UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ]
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended December 31, 2005
June 30, 2006
OR
[ ]
o 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
ePlus
ePlus inc.
(Exact
(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.)
| Delaware | | 54-1817218 | |
| | | | |
| (State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) | |
13595 Dulles Technology Drive, Herndon, VA 20171-3413
(Address,
(Address, including zip code, of principal executive offices)
Registrant's telephone number, including area code: (703) 984-8400
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 ]o No [ ___ ]
x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated“accelerated filer and large accelerated filer"filer” in Rule 12b-2 of the Exchange Act (CheckAct.
(check one):
Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [X]
Large Accelerated filer o | Accelerated filer o | Non-accelerated filer x |
Indicate by check markcheckmark whether the registrant is a shell company (as
(as defined in Rule 12b-2 of the Exchange Act). Yes [_]o No [X]
x
The number of shares of common stock outstanding as of
February 2, 2006,August 31, 2007, was
8,143,191.
TABLE8,231,741.
ePlus inc. AND SUBSIDIARIES
and Subsidiaries
| 1 |
| |
| Part I. Financial Information: | |
| Item 1. Financial Statements - Statements—Unaudited: | |
| | 2 |
| | 3
Condensed Consolidated Statements of Earnings, Nine Months Ended December 31, 2004 and 2005 4
|
| | 4 |
| | 6 |
| | 23 |
| | 34 |
| | 34 |
| |
| Part II. Other Information: | |
| | 38 |
| | 39 |
| | 39 |
| | 40 |
| | 40 |
| | 40 |
| | 40 |
| |
| 41 |
This Quarterly Report on Form 10-Q contains the restatement of our Condensed Consolidated Statements of Operations and Cash Flows for the three months ended June 30, 2005 for the effects of errors in accounting for stock options and other items. See Note 2, “Restatement of Consolidated Financial Statements” to our Unaudited Condensed Consolidated Financial Statements contained elsewhere in this document. For further discussion of the effects of the restatement see the following sections of our Annual Report on Form 10-K for the year ended March 31, 2006: Explanatory Note; Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition; Item 9A. Controls and Procedures; and Note 2 to our Consolidated Financial Statements.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ePlus inc. AND SUBSIDIARIES | | | | | | |
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) | | As of | | | As of | |
| | | March 31, 2006 | | | June 30, 2006 | |
| ASSETS | | (in thousands) | |
| | | | | | | |
| Cash and cash equivalents | | $ | 20,697 | | | $ | 22,616 | |
| Accounts receivable—net | | | 103,060 | | | | 129,779 | |
| Notes receivable | | | 330 | | | | 321 | |
| Inventories | | | 2,292 | | | | 12,025 | |
| Investment in leases and leased equipment—net | | | 205,774 | | | | 212,198 | |
| Property and equipment—net | | | 5,629 | | | | 5,253 | |
| Other assets | | | 10,038 | | | | 10,055 | |
| Goodwill | | | 26,125 | | | | 26,125 | |
| TOTAL ASSETS | | $ | 373,945 | | | $ | 418,372 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
| | | | | | | | | |
| LIABILITIES | | | | | | | | |
| Accounts payable—equipment | | $ | 7,733 | | | $ | 8,530 | |
| Accounts payable—trade | | | 19,235 | | | | 22,364 | |
| Accounts payable—floor plan | | | 46,689 | | | | 66,455 | |
| Salaries and commissions payable | | | 4,124 | | | | 4,407 | |
| Accrued expenses and other liabilities | | | 33,346 | | | | 36,882 | |
| Income taxes payable | | | 104 | | | | 164 | |
| Recourse notes payable | | | 6,000 | | | | 15,000 | |
| Non-recourse notes payable | | | 127,973 | | | | 134,095 | |
| Deferred tax liability | | | 165 | | | | 1,078 | |
| Total Liabilities | | | 245,369 | | | | 288,975 | |
| | | | | | | | | |
| COMMITMENTS AND CONTINGENCIES (Note 7) | | | | | | | | |
| | | | | | | | | |
| STOCKHOLDERS' EQUITY | | | | | | | | |
| | | | | | | | | |
| Preferred stock, $.01 par value; 2,000,000 shares authorized;none issued or outstanding | | | - | | | | - | |
| Common stock, $.01 par value; 25,000,000 shares authorized; 11,037,213 issued and 8,267,223 outstanding at March 31, 2006 and 11,191,231 issued and 8,212,241 outstanding at June 30, 2006 | | | 110 | | | | 112 | |
| Additional paid-in capital | | | 72,811 | | | | 74,455 | |
| Treasury stock, at cost, 2,769,990 and 2,978,990 shares, respectively | | | (29,984 | ) | | | (32,884 | ) |
| Deferred compensation expense | | | (25 | ) | | | - | |
| Retained earnings | | | 85,377 | | | | 87,330 | |
| Accumulated other comprehensive income—foreign currency translation adjustment | | | 287 | | | | 384 | |
| Total Stockholders' Equity | | | 128,576 | | | | 129,397 | |
| TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | | $ | 373,945 | | | $ | 418,372 | |
See Notes to Unaudited Condensed Consolidated Financial Statements.
ePlus inc. AND SUBSIDIARIES | | | | | | |
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS | | | | |
(UNAUDITED) | | | | | | |
| | | | | | | |
| | | Three Months Ended | |
| | | June 30, | |
| | | 2005 | | | 2006 | |
| | | As Restated (1) | | | | |
| | | (dollar amounts in thousands, except per share data) | |
| REVENUES | | | | | | |
| | | | | | | |
| Sales of product and services | | $ | 134,870 | | | $ | 175,493 | |
| Lease revenues | | | 11,294 | | | | 11,332 | |
| Fee and other income | | | 3,640 | | | | 2,845 | |
| | | | | | | | | |
| TOTAL REVENUES | | | 149,804 | | | | 189,670 | |
| | | | | | | | | |
| COSTS AND EXPENSES | | | | | | | | |
| | | | | | | | | |
| Cost of sales, product and services | | | 122,107 | | | | 156,362 | |
| Direct lease costs | | | 3,777 | | | | 5,024 | |
| Professional and other fees | | | 947 | | | | 1,286 | |
| Salaries and benefits | | | 14,789 | | | | 17,303 | |
| General and administrative expenses | | | 4,461 | | | | 4,356 | |
| Interest and financing costs | | | 1,538 | | | | 1,995 | |
| | | | | | | | | |
| TOTAL COSTS AND EXPENSES (2) | | | 147,619 | | | | 186,326 | |
| | | | | | | | | |
| EARNINGS BEFORE PROVISION FOR INCOME TAXES | | | 2,185 | | | | 3,344 | |
| | | | | | | | | |
| PROVISION FOR INCOME TAXES | | | 885 | | | | 1,391 | |
| | | | | | | | | |
| NET EARNINGS | | $ | 1,300 | | | $ | 1,953 | |
| | | | | | | | | |
| NET EARNINGS PER COMMON SHARE—BASIC | | $ | 0.15 | | | $ | 0.24 | |
| NET EARNINGS PER COMMON SHARE—DILUTED | | $ | 0.14 | | | $ | 0.22 | |
| | | | | | | | | |
| | | | | | | | | |
| WEIGHTED AVERAGE SHARES OUTSTANDING—BASIC | | | 8,545,744 | | | | 8,207,369 | |
| WEIGHTED AVERAGE SHARES OUTSTANDING—DILUTED | | | 9,078,604 | | | | 8,723,439 | |
| (1) | See Note 2, “Restatement of Consolidated Financial Statements.” |
| (2) | Includes amounts to related parties of $219 thousand and $233 thousand for the three months ended June 30, 2005 and June 30, 2006, respectively. |
See Notes to Unaudited Condensed Consolidated Financial Statements.
