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 December 31, 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.) 400 Herndon Parkway, Herndon, VA 20170 (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 February 10, 1999, was 7,467,102.
<TABLE> <CAPTION> MLC HOLDINGS, INC. AND SUBSIDIARIES Part I. Financial Information: Item 1. Financial Statements - Unaudited: <S> <C> Condensed Consolidated Balance Sheets as of December 31, 1998 and March 31, 1998 2 Condensed Consolidated Statements of Earnings, Three months ended December 31, 1998 and 1997 3 Condensed Consolidated Statements of Earnings, Nine months ended December 31, 1998 and 1997 4 Condensed Consolidated Statements of Cash Flows, Nine months ended December 31, 1998 and 1997 5 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 Part II. Other Information: Item 1. Legal Proceedings 20 Item 2. Changes in Securities and Use of Proceeds 20 Item 3. Defaults Upon Senior Securities 20 Item 4. Submission of Matters to a Vote of Security Holders 20 Item 5. Other Information 20 Item 6. Exhibits and Reports on Form 8-K 21 Signatures 22 </TABLE> 1
<TABLE> <CAPTION> MLC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS UNAUDITED As of As of December 31, 1998 March 31, 1998 --------------------------------------------------- ASSETS <S> <C> <C> Cash and cash equivalents $ 7,406,250 $ 18,683,796 Accounts receivable 28,515,436 16,383,314 Other receivables 6,612,903 3,801,808 Employee advances 25,136 53,582 Inventories 1,020,030 1,213,734 Investment in direct financing and sales type leases - net 75,080,815 32,495,594 Investment in operating lease equipment - net 5,618,214 7,295,721 Property and equipment - net 1,880,239 1,131,512 Other assets 11,561,170 2,136,554 =================================================== TOTAL ASSETS $ 137,720,193 $ 83,195,615 =================================================== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Accounts payable - trade $ 11,759,261 $ 6,865,419 Accounts payable - equipment 18,931,416 21,283,582 Salaries and commissions payable 544,085 390,081 Accrued expenses and other liabilities 5,356,077 3,560,181 Recourse notes payable 18,646,016 13,037,365 Nonrecourse notes payable 38,379,108 13,027,676 Deferred taxes 1,487,000 1,487,000 Income tax payable 744,789 - --------------------------------------------------- Total Liabilities 95,847,752 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; 7,467,102 and 6,071,505 issued and outstanding at December 31, 1998 and March 31, 1998, respectively 74,671 60,715 Additional paid-in capital 24,972,870 11,460,331 Retained earnings 16,824,900 12,023,265 --------------------------------------------------- Total Stockholders' Equity 41,872,441 23,544,311 =================================================== TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 137,720,193 $ 83,195,615 =================================================== See Notes to Condensed Consolidated Financial Statements. </TABLE> 2
<TABLE> <CAPTION> MLC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS UNAUDITED Three months ended December 31, 1998 1997 ------------------------------------------- REVENUES <S> <C> <C> Sales of equipment $ 25,635,591 $ 10,797,522 Sales of leased equipment 38,053,115 7,299,836 ------------------------------------------- 63,688,706 18,097,358 Lease revenues 4,745,035 3,803,385 Fee and other income 1,512,952 1,662,666 ------------------------------------------- 6,257,987 5,466,051 ------------------------------------------- TOTAL REVENUES 69,946,693 23,563,409 ------------------------------------------- COSTS AND EXPENSES Cost of sales, equipment 22,148,807 8,316,250 Cost of sales, leased equipment 37,476,294 7,308,896 ------------------------------------------- 59,625,101 15,625,146 Direct lease costs 1,550,955 1,558,272 Professional and other fees 375,094 282,278 Salaries and benefits 3,106,179 2,630,773 General and administrative expenses 1,318,912 903,010 Interest and financing costs 1,140,617 396,756 Non-recurring acquisition costs - 39,103 ------------------------------------------- 7,491,757 5,810,192 ------------------------------------------- TOTAL COSTS AND EXPENSES 67,116,858 21,435,338 ------------------------------------------- EARNINGS BEFORE PROVISION FOR INCOME TAXES 2,829,835 2,128,071 ------------------------------------------- PROVISION FOR INCOME TAXES 1,131,934 850,584 ------------------------------------------- NET EARNINGS $ 1,697,901 $ 1,277,487 =========================================== NET EARNINGS PER COMMON SHARE - BASIC $ 0.24 $ 0.21 =========================================== NET EARNINGS PER COMMON SHARE - DILUTED $ 0.24 $ 0.21 =========================================== PRO FORMA NET EARNINGS (See Note 4) $ 1,697,901 $ 1,277,487 =========================================== PRO FORMA NET EARNINGS PER COMMON SHARE - BASIC $ 0.24 $ 0.21 =========================================== PRO FORMA NET EARNINGS PER COMMON SHARE - DILUTED $ 0.24 $ 0.21 =========================================== WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 7,189,324 6,071,305 WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 7,220,060 6,188,990 See Notes to Condensed Consolidated Financial Statements. </TABLE> 3
