions, Inc., has floor planning availability of $1,350,000 through Deutsche Financial, Inc. and $225,000 from IBM Credit Corporation. The outstanding balances to these respective suppliers were $376,249 and $51,788 as of September 30, 1998. MLC Integrated, Inc. has floor planning availability of $1,500,000 from FINOVA Capital Corporation and $750,000 through IBM Credit Corporation. The outstanding balances to these respective suppliers were $1,355,505, and $56,162 as of September 30, 1998. In addition, MLC Integrated, Inc. has a line of credit in place, expiring on October 31, 1998, with PNC Bank, N.A. to provide an asset based credit facility. The Company is currently negotiating an extension of this credit facility. The line has a maximum credit limit of $2,500,000 and interest is based on the bank's prime rate. The outstanding balance was $917,000 as of September 30, 1998. PC Plus, Inc. has floor planning availability of $6,000,000 through Nations Credit as of September 30, 1998. This agreement expires October 1, 1998 and is subject to a one-year renewal. The outstanding balance to this supplier was $1,942,083 as of September 30, 1998. In March 1997, the Company established the Heller Facility, a $10,000,000 partial recourse credit facility agreement, with Heller Financial, Inc., Vendor Finance Division. Under the terms of the Heller Facility, a maximum amount of $10 million is available to the Company, subject to the approval of Heller for each draw. As of September 30, 1998, the principal balance due under the Heller Facility was $3,476,124. Rates are negotiated at the time of each draw. Through MLC/CLC, LLC, the Company has a formal joint venture agreement which provides the equity investment financing for certain of the Company's transactions. Firstar Equipment Finance Company ("FEFCO"), formerly Cargill Leasing Corporation, is an unaffiliated investor which owns 95% of MLC/CLC, LLC. FEFCO's parent company, Firstar Corporation, is a $20 billion bank holding company which is publicly traded on the New York Stock Exchange under the symbol "FSR". This joint venture arrangement enables the Company to invest in a significantly greater portfolio of business than its limited capital base would otherwise allow. A significant portion of the Company's revenue generated by the sale of leased equipment is attributable to sales to MLC/CLC, LLC. (See "RESULTS OF OPERATIONS"). The Company's relationship with GATX, an unaffiliated company which beneficially owns 90% of MLC/GATX Limited Partnership I, was effectively terminated in August, 1998. This termination caused the Company to write off approximately $154,500 in the current period representing its remaining joint venture investment and miscellaneous receivables. The Company's debt financing activities typically provide approximately 80% to 100% of the purchase price of the equipment purchased by the Company for lease to its customers. Any balance of the purchase price (the Company's equity investment in the equipment) must generally be financed by cash flow from its operations, the sale of the equipment lease to MLC/CLC,LLC , or other internal means of financing. Although the Company expects that the credit quality of its leases and its residual return history will continue to allow it to obtain such financing, no assurances can be given that such financing will be available, at acceptable terms, or at all. The Company anticipates that its current cash on hand, operations and additional financing available under the Company's credit facilities will be sufficient to meet the Company's liquidity requirements for its operations through the remainder of the fiscal year. However, the Company intends to continue pursuing additional acquisitions, which are expected to be funded through a combination of cash and the issuance by the Company of shares of its common stock. To the extent that the Company elects to pursue acquisitions involving the payment of significant amounts of cash (to fund the purchase price of such acquisitions and the repayment of assumed indebtedness), the Company is likely to require additional sources of financing to fund such non-operating cash needs. POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS The Company's future quarterly operating results and the market price of its stock may fluctuate. In the event the Company's revenues or earnings for any quarter are less than the level expected by securities analysts or the market in general, such shortfall could have an immediate and significant adverse impact on the market price of the Company's stock. Any such adverse impact could be greater if any such shortfall occurs near the time of any material decrease in any widely followed stock index or in the market price of the stock of one or more public equipment leasing and financing companies or major customers or vendors of the Company. The Company's quarterly results of operations are susceptible to fluctuations for a number of reasons, including, without limitation, any reduction of expected residual values related to the equipment under the Company's leases, timing of specific transactions and other factors. Quarterly operating results could also fluctuate as a result of the sale by the Company of equipment in its lease portfolio, at the expiration of a lease term or prior to such expiration, to a lessee or to a third party. Such sales of equipment may have the effect of increasing revenues and net income during the quarter in which the sale occurs, and reducing revenues and net income otherwise expected in subsequent quarters.