ePlus inc. AND SUBSIDIARIES | | | | | | |
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS | | | | | | |
(UNAUDITED) | | | | | | |
| | | | |
| | | Three Months Ended | |
| | | June 30, | |
| | | 2005 | | | 2006 | |
| | | As Restated (1) | | | | |
| | | (in thousands) | |
Cash Flows From Operating Activities: | | | | | | |
| Net earnings | | $ | 1,300 | | | $ | 1,953 | |
| | | | | | | | | |
| Adjustments to reconcile net earnings to net cash used in operating activities: | | | | | | | | |
| Depreciation and amortization | | | 3,989 | | | | 4,948 | |
| Reserves for credit losses | | | 190 | | | | 591 | |
| Provision for inventory losses | | | - | | | | (2 | ) |
| Impact of stock-based compensation | | | (3 | ) | | | 254 | |
| Excess tax benefit from exercise of stock options | | | - | | | | (101 | ) |
| Tax benefit of options exercised | | | 5 | | | | - | |
| Deferred taxes | | | (371 | ) | | | 913 | |
| Payments from lessees directly to lenders—operating leases | | | (1,173 | ) | | | (2,520 | ) |
| Loss on disposal of property and equipment | | | 6 | | | | 9 | |
| Gain on disposal of operating lease equipment | | | (116 | ) | | | (316 | ) |
| Changes in: | | | | | | | | |
| Accounts receivable—net | | | (13,069 | ) | | | (27,350 | ) |
| Notes receivable | | | (231 | ) | | | 9 | |
| Inventories | | | (849 | ) | | | (9,731 | ) |
| Investment in leases and leased equipment—net | | | (3,127 | ) | | | (12,275 | ) |
| Other assets | | | 321 | | | | 38 | |
| Accounts payable—equipment | | | 4,107 | | | | 109 | |
| Accounts payable—trade | | | 1,474 | | | | 3,129 | |
| Salaries and commissions payable, accrued expenses and other liabilities | | | (12,501 | ) | | | 3,879 | |
| Net cash used in operating activities | | | (20,048 | ) | | | (36,463 | ) |
| | | | | | | | | |
Cash Flows From Investing Activities: | | | | | | | | |
| Proceeds from sale of operating lease equipment | | | 381 | | | | 497 | |
| Purchases of operating lease equipment | | | (12,206 | ) | | | (4,734 | ) |
| Proceeds from sale of property and equipment | | | 44 | | | | - | |
| Purchases of property and equipment | | | (525 | ) | | | (546 | ) |
| Premiums paid on officers life insurance | | | - | | | | (55 | ) |
| Net cash used in investing activities | | | (12,306 | ) | | | (4,838 | ) |
ePlus inc. AND SUBSIDIARIES | |
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS — continued | |
(UNAUDITED) | |
| | | | |
| | | Three Months Ended | |
| | | June 30, | |
| | | 2005 | | | 2006 | |
| | | As Restated (1) | | | | |
| | | (in thousands) | |
Cash Flows From Financing Activities: | | | | | | |
| Borrowings: | | | | | | |
| Non-recourse | | $ | 17,164 | | | $ | 23,497 | |
| Repayments: | | | | | | | | |
| Non-recourse | | | (8,904 | ) | | | (7,758 | ) |
| Purchase of treasury stock | | | (622 | ) | | | (2,900 | ) |
| Proceeds from issuance of capital stock, net of expenses | | | 31 | | | | 1,109 | |
| Excess tax benefit from exercise of stock options | | | - | | | | 101 | |
| Tax benefit of stock options exercised | | | - | | | | 308 | |
| Net borrowings on floor plan financing | | | 7,929 | | | | 19,766 | |
| Net borrowings on lines of credit | | | 148 | | | | 9,000 | |
| Net cash provided by financing activities | | | 15,746 | | | | 43,123 | |
| | | | | | | | | |
Effect of Exchange Rate Changes on Cash | | | (11 | ) | | | 97 | |
| | | | | | | | | |
Net (Decrease) Increase in Cash and Cash Equivalents | | | (16,619 | ) | | | 1,919 | |
| | | | | | | | | |
Cash and Cash Equivalents, Beginning of Period | | | 38,852 | | | | 20,697 | |
| | | | | | | | | |
Cash and Cash Equivalents, End of Period | | $ | 22,233 | | | $ | 22,616 | |
| | | | | | | | | |
Supplemental Disclosures of Cash Flow Information: | | | | | | | | |
| Cash paid for interest | | $ | 691 | | | $ | 529 | |
| Cash paid for income taxes | | $ | 723 | | | $ | 16 | |
| | | | | | | | | |
Schedule of Noncash Investing and Financing Activities: | | | | | | | | |
| Purchase of property and equipment included in accounts payable | | $ | 98 | | | $ | 112 | |
| Payments from lessees directly to lenders | | $ | 6,057 | | | $ | 9,617 | |
(1) See Note 2, “Restatement of Consolidated Financial Statements.”
See Notes to Unaudited Condensed Consolidated Financial Statements.
ePlus inc. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
As of March 31, 2005 As of December 31, 2005
-------------------- -----------------------
ASSETS
Cash and cash equivalents $ 38,851,714 $ 17,416,397
Accounts receivable, net of allowance for doubtful accounts
of $1,959,049 and $2,238,904 as of March 31, 2005 and December 31,
2005, respectively 93,555,462 120,003,176
Notes receivable 114,708 151,350
Inventories 2,116,855 3,671,913
Investment in leases and leased equipment - net 189,468,926 205,819,210
Property and equipment - net 6,647,781 5,961,351
Other assets 3,859,791 3,708,287
Goodwill 26,125,212 26,125,212
-------------------- -----------------------
TOTAL ASSETS $ 360,740,449 $ 382,856,896
==================== =======================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Accounts payable - equipment $ 8,965,022 $ 5,961,928
Accounts payable - trade 54,751,962 73,604,506
Salaries and benefits payable 3,273,700 4,728,368
Accrued expenses and other liabilities 31,024,749 17,396,264
Income taxes payable - 1,449,011
Recourse notes payable 6,264,897 7,000,000
Non-recourse notes payable 114,838,994 134,411,118
Deferred tax liability 9,519,309 7,179,820
-------------------- -----------------------
Total Liabilities 228,638,633 251,731,015
COMMITMENTS AND CONTINGENCIES (Note 7) - -
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; 2,000,000 shares authorized;
none issued or outstanding - -
Common stock, $.01 par value; 25,000,000 shares authorized;
10,807,392 issued and 8,581,492 outstanding at March 31, 2005 and
10,831,042 issued and 8,158,086 outstanding at December 31, 2005 $ 108,074 $ 108,310
Additional paid-in capital 65,181,862 65,418,576
Treasury stock, at cost, 2,225,900 and 2,672,956 shares, respectively (22,887,881) (28,620,209)
Retained earnings 89,499,096 93,926,395
Accumulated other comprehensive income -
Foreign currency translation adjustment 200,665 292,809
-------------------- -----------------------
Total Stockholders' Equity 132,101,816 131,125,881
-------------------- -----------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 360,740,449 $ 382,856,896
==================== =======================
See Notes to Condensed Consolidated Financial Statements.