<TABLE> <CAPTION> MLC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS UNAUDITED Nine months ended December 31, 1998 1997 ------------------------------------------ REVENUES <S> <C> <C> Sales of equipment $ 55,740,476 $ 36,290,550 Sales of leased equipment 74,612,679 39,486,348 ------------------------------------------ 130,353,155 75,776,898 Lease revenues 14,994,505 11,021,736 Fee and other income 4,182,928 4,481,831 ------------------------------------------ 19,177,433 15,503,567 ------------------------------------------ TOTAL REVENUES 149,530,588 91,280,465 ------------------------------------------ COSTS AND EXPENSES Cost of sales, equipment 47,157,230 28,401,639 Cost of sales, leased equipment 73,630,008 38,888,847 ------------------------------------------ 120,787,238 67,290,486 Direct lease costs 5,221,414 4,889,244 Professional and other fees 894,587 723,152 Salaries and benefits 8,508,006 7,415,657 General and administrative expenses 3,618,588 3,057,796 Interest and financing costs 2,498,012 1,372,020 Non-recurring acquisition costs - 222,557 ------------------------------------------ 20,740,607 17,680,426 ------------------------------------------ TOTAL COSTS AND EXPENSES 141,527,845 84,970,912 ------------------------------------------ EARNINGS BEFORE PROVISION FOR INCOME TAXES 8,002,743 6,309,553 ------------------------------------------ PROVISION FOR INCOME TAXES 3,201,099 1,722,717 ------------------------------------------ NET EARNINGS $ 4,801,644 $ 4,586,836 ========================================== NET EARNINGS PER COMMON SHARE - BASIC $ 0.73 $ 0.76 ========================================== NET EARNINGS PER COMMON SHARE - DILUTED $ 0.72 $ 0.75 ========================================== PRO FORMA NET EARNINGS (See Note 4) $ 4,801,644 $ 3,973,575 ========================================== PRO FORMA NET EARNINGS PER COMMON SHARE - BASIC $ 0.73 $ 0.66 ========================================== PRO FORMA NET EARNINGS PER COMMON SHARE - DILUTED $ 0.72 $ 0.65 ========================================== WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 6,540,359 6,017,920 WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 6,648,754 6,127,933 See Notes to Condensed Consolidated Financial Statements. 4 </TABLE>
<TABLE> <CAPTION> MLC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS UNAUDITED Nine Months Ended December 31, 1998 1997 ------------------------------------- Cash Flows From Operating Activities: <S> <C> <C> Net earnings $ 4,801,644 $ 4,586,836 Adjustments to reconcile net earnings to net cash (used in) provided by operating activities: Depreciation and amortization 3,850,449 3,443,864 Provision for credit losses 500,000 (13,865) Gain on sale of operating lease equipment (5,267) (92,800) Loss on disposal of property and equipment 9,809 - Adjustment of basis to fair market value of equipment and investments 268,506 - Payments from lessees directly to lenders (771,465) (1,375,099) Compensation to outside directors - stock options - 18,283 Changes in assets and liabilities, net of effects of purchase acquisition: Accounts receivable (5,837,220) (2,311,932) Other receivables (2,811,095) 368,656 Employee advances 26,630 (6,649) Inventories 1,036,507 (181,764) Other assets (2,764,961) (1,216,167) Accounts payable - equipment (1,397,591) 5,581,535 Accounts payable - trade (2,032,538) (496,075) Salaries and commissions payable, accrued expenses and other liabilities 2,195,466 (399,557) ------------------------------------- Net cash (used in) provided by operating activities (2,931,126) 7,905,266 ------------------------------------- Cash Flows From Investing Activities: Proceeds from sale of operating lease equipment 22,151 609,722 Purchase of operating lease equipment (1,824,989) (1,987,058) Increase in investment in direct financing and sales-type leases (66,557,986) (6,373,493) Purchases of property and equipment (915,346) (428,952) Proceeds from sale of property and equipment 2,000 - Cash used in acquisition, net of cash acquired (3,485,279) - Increase in other assets (709,216) (353,181) ------------------------------------- Net cash used in investing activities (73,468,665) (8,532,962) ------------------------------------- Cash Flows From Financing Activities: Borrowings: Nonrecourse 53,236,003 3,587,039 Recourse 319,586 174,894 Repayments: Nonrecourse (3,640,341) (3,364,608) Recourse (136,833) (161,282) Distributions to shareholders of combined companies prior to business combination - (1,021,012) Proceeds from issuance of capital stock, net of expenses 177,931 - Proceeds from sale of stock, net of underwriting costs 9,725,742 2,000,000 Proceeds from lines of credit 5,440,157 362,000 ------------------------------------- Net cash provided by financing activities 65,122,245 1,577,031 ------------------------------------- 5 </TABLE>