Given the possibility of such fluctuations, the Company believes that comparisons of the results of its operations to immediately succeeding quarters are not necessarily meaningful and that such results for one quarter should not be relied upon as an indication of future performance. INFLATION The Company does not believe that inflation has had a material impact on its results of operations during the first two quarters of fiscal 1999. FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS The future operating results of the Company may be affected by a number of factors, including the matters discussed below: The Company's strategy depends upon acquisitions and organic growth to increase its earnings. There can be no assurance that the Company will complete acquisitions in a manner that coincides with the end of its fiscal quarters. The failure to complete acquisitions on a timely basis could have a material adverse effect on the Company's quarterly results. Likewise, delays in implementing planned integration strategies and cross selling activities also could adversely affect the Company's quarterly earnings. In addition, there can be no assurance that acquisitions will occur at the same pace as in prior periods or be available to the Company on favorable terms, if at all. If the Company is unable to use the Company's common stock as consideration in acquisitions, for example, because it believes that the market price of the common stock is too low or because the owners of potential acquisition targets conclude that the market price of the Company's common stock is too volatile, the Company would need to use cash to make acquisitions, and, therefore, would be unable to negotiate acquisitions that it would account for under the pooling-of-interests method of accounting (which is available only for all-stock acquisitions). This might adversely affect the pace of the Company's acquisition program and the impact of acquisitions on the Company's quarterly results. In addition, the consolidation of the equipment leasing business has reduced the number of companies available for sale, which could lead to higher prices being paid for the acquisition of the remaining domestic, independent companies. The failure to acquire additional businesses or to acquire such businesses on favorable terms in accordance with the Company's growth strategy could have a material adverse impact on future sales and profitability. There can be no assurance that companies that have been acquired or that may be acquired in the future will achieve sales and profitability levels that justify the investment therein. Acquisitions may involve a number of special risks that could have a material adverse effect on the Company's operations and financial performance, including adverse short-term effects on the Company's reported operating results; diversion of management's attention; difficulties with the retention, hiring and training of key personnel; risks associated with unanticipated problems or legal liabilities; and amortization of acquired intangible assets. The Company has increased the range of products and services it offers through acquisitions of companies offering products and services that are complementary to the core financing and equipment brokering services that the Company has offered since it began operations. The Company's ability to manage an aggressive consolidation program in markets other than domestic equipment financing has not yet been fully tested. The Company's efforts to sell additional products and services to existing customers are in their early stages and there can be no assurance that such efforts will be successful. In addition, the Company expects that certain of its products and services will not be easily cross-sold and may be marketed and sold independently of other products and services. The Company's acquisition strategy has resulted in a significant increase in sales, employees, facilities and distribution systems. While the Company's decentralized management strategy, together with operating efficiencies resulting from the elimination of duplicative functions and economies of scale, may present opportunities to reduce costs, such strategies may initially necessitate costs and expenditures to expand operational and financial systems and corporate management administration. The various costs and possible cost-savings strategies may make historical operating results not indicative of future performance. There can be no assurance that the Company's executive management group can continue to oversee the Company and effectively implement its operating or growth strategies in each of the markets that it serves. In addition, there can be no assurance that the pace of the Company's acquisitions, or the diversification of its business outside of its core leasing operations, will not adversely affect the Company's efforts to implement its cost-savings and integration strategies and to manage its acquisitions profitability. The Company operates in a highly competitive environment. In the markets in which it operates, the Company generally competes with a large number of smaller, independent companies, many of which are well-established in their markets. Several of its large competitors operate in many of its geographic and product markets, and other competitors may choose to enter the Company's geographic and product markets in the future. No assurances can be give that competition will not have an adverse effect on the Company's business.
YEAR 2000 ISSUE The Company has identified all significant internal software and hardware applications that will require modifications to ensure Year 2000 compliance of the Company's IT and non-IT systems. Internal and external resources are being used to make the required modifications and test Year 2000 compliance. The modification process of all significant internal applications and operational systems is substantially complete. The Company plans on completing the process of modifying all significant applications by December 31, 1998. The total cost to the Company of these Year 2000 compliance activities has not been and is not anticipated to be material to its financial position, results of operations or cash flows in any given year. The Company is aware of general risks to third parties with whom it deals on financial transactions from such parties' failure to remediate their own year 2000 issues; however, due to the nature of the Company's business and relationships, the Company believes that economy-wide year 2000 issues pose a greater potential risk than issues arising from the specific nature of the Company's business or relationships. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable PART II. OTHER INFORMATION Item 1. Legal Proceedings Not Applicable Item 2. Changes in Securities and Use of Proceeds Not Applicable Item 3. Defaults Under Senior Securities Not Applicable Item 4. Submission of Matters to a Vote of Security Holders On September 16, 1998, the Company held its Annual Meeting of Stockholders. 1. At the Annual Meeting, Terrence O'Donnell was elected to the Board of Directors as a Class II director to hold office for three years until his successor has been duly elected and shall qualify, with votes cast and withheld as follows: For Withheld 4,877,610 1,467,873 2. At the Annual Meeting, Carl J. Rickertson was elected to the Board of Directors as a Class II director to hold office for three years until his successor has been For Withheld 4,877,610 1,467,873 In addition, the Company's stockholders approved the following proposals at the Annual Meeting, with votes for and against, abstentions and broker non-votes follow: 3. To approve and adopt the long-term incentive plan. For Against Abstain Broker Non-Votes 4,458,649 48,000 0 1,838,834 4. To ratify the appointment of Deloitte & Touche LLP as the Company's independent auditors for the Company's fiscal year ending March 31, 1999. For Against Abstain Broker Non-Votes 4,877,610 0 0 1,467,873 Item 5. Other Information Not Applicable
Item 6(a) Exhibits Exhibit Number Description Page -------------- --------------------------------------------------------- 10.27 1998 Long Term Incentive Plan X 27.1 Financial Data Schedule X Item 6(b) Reports on Form 8-K During the second fiscal quarter covered by this report, the Company filed the following Current Reports on form 8-K: Form 8-K Dated June 30, 1998 and filed with the Commission on July 31, 1998, reporting interim information regarding the acquisition of PC Plus, Inc. of Reston, Virginia. No financial statements were included.
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. MLC Holdings, Inc. /s/ PHILLIP G. NORTON By: Phillip G. Norton, Chairman of the Board, President and Chief Executive Officer Date: November 11, 1998 /s/ STEVEN J. MENCARINI By: Steven J. Mencarini, Senior Vice President and Chief Financial Officer Date: November 11, 1998