2
ePlus inc. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
Three Months Ended
December 31,
2004 2005
-------------------- --------------------
REVENUES
Sales of product $ 133,728,559 $ 146,384,576
Lease revenues 11,147,094 13,758,427
Fee and other income 2,774,614 2,930,615
-------------------- --------------------
TOTAL REVENUES 147,650,267 163,073,618
-------------------- --------------------
COSTS AND EXPENSES
Cost of sales, product 120,892,787 131,734,303
Direct lease costs 3,060,531 4,741,811
Professional and other fees 600,484 2,464,259
Salaries and benefits 14,365,021 15,677,592
General and administrative expenses 4,370,363 4,468,922
Interest and financing costs 1,622,837 1,950,431
-------------------- --------------------
TOTAL COSTS AND EXPENSES 144,912,023 161,037,318
-------------------- --------------------
EARNINGS BEFORE PROVISION FOR INCOME TAXES 2,738,244 2,036,300
-------------------- --------------------
PROVISION FOR INCOME TAXES 1,122,680 824,701
-------------------- --------------------
NET EARNINGS $ 1,615,564 $ 1,211,599
==================== ====================
NET EARNINGS PER COMMON SHARE - BASIC $ 0.18 $ 0.15
==================== ====================
NET EARNINGS PER COMMON SHARE - DILUTED $ 0.17 $ 0.14
==================== ====================
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 8,957,280 8,215,221
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 9,375,666 8,890,948
See Notes to Condensed Consolidated Financial Statements.
3
ePlus inc. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
Nine Months Ended
December 31,
2004 2005
-------------------- --------------------
REVENUES
Sales of product $ 363,762,423 $ 440,663,026
Lease revenues 35,213,926 36,968,881
Fee and other income 8,558,351 9,488,230
-------------------- --------------------
TOTAL REVENUES 407,534,700 487,120,137
-------------------- --------------------
COSTS AND EXPENSES
Cost of sales, product 326,396,119 397,564,106
Direct lease costs 8,667,800 12,335,864
Professional and other fees 5,180,734 5,188,068
Salaries and benefits 40,040,719 45,482,831
General and administrative expenses 13,025,413 13,905,504
Interest and financing costs 4,315,623 5,202,926
-------------------- --------------------
TOTAL COSTS AND EXPENSES 397,626,408 479,679,299
-------------------- --------------------
EARNINGS BEFORE PROVISION FOR INCOME TAXES 9,908,292 7,440,838
-------------------- --------------------
PROVISION FOR INCOME TAXES 4,062,401 3,013,540
-------------------- --------------------
NET EARNINGS $ 5,845,891 $ 4,427,298
==================== ====================
NET EARNINGS PER COMMON SHARE - BASIC $ 0.65 $ 0.53
==================== ====================
NET EARNINGS PER COMMON SHARE - DILUTED $ 0.62 $ 0.49
==================== ====================
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 8,933,702 8,411,268
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 9,358,693 8,992,035
See Notes to Condensed Consolidated Financial Statements.
4
ePlus inc. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
December 31,
2004 2005
-------------------- --------------------
Cash Flows From Operating Activities:
Net earnings $ 5,845,891 $ 4,427,298
Adjustments to reconcile net earnings to net cash
used in operating activities:
Depreciation and amortization 7,887,206 12,673,230
Write-off of non-recourse debt (489,607) (21,952)
Provision for credit losses 197,841 (279,855)
Tax benefit of stock options exercised - 49,569
Deferred taxes 832,315 (2,339,489)
Payments from lessees directly to lenders (3,100,205) (5,644,747)
(Gain) loss on disposal of property and equipment (3,766) 142,351
Gain on disposal of operating lease equipment (142,803) (931,993)
Changes in:
Accounts receivable (57,464,540) (26,354,060)
Other receivable (91,816) (36,642)
Inventories (2,860,418) (1,555,058)
Decrease (increase) in investment in leases and leased equipment 906,856 (4,525,598)
Other assets (2,226,429) 151,504
Accounts payable - equipment (4,511,283) (2,958,889)
Accounts payable - trade 27,293,168 18,247,310
Salaries and commissions payable, accrued
expenses and other liabilities 5,505,703 (10,143,775)
-------------------- --------------------
Net cash used in operating activities (22,421,887) (19,100,796)
-------------------- --------------------
Cash Flows From Investing Activities:
Purchases of operating lease equipment (10,569,185) (22,577,625)
Purchases of property and equipment (2,237,600) (1,927,303)
Proceeds from sale of operating equipment 751,147 1,647,664
Proceeds from sale of property and equipment - 1,620
Cash used in acquisitions, net of cash acquired (5,000,000) -
-------------------- --------------------
Net cash used in investing activities (17,055,638) (22,855,644)
-------------------- --------------------
5
ePlus inc. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - continued
(UNAUDITED)
2004 2005
-------------------- --------------------
Cash Flows From Financing Activities:
Borrowings:
Non-recourse $ 55,794,988 $ 68,681,848
Repayments:
Non-recourse (38,747,494) (43,443,025)
Purchase of treasury stock (701,258) (5,732,328)
Proceeds from issuance of capital stock, net of expenses 450,935 187,381
Net borrowings on lines of credit 16,122,323 735,103
-------------------- --------------------
Net cash provided by financing activities 32,919,494 20,428,979
-------------------- --------------------
Effect of Exchange Rate Changes on Cash 89,991 92,144
-------------------- --------------------
Net Decrease in Cash and Cash Equivalents (6,468,040) (21,435,317)
Cash and Cash Equivalents, Beginning of Period 25,155,011 38,851,714
-------------------- --------------------
Cash and Cash Equivalents, End of Period $ 18,686,971 $ 17,416,397
==================== ====================
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest $ 2,258,823 $ 2,093,575
==================== ====================
Cash paid for income taxes $ 2,573,578 $ 3,695,095
==================== ====================
Non-Cash Investing Activities:
Purchase of property and equipment included in accounts payable $ - $ 24,203
==================== ====================
See Notes To Condensed Consolidated Financial Statements.
6
ePlus inc. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except percentages, share and per share amounts and where otherwise noted)
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The unaudited condensed consolidated interim financial statementsCondensed Consolidated Financial Statements of ePlusePlus inc. and subsidiaries and Notes thereto included herein are unaudited, have been prepared by us, pursuant to the rules and regulations of the SECSecurities and Exchange Commission (“SEC”) 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 of a normal recurring accruals. Certain prior
period amounts have been reclassified to conform to the current period's
presentation.
nature.
Certain information and note disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America(“U.S. GAAP”) have been condensed or omitted pursuant to SEC rules and regulations.
For the nine months ended December 31, 2004 and 2005, accumulated other
comprehensive income increased $89,991 and $92,144, respectively, resulting in
total comprehensive income of $5,935,882 and $4,519,442, respectively.
These interim financial statements should be read in conjunction with the
consolidated financial statementsour Consolidated Financial Statements and notesNotes thereto contained in our Annual Report on Form 10-K (No. 0-28926) for the fiscal year ended March 31, 2005.2006. Operating results for the interim periods are not necessarily indicative of results for an entire year.
2. STOCK-BASED COMPENSATION
As
PRINCIPLES OF CONSOLIDATION — The Condensed Consolidated Financial Statements include the accounts of December 31, 2005, we had three stock-based employee compensation plans.ePlus inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.