<TABLE> <CAPTION> MLC HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS UNAUDITED - Continued Nine Months Ended December 31, 1998 1997 ------------------------------------- <S> <C> <C> Net (Decrease) Increase in Cash and Cash Equivalents (11,277,546) 949,335 Cash and Cash Equivalents, Beginning of Period 18,683,796 6,654,209 ------------------------------------- Cash and Cash Equivalents, End of Period $ 7,406,250 $ 7,603,544 ===================================== Supplemental Disclosures of Cash Flow Information: Cash paid for interest $ 990,676 $ 116,787 ===================================== Cash paid for income taxes $ 2,443,818 $ 257,137 ===================================== See Notes To Condensed Consolidated Financial Statements. </TABLE> 6
MLC HOLDINGS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The condensed consolidated interim financial statements of MLC Holdings, Inc. and subsidiaries (the "Company") included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and reflect all adjustments that are, in the opinion of management, necessary for a fair statement of results for the interim periods. All adjustments made were normal, recurring accruals. These interim financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company's Annual Report on Form 10-K (No. 0-28926) for the year ended March 31, 1998 (the "Company's 1998 Form 10-K"). Operating results for the interim periods are not necessarily indicative of results for an entire year. 2. INVESTMENT IN DIRECT FINANCING AND SALES TYPE LEASES The Company's investment in direct financing and sales type leases consists of the following components: <TABLE> <CAPTION> December 31, March 31, 1998 1998 ------------------ ------------------ (In thousands) <S> <C> <C> Minimum lease payments $ 69,079 $ 29,968 Estimated unguaranteed residual value 15,218 7,084 Initial direct costs - net of amortization 1,452 760 Less: Unearned lease income (10,122) (5,270) Reserve for credit losses (546) (46) ================== ================== Investment in direct financing and sales type leases - net $ 75,081 $ 32,496 ================== ================== </TABLE> 7
3. INVESTMENT IN OPERATING LEASE EQUIPMENT The components of the net investment in operating lease equipment are as follows: <TABLE> <CAPTION> December 31, March 31, 1998 1998 ----------------- ------------------ (In thousands) <S> <C> <C> Cost of equipment under operating leases $ 14,808 $ 13,990 Initial direct costs 29 51 Accumulated depreciation and amortization (9,219) (6,745) ----------------- ------------------ Investment in operating leases - net $ 5,618 $ 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 Nine Months Ended December 31, December 31, 1998 1997 1998 1997 ------------ -------------- ------------- --------------- (In Thousands) Net earnings before pro forma <S> <C> <C> <C> <C> adjustment $ 1,698 $ 1,277 $ 4,802 $ 4,587 Additional provision for income tax - - - 613 Pro forma net income ---------------------------------------------------- $ 1,698 $1,277 $ 4,802 $ 3,974 ============ ============== ============= =============== </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. 8
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 nine months ended December 31, 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. Nine Months Ended December 31, ( in thousands) 1998 1997 --------------- ------------- Total Revenues $161,469 $116,506 Net Earnings 5,021 5,197 Net Earnings per Common Share - Basic .77 .83 Net Earnings per Common Share - Diluted .76 .81 7. OTHER DEVELOPMENT The Company has two major customers who have filed for voluntary bankruptcy protection. The largest is Allegheny Health, Education & Research Foundation ("AHERF") which is a Pittsburgh based not-for-profit hospital entity. The bankruptcy court has held an auction and Tenet Healthcare, Inc. acquired AHERF's assets. As of December 31, 1998, the Company's net book value of leases to AHERF is approximately $1,874,000 and receivable balance is approximately $478,000. The Company believes that the fair market value of the equipment is below its current book balances. Depending on the decisions 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 will probably sustain a loss, and has accordingly provided for such loss in the statement of earnings for the nine month period ended December 31, 1998. The amount and timing of such loss cannot be accurately estimated by the Company at this time due to the recent filing and unknown status of many of its claims. The Company has received a deposit on the purchase of the leased equipment from Tenet Healthcare, Inc. which represents the total cash consideration for the future transfer of title of the equipment once the bankruptcy court makes the equipment available for liquidation. During the quarter ending December 31, 1998, PHP Healthcare, Inc. a lessee of the Company, was placed in receivership by the New Jersey Insurance Commission which led to them filing for voluntary 9