REVENUE RECOGNITION — We account for those plans under the recognitionadhere to guidelines and measurement principles of APB Opinionsales recognition described in Staff Accounting Bulletin (“SAB”) No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations104, “Revenue Recognition,” issued by the staff of the SEC. Under SAB No. 104, sales are recognized when the title and risk of loss are passed to the customer, there is persuasive evidence of an arrangement for sale, delivery has occurred and/or services have been rendered, the sales price is fixed or determinable and collectibility is reasonably assured. Using these tests, the vast majority of our sales represent product sales recognized upon delivery.
From time to time, in the sales of product and services, we may enter into contracts that contain multiple elements. Sales of services currently represent a small percentage of our sales. For services that are performed in conjunction with product sales and are completed in our facilities prior to shipment of the product, sales for both the product and services are recognized upon shipment. Sales of services that are performed at customer locations are recorded as Sales of Product and Services on the accompanying Statement of Operations when the services are performed. If the service is performed at a customer location in conjunction with a product sale or other service sale, we recognize the sale in accordance with SAB No. 104 and Emerging Issues Task Force (“EITF”) 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Accordingly, in an arrangement with multiple deliverables, we recognize sales for delivered items only when all of the following criteria are satisfied:
| · | the delivered item(s) has value to the client on a stand-alone basis; |
| · | there is objective and reliable evidence of the fair value of the undelivered item(s); and |
| · | if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in our control. |
We sell certain third-party service contracts and software assurance or subscription products for which we evaluate whether the subsequent sales of such services should be recorded as gross sales or net sales in accordance with the sales recognition criteria outlined in SAB No. 104, EITF 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” and Financial Accounting Standards Board. No
stock-based employee compensationBoard (“FASB”) Technical Bulletin 90-1, “Accounting for Separately Priced Extended Warranty and Product Contracts.” We must determine whether we act as a principal in the transaction and assume the risks and rewards of ownership or if we are simply acting as an agent or broker. Under gross sales recognition, the entire selling price is recorded in sales of product and services and our costs to the third-party service provider or vendor is recorded in cost of sales, product and services. Under net sales recognition, the cost to the third-party service provider or vendor is reflectedrecorded as a reduction to sales resulting in net income, as all
options granted under those plans had an exercise pricesales equal to the market
valuegross profit on the transaction and there is no cost of sales.
In accordance with EITF 00-10, “Accounting for Shipping and Handling Fees and Costs,” we record freight billed to our customers as sales of product and services and the related freight costs as a cost of sales, product and services.
We receive payments and credits from vendors, including consideration pursuant to volume sales incentive programs, volume purchase incentive programs and shared marketing expense programs. Vendor consideration received pursuant to volume sales incentive programs is recognized as a reduction to costs of sales, product and services in accordance with EITF Issue No. 02-16, “Accounting for Consideration Received from a Vendor by a Customer (Including a Reseller of the underlying common stockVendor’s Products).” Vendor consideration received pursuant to volume purchase incentive programs is allocated to inventories based on the dateapplicable incentives from each vendor and is recorded in cost of grant. The following table
illustratessales, product and services, as the effect on net incomeinventory is sold. Vendor consideration received pursuant to shared marketing expense programs is recorded as a reduction of the related selling and earnings per shareadministrative expenses in the period the program takes place only if the Company had
appliedconsideration represents a reimbursement of specific, incremental, identifiable costs. Consideration that exceeds the fair value recognition provisionsspecific, incremental, identifiable costs is classified as a reduction of SFAScost of sales, product and services.
We are the lessor in a number of transactions and these transactions are accounted for in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, "Accounting13, “Accounting for Stock-Based Compensation,"Leases.” Each lease is classified as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transitioneither a direct financing lease, sales-type lease, or operating lease, as appropriate. Under the direct financing and Disclosure," to stock-based employee
compensation:
Three Months Ended Nine Months Ended
December 31, December 31,
(unaudited) (unaudited)
2004 2005 2004 2005
--------------- --------------- --------------- ---------------
Net earnings, as reported $ 1,615,564 $ 1,211,599 $ 5,845,891 $ 4,427,298
Stock based compensation expense (202,919) (202,051) (911,217) (627,321)
--------------- --------------- --------------- ---------------
Net earnings, pro forma $ 1,412,645 $ 1,009,548 $ 4,934,674 $ 3,799,977
=============== =============== =============== ===============
Basic earnings per share, as reported $0.18 $0.15 $0.65 $0.53
Basic earnings per share, pro forma $0.16 $0.12 $0.55 $0.45
Diluted earnings per share, as reported $0.17 $0.14 $0.62 $0.49
Diluted earnings per share, pro forma $0.15 $0.11 $0.53 $0.42
7
3. INVESTMENTS IN LEASES AND LEASED EQUIPMENT - NET
Investments in leases and leased equipment - net consists ofsales-type lease methods, we record the following:
As of
March 31, 2005 December 31, 2005
(In Thousands)
---------------------------------------
Investment in direct financing and sales-type leases-net $ 157,519 $ 161,460
Investment in operating lease equipment-net 31,950 44,359
------------------ ------------------
$ 189,469 $ 205,819
================== ==================
Our net investment in leases, which consists of the sum of the minimum lease payments, initial direct costs (direct financing leases only), and unguaranteed residual value (gross investment) less the unearned income. The difference between the gross investment and the cost of the leased equipment for direct finance leases is recorded as unearned income at the inception of the lease. The unearned income is amortized over the life of the lease using the interest method. Under sales-type leases, the difference between the fair value and cost of the leased property plus initial direct costs (net margins) is recorded as revenue at the inception of the lease. For operating leases, rental amounts are accrued on a straight-line basis over the lease term and are recognized as lease revenue. SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” establishes criteria for determining whether a transfer of financial assets in exchange for cash or other consideration should be accounted for as a sale or as a pledge of collateral in a secured borrowing. Certain assignments of direct finance leases we make on a non-recourse basis meet the criteria for surrender of control set forth by SFAS No. 140 and have therefore been treated as sales for financial statement purposes. Sales of leased equipment represent revenue from the sales of equipment subject to a lease in which we arethe lessor. If the rental stream on such lease has non-recourse debt associated with it, sales revenue is recorded at the amount of consideration received, net of the amount of debt assumed by the purchaser. If there is no non-recourse debt associated with the rental stream, sales revenue is recorded at the amount of gross consideration received, and recoursecosts of sales is recorded at the book value of the lease. Sales of equipment notes, if any.
INVESTMENT IN DIRECT FINANCING AND SALES-TYPE LEASES
Our investment inrepresents revenue generated through the sale of equipment sold primarily through our technology business unit.
Lease revenues consist of rentals due under operating leases and amortization of unearned income on direct financing and sales-type
leases. Equipment under operating leases
consists of the
following:
As of
March 31, 2005 December 31, 2005
(In Thousands)
---------------------------------------
Minimum lease payments $ 151,139 $ 155,280
Estimated unguaranteed residual value (1) 23,794 23,870
Initial direct costs, net of amortization (2) 1,850 1,739
Less: Unearned lease income (16,208) (16,374)
Reserve for credit losses (3,056) (3,055)
------------------ ------------------
Investment in direct finance and sales-type leases-net $ 157,519 $ 161,460
================== ==================
(1) Includes estimated unguaranteed residual values of $801is recorded at cost and
$950 as of
March 31, 2005 and December 31, 2005, respectively, for direct financing
SFAS 140 leases.
(2) Initial direct costs are shown net of amortization of $2,387 and $1,877 as
of March 31, 2005 and December 31, 2005, respectively.
INVESTMENT IN OPERATING LEASE EQUIPMENT
Investment in operating lease equipment primarily represents leases that do not
qualify as direct financing leases or are leases that are short-term renewals on
month-to-month status. The components of the net investment in operating lease
equipment are as follows:
As of
March 31, 2005 December 31, 2005
(In Thousands)
----------------------------------------
Cost of equipment under operating leases $ 45,453 $ 63,158
Less: Accumulated depreciation and amortization (13,503) (18,799)
------------------ ------------------
Investment in operating lease equipment-net $ 31,950 $ 44,359
================== ==================
8
4. PROVISION FOR CREDIT LOSSES
As of March 31 and December 31, 2005, our provision for credit losses was
$5,014,905 and $5,294,234, respectively. Our provision for credit losses are
segregated between our accounts receivable and our lease-related assets as
follows (in thousands):
Accounts Lease-Related
Receivable Assets Total
--------------- --------------- ---------------
Balance April 1, 2004 $ 1,584 $ 3,146 $ 4,730
Bad Debts Expense 1,131 - 1,131
Recoveries (350) - (350)
Write-offs and other (406) (90) (496)
--------------- --------------- ---------------
Balance March 31, 2005 1,959 3,056 5,015
--------------- --------------- ---------------
Bad Debts Expense 982 - 982
Recoveries (202) - (202)
Write-offs and other (500) (1) (501)
--------------- --------------- ---------------
Balance December 31, 2005 $ 2,239 $ 3,055 $ 5,294
=============== =============== ===============
5. SEGMENT REPORTING
We manage our business segments on the basis of the products and services
offered. Our reportable segments consist of our traditional financing business
unit and our technology sales business unit. The financing business unit offers
lease-financing solutions to corporations and governmental entities nationwide.
The technology sales business unit sells information technology ("IT") equipment
and software and related services primarily to corporate customersdepreciated on a nationwide basis. The technology sales business unit also provides
Internet-based business-to-business supply-chain-management solutions for
information technology and other operating resources. We evaluate segment
performance on thestraight-line basis of segment net earnings.
Both segments utilize our proprietary software and services throughout the
organization. Sales and services and related costs of e-procurement software are
included in the technology sales business unit. Service fees generated by our
proprietary software and services are also included in the technology sales
business unit.
The accounting policies of the financing and technology sales business units are
the same as those described in Note 1, "Organization and Summary of Significant
Accounting Policies," in our 2005 Form 10-K. Corporate overhead expenses are
allocated on the basis of revenue volume, or estimates of actual time spent by
corporate staff, or asset utilization, depending on the type of expense. Certain
items have been reclassified in the three- and nine-month periods ended December
31, 2004 to conform to the December 31, 2005 presentation.
9
Financing Technology Sales
Business Unit Business Unit Total
----------------- ----------------- -----------------
Three months ended December 31, 2004
Sales of product $ 702,699 $ 133,025,860 $ 133,728,559
Lease revenues 11,147,094 - 11,147,094
Fee and other income 492,001 2,282,613 2,774,614
----------------- ----------------- -----------------
Total revenues 12,341,794 135,308,473 147,650,267
Cost of sales 676,116 120,216,671 120,892,787
Direct lease costs 3,060,531 - 3,060,531
Selling, general and administrative expenses 5,196,957 14,138,911 19,335,868
----------------- ----------------- -----------------
Segment earnings 3,408,190 952,891 4,361,081
Interest expense 1,418,530 204,307 1,622,837
----------------- ----------------- -----------------
Earnings before income taxes $ 1,989,660 $ 748,584 $ 2,738,244
================= ================= =================
Assets as of December 31, 2004 $ 202,861,730 $ 151,471,799 $ 354,333,529
================= ================= =================
Three months ended December 31, 2005
Sales of product $ 1,069,202 $ 145,315,374 $ 146,384,576
Lease revenues 13,758,427 - 13,758,427
Fee and other income 153,199 2,777,416 2,930,615
----------------- ----------------- -----------------
Total revenues 14,980,828 148,092,790 163,073,618
Cost of sales 779,060 130,955,243 131,734,303
Direct lease costs 4,741,811 - 4,741,811
Selling, general and administrative expenses 5,490,791 17,119,982 22,610,773
----------------- ----------------- -----------------
Segment earnings 3,969,166 17,565 3,986,731
Interest expense 1,807,764 142,667 1,950,431
----------------- ----------------- -----------------
Earnings before income taxes $ 2,161,402 $ (125,102) $ 2,036,300
================= ================= =================
Assets as of December 31, 2005 $ 273,979,436 $ 108,877,460 $ 382,856,896
================= ================= =================
Nine months ended December 31, 2004
Sales of product $ 2,443,502 $ 361,318,921 $ 363,762,423
Lease revenues 35,213,926 - 35,213,926
Fee and other income 1,927,268 6,631,083 8,558,351
----------------- ----------------- -----------------
Total revenues 39,584,696 367,950,004 407,534,700
Cost of sales 2,302,364 324,093,755 326,396,119
Direct lease costs 8,667,800 - 8,667,800
Selling, general and administrative expenses 16,045,118 42,201,748 58,246,866
----------------- ----------------- -----------------
Segment earnings 12,569,414 1,654,501 14,223,915
Interest expense 3,984,492 331,131 4,315,623
----------------- ----------------- -----------------
Earnings before income taxes $ 8,584,922 $ 1,323,370 $ 9,908,292
================= ================= =================
Assets as of December 31, 2004 $ 202,861,730 $ 151,471,799 $ 354,333,529
================= ================= =================
Nine months ended December 31, 2005
Sales of product $ 3,150,694 $ 437,512,332 $ 440,663,026
Lease revenues 36,968,881 - 36,968,881
Fee and other income 953,714 8,534,516 9,488,230
----------------- ----------------- -----------------
Total revenues 41,073,289 446,046,848 487,120,137
Cost of sales 3,033,509 394,530,597 397,564,106
Direct lease costs 12,335,864 - 12,335,864
Selling, general and administrative expenses 16,395,638 48,180,765 64,576,403
----------------- ----------------- -----------------
Segment earnings 9,308,278 3,335,486 12,643,764
Interest expense 4,861,126 341,800 5,202,926
----------------- ----------------- -----------------
Earnings before income taxes $ 4,447,152 $ 2,993,686 $ 7,440,838
================= ================= =================
Assets as of December 31, 2005 $ 273,979,436 $ 108,877,460 $ 382,856,896
================= ================= =================
10
6. EARNINGS PER SHARE
The weighted average number of common shares used in determining basic and
diluted net income per share for the three and nine months ended December 31,
2004 and 2005 are as follows:
Three Months Ended Nine Months Ended
December 31, December 31,
2004 2005 2004 2005
----------- ----------- ----------- -----------
Basic common shares outstanding 8,957,280 8,215,221 8,933,702 8,411,268
Common stock equivalents 418,386 675,727 424,991 580,767
----------- ----------- ----------- -----------
Diluted common shares outstanding 9,375,666 8,890,948 9,358,693 8,992,035
=========== =========== =========== ===========
7. COMMITMENTS AND CONTINGENCIES
We are involved in three lawsuits concerning a lessee named Cyberco Holdings,
Inc. who was allegedly perpetrating a fraud. The schedules were all non-recourse
to us; however, the underlying lenders are seeking repayment. We are engaged in
other ordinary and routine litigation incidental to our business. While we
cannot predict the outcome of these various legal proceedings, management
believes that the resolution of these matters will not have a material adverse
effect on our financial position or results of operations.