bankruptcy protection. The Company has a net book value of assets totaling approximately $359,000 at risk with this lessee. The remainder of the lease risk is the financial responsibility of the non-recourse lenders. The Company is vigorously pursuing all available remedies in bankruptcy court for all prior claims against these bankrupt lessees. The Company believes that as of December 31, 1998, its reserves are adequate to provide for the potential losses resulting from these customers. 8. PRIVATE PLACEMENT OF EQUITY 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 1,090,909 shares of common stock at an exercise price of $11.00 per share. The warrant expires December 31, 2001. 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following discussion and analysis compares the consolidated results of operations for the nine- and three-month periods ended December 31, 1998 to the nine- and three-month periods ended December 31, 1997. The operating results of these nine- and three-month periods are not necessarily indicative of operating results in future periods. The following comparative information should be read in conjunction with the Condensed Consolidated Financial Statements and accompanying Notes, as well as the information presented elsewhere herein and in the financial statements and related notes for the year ended March 31, 1998 included in the Company's 1998 Form 10-K. "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 Nine Months Ended December 31, 1998, Compared to Three and Nine Months Ended December 31, 1997 Total revenues generated by the Company during the three month period ended December 31, 1998 were $69,946,693 compared to revenues of $23,563,409 during the comparable period in the prior fiscal year, an increase of 196.84%. During the nine month period ended December 31, total revenues were $149,530,588 and $91,280,465 in 1998 and 1997, respectively, an increase of 63.81%. 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 251.92% to $63,688,706 during the three month period ended December 31, 1998, as compared to $18,097,358 in the corresponding period in the prior fiscal year. For the nine month period ended December 31, 1998, sales increased 72.02% to $130,353,155 over the corresponding period in the prior year. 11
During the three months ended December 31, 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 nine month periods ended December 31, sales to MLC/CLC LLC accounted for 100% and 85.9% 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 (137.42%) $14,836,069 compared to the corresponding period in the prior fiscal year. For the fiscal year to date through December 31, equipment sales increased 53.6% to $55,740,476. On a pro forma basis, had PC Plus, Inc.'s equipment sales been included throughout the periods presented, equipment sales would have increased 22.34% and 53.42% during the three and nine month periods ended December 31, 1998 as compared to the comparable periods in the prior fiscal year. The Company's brokerage and re-marketing activities accounted for 2.11% and 25.1% of equipment sales during the three month period in 1998 and 1997, respectively. During the nine month periods ended December 31, brokerage and re-marketing activities accounted for 3.2% and 18.6% 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 13.6% and 15.4% for the three and nine month periods ended December 31, 1998, respectively, as compared to a gross margin of 23.0% and 21.7% realized on sales of equipment generated during the three and nine month 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 December 31, 1998, the Company recognized a gross margin of $576,821 on equity sales of $38,053,115 as compared to a net loss of $9,060 on equity sales of $7,299,836 during the same period in the prior fiscal year. For the fiscal year to date through December 31, 1998, the Company recognized a gross margin of $982,671 on equity sales of $74,612,679, as compared to a gross margin of $597,501 on equity sales of $39,486,348 during the same period in the prior fiscal year. 12
The Company's lease revenues increased 24.76% to $4,745,035 for the three-month period ended December 31, 1998, compared with the corresponding period in the prior fiscal year. For the fiscal year to date through December 31, lease revenues increased 36.04% to $14,994,505 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 December 31, 1998 and March 31, 1998 were $75,080,815 and $32,495,594, respectively. The December 31, 1998 balance represents an increase of $42,585,221 or 131.05% 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 Statement 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 nine month periods ending December 31, 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 nine months ended December 31, 1998, fee and other income decreased 9.00% and 6.67%, 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 6.79% during the nine month periods ended December 31, 1998 as compared to the same period in the prior fiscal year. There was a slight decrease, less than 1%, in direct lease costs for the three month period ended December 31, 1998 as compared to December 31, 1997. 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 and increased amortization of initial direct costs. Salaries and benefits expenses increased 18.07% during the three month period ended December 31, 1998 over the same period in the prior year. For the fiscal year to date through December 31, 1998, salaries and benefits had increased 14.73% over the prior year. These increases reflect both the higher commission expenses in the value added reseller businesses and the increased number of personell employed by the Company. Interest and financing costs incurred by the Company for the three and nine months ended December 31, 1998 amounted to $1,140,617 and $2,498,012, 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 13