In addition, we are the plaintiff in a lawsuit filed against SAP America, Inc.
and SAP AG whereby we are alleging patent infringement. For the quarter ended
December 31, 2005, we incurred $1,600,130 in legal fees seeking to enforce our
patent.
8. RELATED PARTIES
On December 23, 2004, we entered into an office lease agreement with Norton
Building 1, LLC, the Landlord, pursuant to which we lease 50,322 square feet for
use as our principal headquarters. The property is located at 13595 Dulles
Technology Drive, Herndon, Virginia. The term of the lease is for five years
with one five-year renewal option. The annual base rent is $19.50 per square
foot for the first year, with a rent escalation of three percent per year for
each year thereafter. Phillip G. Norton is the Trustee of Norton Building 1, LLC
and is Chairman of the Board, President, and Chief Executive Officer of ePlus
inc. The lease is at or below market taking into consideration the rental
charges and the ability to terminate the lease. For the three and nine months
ended December 31, 2005, rent expense paid to the Landlord was $219,263 and
$657,788, respectively.
During the quarter ended June 30, 2005, we reimbursed the landlord for certain
construction costs in the amount of $280,163, which are being amortized over the
lease term.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of results of operations and financial
condition of the Company should be read in conjunction with the condensed
consolidated financial statements and the related notes included in Item 1 of
this report, and our Annual Report on Form 10-K (No. 0-28926) for the year ended
March 31, 2005. Operating results for interim periods are not necessarily
indicative of results for an entire year.
Overview
Certain statements contained herein are not based on historical fact, but are
forward-looking statements that are based upon numerous assumptions about future
conditions that may not occur. Actual events, transactions and results may
materially differ from the anticipated events, transactions or results described
in such statements. Our ability to consummate such transactions and achieve such
events or results is subject to certain risks and uncertainties. These risks and
uncertainties include, but are not limited to, the existence of demand for, and
acceptance of, our services, economic conditions, the impact of competition and
pricing, results of financing efforts and other factors affecting our business
that are beyond our control. We undertake no obligation and do not intend to
update, revise or otherwise publicly release the results of any revisions to
11
these forward-looking statements that may be made to reflect future events or
circumstances. See "Part II. Other Information - Item 1A. Risk Factors."
Our results of operations are susceptible to fluctuations for a number of
reasons, including, without limitation, customer demand for our products and
services, supplier costs, interest rate fluctuations and differences between
estimated residual values and actual amounts realized related to the equipment
we lease. Operating results could also fluctuate as a result of the sales of
equipment in our lease portfolio prior to the expiration of the lease term to the lessee orour estimate of residual value.
We assign all rights, title, and interests in a number of our leases to a third party. Suchthird-party financial institutions without recourse. These assignments are accounted for as sales of leased equipment prior to the
expirationsince we have completed our obligations as of the lease term may have the effect of increasing revenuesassignment date, and net
earnings during the period in which the sale occurs, and reducing revenues and
net earnings otherwise expected in subsequent periods. See "Potential
Fluctuations in Quarterly Operating Results."
We have expanded our product and service offerings under the Enterprise Cost
Management ("eECM") model which represents the continued evolution of our
original implementation of ePlus e-commerce products entitled ePlusSuite. Our
eECM model is our framework for combining IT sales and professional services,
leasing and financing services, asset management software and services,
procurement software, and electronic catalog content management software and
services. Our current operations consist of traditional financing and technology
sales. The financing business unit generates revenue by offering lease-financing
solutions to corporations and government entities nationwide. These revenues are
primarily made up of lease revenues and sales of products under eECM. Our
technology sales business unit generates revenue from the sale of IT equipment
and software and related services to corporations and governmental entities
nationwide. These revenues primarily consist of sales of products under eECM.
Our total sales and marketing staff at our 30 locationswe retain no ownership interest in the United States
consisted of 206 people as of December 31, 2005.
On May 28, 2004, we purchased certain assets and assumed certain liabilities of
Manchester Technologies, Inc. The acquisition added to our IT reseller and
professional services business. Approximately 125 former Manchester
Technologies, Inc. personnel have been hired by ePlus as part of the transaction
and are located in four established offices, two in metropolitan New York, one
in South Florida and one in Baltimore. These IT reseller activities and
services, and the associated expenses with this business acquisition have
substantially increased our expenses, and our ability to sell these products and
services is expected to fluctuate depending on the customer demand for these
products and services. The products and services from this acquisition are
included in our technology sales business unit segment, and are combined with
our other sales of IT products and services.
As a result of all our acquisitions and changes in the number of sales
locations, our historical results of operations and financial position may not
be indicative of future performance over time.
CRITICAL ACCOUNTING POLICIES
SALES OF PRODUCT. Sales of product includes the following types of transactions:
(1) sales of new or used equipment; (2) service revenue in our technology sales
business unit; (3) sales of off-lease equipment to the secondary market; and (4)
sales of procurement software. Sales of new or used equipment are recognized
upon shipment and sales of off-lease equipment are recognized when constructive
title passes to the purchaser. Service revenue is recognized as the related
services are rendered.
SOFTWARE SALES AND RELATED COSTS. under lease.
Revenue from hosting arrangements is recognized in accordance with Emerging Issues Task Force ("EITF")EITF 00-3, "Application“Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity's Hardware." HostingEntity’s Hardware.” Our hosting arrangements thatdo not contain a contractual right to take possession of the software. Therefore, our hosting arrangements are not in the scope of SOP 97-2, “Software Revenue Recognition,” and require that allocation of the portion of the fee allocated to the hosting elements be recognized as the service is provided. Currently, the majority of our software revenues arerevenue is generated through hosting agreements.
12
agreements and is included in fee and other income on our Condensed Consolidated Statements of Operations.
Revenue from sales of our software is recognized in accordance with the American
Institute of Certified Public Accountants Statement of Position (SOP)SOP 97-2,
"Software Revenue Recognition," as amended by SOP 98-4, "Deferral“Deferral of the Effective Date of a Provision of SOP 97-2",” and SOP 98-9, "Modification“Modification of SOP 97-2 With Respect to Certain Transactions."Transactions.” We recognize revenue when all the following criteria exist: (1) there is persuasive evidence that an arrangement exists,exists; (2) delivery has occurred,occurred; (3) no significant obligations by us related to services essential to the functionality of the software remain with regard to implementation,implementation; (4) the sales price is determinable,determinable; and (5) and it is probable that collection will occur. Revenue from sales of our software is included in fee and other income on our Condensed Consolidated Statements of Operations.
At the time of each sale transaction, we make an assessment of the collectibility of the amount due from the customer. Revenue is only recognized at that time if management deems that collection is probable. In making this assessment, we consider customer credit-worthinesscreditworthiness and assess whether fees are fixed or determinable and free of contingencies or significant uncertainties. If the fee is not fixed or determinable, revenue is recognized only as payments become due from the customer, provided that all other revenue recognition criteria are met. In assessing whether the fee is fixed or determinable, we consider the payment terms of the transaction and our collection experience in similar transactions without making concessions, among other factors. Our software license agreements generally do not include customer acceptance provisions. However, if an arrangement includes an acceptance provision, we record revenue only upon the earlier of (1) receipt of written acceptance from the customer or (2) expiration of the acceptance period.
Our software agreements often include implementation and consulting services that are sold separately under consulting engagement contracts or as part of the software license arrangement. When we determine that such services are not essential to the functionality of the licensed software and qualify as "service
transactions"“service transactions” under SOP 97-2, we record revenue separately for the license and service elements of these agreements. Generally, we consider that a service is not essential to the functionality of the software based on various factors, including if the services may be provided by independent third parties experienced in providing such consulting and implementation in coordination with dedicated customer personnel. If an arrangement does not qualify for separate accounting of the license and service elements, then license revenue is recognized together with the consulting services using either the percentage-of-completion or completed-contract method of contract accounting. Contract accounting is also applied to any software agreements that include customer-specific acceptance criteria or where the license payment is tied to the performance of consulting services. Under the percentage-of-completion method, we may estimate the stage of completion of contracts with fixed or "not“not to exceed"exceed” fees based on hours or costs incurred to date as compared with estimated total project hours or costs at completion. If we do not have a sufficient basis to measure progress towards completion, revenue is recognized upon completion of the contract. When total cost estimates exceed revenues, we accrue for the estimated losses immediately. The use of the percentage-of-completion method of accounting requires significant judgment relative to estimating total contract costs, including assumptions relative to the length of time to complete the project, the nature and complexity of the work to be performed, and anticipated changes in salaries and other costs. When adjustments in estimated contract costs are determined, such revisions may have the effect of adjusting, in the current period, the earnings applicable to performance in prior periods.
We generally use the residual method to recognize revenues from agreements that include one or more elements to be delivered at a future date when evidence of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements (e.g., maintenance, consulting and training services) based on vendor-specific objective evidence
(VSOE)(“VSOE”) is deferred and the remaining portion of the arrangement fee is allocated to the delivered elements (i.e., software license). If evidence of the fair value of one or more of the undelivered services does not exist, all revenues are deferred and recognized when delivery of all of those services has occurred or when fair values can be established. We determine VSOE of the fair value of services
revenuesrevenue based upon our recent pricing for those services when sold separately. VSOE of the fair value of maintenance services may also be determined based on a substantive maintenance renewal clause, if any, within a customer contract. Our current pricing practices are influenced primarily by product type, purchase volume, maintenance term and customer location. We review services
revenuesrevenue sold separately and maintenance renewal rates on a periodic
13
basis and update when appropriate; our VSOE of fair value for such services to ensure that it reflects our recent pricing experience.
experience, when appropriate.
Maintenance services generally include rights to unspecified upgrades (when and if available), telephone and Internet-based support, updates and bug fixes. Maintenance revenue is recognized ratably over the term of the maintenance contract (usually one year) on a straight-line basis.
basis and is included in fee and other income on our Condensed Consolidated Statements of Operations.
When consulting qualifies for separate accounting, consulting revenues under time and materials billing arrangements are recognized as the services are performed. Consulting revenues under fixed-price contracts are generally recognized using the percentage-of-completion method. If there is a significant uncertainty about the project completion or receipt of payment for the consulting services, revenue is deferred until the uncertainty is sufficiently resolved. Consulting revenues are classified as fee and other income on our Condensed Consolidated Statements of Operations.
Training services include on-site training, classroom training and computer-based training and assessment. Training revenues arerevenue is recognized as the related training services are provided and is included in fee and other income on our Condensed Consolidated Statements of Operations.
Amounts charged for our Procure+ service are recognized as services are rendered. Amounts charged for the Manage+ service are recognized on a straight-line basis over the contractual period for which the services are provided. Fee and other income results from: (1) income from events that occur after the initial sale of a financial asset; (2) remarketing fees; (3) brokerage fees earned for the placement of financing transactions; and (4) interest and other miscellaneous income. These revenues are included in fee and other income in our Condensed Consolidated Statements of Operations.
RESIDUALS — Residual values, representing the estimated value of equipment at the termination of a lease, are recorded in our Condensed Consolidated Financial Statements at the inception of each sales-type or direct financing lease as amounts estimated by management based upon its experience and judgment. Unguaranteed residual values for sales-type and direct financing leases are recorded at their net present value and the unearned income is amortized over the life of the lease using the interest method. The residual values for operating leases are included in the leased equipment’s net book value.
We evaluate residual values on an ongoing basis and record any downward adjustment, if required. No upward revision of residual values is made subsequent to lease inception.
RESERVES FOR CREDIT LOSSES — The reserves for credit losses (the “reserve”) is maintained at a level believed by management to be adequate to absorb losses inherent in our lease and accounts receivable portfolio. Management’s determination of the adequacy of the reserve is based on an evaluation of historical credit loss experience, current economic conditions, volume, growth, the composition of the lease portfolio, and other relevant factors. The reserve is increased by provisions for potential credit losses charged against income. Accounts are either written off or written down when the loss is both probable and determinable, after giving consideration to the customer’s financial condition, the value of the underlying collateral and funding status (i.e., discounted on a non-recourse or recourse basis).
CASH AND CASH EQUIVALENTS — Cash and cash equivalents include funds in operating accounts as well as money market funds.
INVENTORIES — Inventories are stated at the lower of cost (weighted average basis) or market.
PROPERTY AND EQUIPMENT — Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets, which range from three to ten years.
CAPITALIZATION OF COSTS OF SOFTWARE FOR INTERNAL USE — We have capitalized certain costs for the development of internal use software under the guidelines of SOP 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” Approximately $50 thousand and $69 thousand of internal use software were capitalized during the quarters ended June 30, 2006 and 2005, respectively, which is included in the accompanying Condensed Consolidated Balance Sheets as a component of property and equipment.
CAPITALIZATION OF COSTS OF SOFTWARE TO BE MADE AVAILABLE TO CUSTOMERS — In accordance with SFAS No. 86, “Accounting for Costs of Computer Software to be Sold, Leased, or Otherwise Marketed,” software development costs are expensed as incurred until technological feasibility has been established. At such time such costs are capitalized until the product is made available for release to customers. For the quarter ended June 30, 2006, costs of $20 thousand were capitalized for software to be made available to customers. There were no such costs capitalized for the quarter ended June 30, 2005.
INTANGIBLE ASSETS — In June 2001, the FASB issued SFAS No. 141, “Business Combinations.” SFAS No. 141 requires that the purchase method of accounting be used for all business combinations transacted after June 30, 2001. SFAS No. 141 also specifies criteria that intangible assets acquired in a business combination must be recognized and reported separately from goodwill. In May 2004, we acquired certain assets and liabilities of Manchester Technologies, Inc. The excess of the cost over the fair value of net tangible assets acquired was assigned to identifiable intangible assets and goodwill utilizing the purchase method of accounting. The final determination of the purchase price allocation was based on the fair values of the assets and liabilities assumed, including acquired intangible assets. This determination was made by management through various means, including obtaining a third-party valuation of identifiable intangible assets acquired and an evaluation of the fair value of other assets and liabilities acquired.
Effective January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which eliminates amortization of goodwill and intangible assets that have indefinite useful lives and requires annual tests of impairment of those assets. SFAS No. 142 also provides specific guidance about how to determine and measure goodwill and intangible asset impairments, and requires additional disclosures of information about goodwill and other intangible assets.