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 nine month periods in the current fiscal year as compared to the prior fiscal year. The Company's provision for income taxes increased to $1,131,934 for the three months ended December 31, 1998 from $850,584 for the three months ended December 31, 1997, reflecting effective income tax rates of 40% for both periods. For the nine months ended December 31, 1998, the Company's provision for income tax was $3,201,099 as compared to $1,722,717 during the comparable period in the prior year, reflecting effective income tax rates of 40% and 27.3%, respectively. The low effective income tax rate for December 31, 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 nine months ended December 31, 1997, would have increased the expense by approximately $-0- and $613,261. The foregoing resulted in a 32.91% and 4.68% increase in net earnings for the three and nine month periods ended December 31, 1998, respectively, as compared to the same periods in the prior fiscal year after taking into consideration the pro forma tax expense. Basic and fully diluted earnings per common share were $.24 for the three months ended December 31, 1998, as compared to $.21 for the three months ended December 31, 1997, based on weighted average common shares outstanding of 7,189,324 and 7,220,060, respectively, for 1998, and 6,071,305 and 6,188,990, respectively, for 1997. For the fiscal year to date through December 31, 1998, the Company's basic and fully diluted earnings per common share were $.73 and $.72, respectively, as compared to $.76 and $.75, respectively, for the same period in 1997, based on weighted average common shares outstanding of 6,540,359 and 6,648,754, respectively, for 1998, and 6,017,920 and 6,127,933 respectively, for 1997. LIQUIDITY AND CAPITAL RESOURCES During the nine month period ended December 31, 1998, the Company used cash flows in operations of $2,931,126, and used cash flows from investing activities of $73,468,665. Cash flows generated by financing activities amounted to $65,122,245 during the same period. The net effect of these cash flows was a net decrease in cash and cash equivalents of $11,277,546 during the nine month period. During the same period, the Company's total assets increased $54,524,577, or 65.54%, 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 December 31, 1998, the Company had $18,931,416 of unpaid equipment cost, as compared to $21,283,582 at March 31, 1998. 14
Prior to the permanent financing of its leases, interim financing has been obtained through short-term, secured, recourse facilities. From June 5, 1997 until December 18, 1998, the Company had entered into the First Union Facility with First Union National Bank, N.A., for a maximum facility limit of $35 million which bore interest at LIBOR+110 basis points, or, at the Company's option, prime minus one percent. On December 18, 1998, MLC Holdings, Inc., with its two wholly-owned subsidiaries, MLC Group, Inc., and MLC Federal, Inc., as co-borrowers finalized and executed documents establishing a $50,000,000 committed recourse line of credit with First Union National Bank. Under the terms of the successor First Union Credit Facility, a maximum amount of $50 million is available to MLC, though each draw is subject to the availability of sufficient collateral in the borrowing base. The First Union Credit Facility is evidenced by a credit agreement, dated as of December 31, 1998, a security agreement and a pledge agreement both dated as of December 18, 1998. Borrowings under the First Union Credit Facility will bear interest at LIBOR + 150 basis points, or, at the Company's option, prime minus one-half percent. The Credit Facility is secured by certain of the three company's assets such as chattel paper (including leases), receivables, inventory, and equipment. In addition, MLC Holdings, Inc. has entered into pledge agreements to pledge the common stock of each of its subsidiaries. The availability of the line is subject to a borrowing base, which consists of inventory, receivables, purchased assets, and leases. Availability under the revolving lines of credit may be limited by the asset value of equipment purchased by MLC and may be further limited by certain covenants and terms and conditions of the facilities. In the event that MLC is unable to sell the equipment or unable to finance the equipment on a permanent basis within a certain period of time, the availability of credit under the lines could be diminished or eliminated. Furthermore, in the event that receivables collateralizing the line are uncollectible, MLC would be responsible for repayment of the lines of credit. The First Union Credit Facility contains a number of covenants binding on MLC requiring, among other things, minimum tangible net worth, cash flow coverage ratios, maximum debt to equity ratio, maximum amount of guarantees of subsidiary obligations, mergers, acquisitions, and asset sales. The Credit Facility is a full recourse facility, secured by first-priority blanket liens on all of MLC's assets. 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. The new First Union Credit Facility expires on December 18, 1999. Other participants in the First Union Credit Facility, each for $7,000,000, are: Riggs Bank, N.A., Key Bank, N.A., Summit Bank, N.A., Bank Leumi USA, and Wachovia Bank., N.A. As of December 31, 1998, the Company had an outstanding balance of $17,000,000 on the First Union Facility. 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 December 31, 1998, MLC Network Solutions, Inc., has floor planning availability of $2,600,000 through Deutsche Financial, Inc. and $225,000 from IBM Credit Corporation. The outstanding balances to these respective suppliers were $1,047,889 and $32,898 as of December 31, 1998. MLC Integrated, Inc. has floor planning availability of $3,000,000 from FINOVA Capital Corporation and $750,000 through IBM Credit Corporation. The outstanding balances to these respective suppliers were $2,045,545, and $197,640 as of December 31, 1998. In addition, MLC Integrated, 15
Inc. has a line of credit in place, expiring on July 31, 1999, with PNC Bank, N.A. to provide an asset based 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 $1,179,000 as of December 31, 1998. PC Plus, Inc. has floor planning availability of $6,000,000 through NationsCredit Commercial Corporation as of December 31, 1998. This agreement expires October 1, 1999. The outstanding balance to this supplier was $1,956,344 as of December 31, 1998. Non-recourse debt and debt that is partially recourse is provided by various lending institutions. The Company has formal programs with Heller Financial, Inc., Key Corporate Capital, Inc., and Sanwa Business Credit Corporation. These programs require that each transaction is specifically approved and done solely at the lender's discretion. 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 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. 16
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 three 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 business, financial condition, results of operations and cash flows. 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 business, financial condition, results of operations and cash flows. 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. 17
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 business, financial condition, results of operations and cash flows, 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. 18
YEAR 2000 ISSUE The Company has identified all significant hardware and software applications, both IT and non-IT based, that will require upgrade or modification to ensure Year 2000 compliance. The upgrade and/or modification of the majority of these systems is substantially complete. The Company plans on completing the process of modifying and/or upgrading its remaining systems by March 31, 1999. The total cost of these Year 2000 compliance activities has not been, nor is it anticipated to become, material to the Company's financial position, results of operations or cash flows in any given year. The Company recognizes the risks surrounding its own Year 2000 readiness, for which it believes it has adequately addressed, as well as the risks arising from the failure of third parties with whom it has a material relationship to remediate their own Year 2000 issues. While the risks of third party non-compliance may temporarily affect the ability of a third party to transact business with the Company, the Company believes such risks are adequately mitigated by its own contingency plans. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable 19
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 Not Applicable Item 5. Other Information Not Applicable 20
Item 6(a) Exhibits Exhibit Number Description Page -------------- --------------------------------------------------------------- 10.28 Sublease by and between Cisco Systems ("Tenant") and MLC Holdings, Inc. ("Subtenant") 27 Financial Data Schedule Item 6(b) Reports on Form 8-K During the third fiscal quarter covered by this report, the Company filed the ollowing Current Reports on form 8-K: Form 8-K dated October 23, 1998 and filed with the Commission on November 13, 1998, reporting interim information regarding the issuance of 1,111,111 shares of common stock in a private placement. No financial statements were included. Form 8-K dated December 18, 1998 and filed with the Commission on December 31, 1998, reporting the establishment of a $50,000,000 line of credit with First Union National Bank. No financial statements were included. 21
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: February 10, 1999 /s/ STEVEN J. MENCARINI By: Steven J. Mencarini, Senior Vice President and Chief Financial Officer Date: February 10, 1999 22