Further, SFAS No. 142 requires us to perform an impairment test at least on an annual basis at any time during the fiscal year, provided the test is performed at the same time every year. We perform the impairment test as of September 30th of each year and follow the two-step process prescribed in SFAS No. 142 to test our goodwill for impairment under the goodwill impairment test. The first step is to screen for potential impairment, while the second step measures the amount of the impairment, if any.
IMPAIRMENT OF LONG-LIVED ASSETS — We review long-lived assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be fully recoverable. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between the fair value and the carrying value of the asset.
FAIR VALUE OF FINANCIAL INSTRUMENTS — The carrying value of our financial instruments, which include cash and cash equivalents, accounts receivable, accounts payable, and other accrued expenses and debt, approximates fair value due to their short maturities.
TREASURY STOCK — We account for treasury stock under the cost method and include treasury stock as a component of stockholders’ equity.
INCOME TAXES — Deferred income taxes are accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under this method, deferred income tax assets and liabilities are determined based on the temporary differences between the financial statement reporting and tax bases of assets and liabilities, using tax rates currently in effect. Future tax benefits, such as net operating loss carryforwards, are recognized to the extent that realization of these benefits is considered to be more likely than not.
ESTIMATES — The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
COMPREHENSIVE INCOME — Comprehensive income consists of net income and foreign currency translation adjustments. Accumulated other comprehensive income increased $97.0 thousand for the three months ended June 30, 2006 and decreased $10.5 thousand for the three months ended June 30, 2005, resulting in total comprehensive income of $2.1 million and $1.3 million, respectively.
EARNINGS PER SHARE — Earnings per share (“EPS”) have been calculated in accordance with SFAS No. 128, “Earnings per Share.” In accordance with SFAS No. 128, basic EPS amounts were calculated based on weighted average shares outstanding of 8,545,744 for the three months ended June 30, 2005 and 8,207,369 for the three months ended June 30, 2006. Diluted EPS amounts were calculated based on weighted average shares outstanding and potentially dilutive common stock equivalents of 9,078,604 for the three months ended June 30, 2005, and 8,723,439 for the three months ended June 30, 2006. Additional shares included in the diluted EPS calculations are attributable to incremental shares issuable upon the assumed exercise of stock options and other common stock equivalents. Both basic and diluted EPS and weighted average shares outstanding for the three months ended June 30, 2005 have been restated for changes in measurement dates resulting from the Audit Committee Investigation (as defined in Note 2, “Restatement of Consolidated Financial Statements”).
STOCK-BASED COMPENSATION — In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” or SFAS No. 123R. SFAS No. 123R replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB 25, “Accounting for Stock Issued to Employees,” and subsequently issued stock option related guidance. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. Entities are required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide services in exchange for the award (usually the vesting period). The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models. If an equity award is modified after the grant date, incremental compensation expense will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.
On April 1, 2006, we adopted SFAS No. 123R and elected the modified-prospective transition method. Under the modified prospective method, we must recognize compensation expense for all awards subsequent to adopting the standard and for the unvested portion of previously granted awards outstanding upon adoption. We have recognized compensation expense equal to the fair values for the unvested portion of share-based awards at April 1, 2006 over the remaining period of service, as well as compensation expense for those share-based awards granted or modified on or after April 1, 2006 over the vesting period based on the grant-date fair values using the straight-line method. For those awards granted prior to the date of adoption, compensation expense is recognized on an accelerated basis based on the grant-date fair value amount as calculated for pro forma purposes under SFAS No. 123.
RECENT ACCOUNTING PRONOUNCEMENTS —In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections — A Replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS No. 154 requires retrospective application, or the latest practical date, as the preferred method to report a change in accounting principle or correction of an error. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. While the adoption of SFAS No. 154 did not have a material impact on our Condensed Consolidated Financial Statements, the restatement disclosures included herein comply with the provisions of the standard.
In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”). The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” Specifically, the pronouncement prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the related derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The interpretation is effective for us on April 1, 2007. We are currently evaluating the impact that FIN 48 will have on our financial condition and results of operations.
During September 2006, the SEC released SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 requires a registrant to quantify all misstatements that could be material to financial statement users under both the “rollover” and “iron curtain” approaches. If either approach results in quantifying a misstatement that is material, the registrant must adjust its financial statements. SAB No. 108 is applicable for our fiscal year 2007. We are currently evaluating the impact that SAB No. 108 will have on our financial condition and results of operations.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 does not require any new fair value measurements. SFAS No. 157 is effective for our fiscal year 2009. We are currently evaluating the impact that SFAS No. 157 will have on our financial condition and results of operations.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115.” SFAS No. 159 gives companies an opportunity to use fair value measurements in financial reporting and permits entities to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact that SFAS No. 159 will have on our financial condition and results of operations.
2. RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS
As a result of the errors discussed below, we have restated our Condensed Consolidated Statements of Operations and Cash Flows, including related disclosures, for the three months ended June 30, 2005.
Restatement for Historical Stock Option Grants
Restated Accounting for Historical Stock Option Grants
In response to a letter received by our Chief Executive Officer (“CEO”), the Audit Committee, with the assistance of outside legal counsel and forensic accountants, commenced an investigation (“Audit Committee Investigation” or “Investigation”) into our historical practices related to stock options, including a review of option grant measurement dates. Prior to April 1, 2006, we accounted for all of our employee and director-based compensation awards under APB 25 and provided the required disclosures in accordance with SFAS No. 123.
In connection with the Audit Committee Investigation, we performed a review of stock option grants recorded for financial reporting purposes. Based on the individual facts and circumstances, we concluded that the exercise price for a number of option grants from our initial public offering (“IPO”) in 1996 through August 10, 2006 were below the fair market value of our common stock on the revised measurement date of the grant. This resulted from certain option grant dates having been established prior to the completion of all the final granting actions necessary for those grants. In some cases, the exercise price and date of the grant was determined with hindsight to provide a more favorable exercise price for such grants at quarterly or monthly low stock prices. The grants in question included grants made to newly hired employees, annual director grants, grants made to employees in connection with an acquisition, and discretionary grants made to officers, non-employee and employee directors, and rank and file employees. Applying the revised measurement dates to the impacted stock option grants resulted in a stock-based compensation charge if the fair market value of our common stock as of the revised measurement date exceeded the exercise price of the option grant, in accordance with APB 25.
Based on the facts and circumstances, we concluded that we (1) used incorrect measurement dates for the accounting of certain stock options, (2) had not properly accounted for certain modifications of stock options, and (3) had incorrectly accounted for certain stock options that required the application of the variable accounting method.
We determined revised measurement dates for those option grants with incorrect measurement dates and recorded stock-based compensation expense to the extent that the fair market value of our stock on the revised measurement date exceeded the exercise price of the stock option, in accordance with APB 25 and related FASB interpretations. Additionally, we restated both basic and diluted weighted average shares outstanding for changes in measurement dates resulting from the Investigation. The combination of recording stock-based compensation expense and restating our weighted average shares outstanding has resulted in restated basic and diluted EPS.
We also determined that we should have recorded stock-based compensation expense associated with the modification of certain stock option grants which resulted in the application of variable accounting under FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation” (“FIN 44”). The modified grants included certain grants made to newly hired employees, annual director grants, grants made to employees in connection with an acquisition, and discretionary grants made to officers, employee directors, and rank and file employees. For these grants, documentation exists that supports the completion of all the final granting actions necessary for an original grant and measurement date. However, certain of the terms of the awards were subsequently modified.
Income and Payroll Tax Related Matters
In certain instances where a revised measurement date was applied to those stock options classified as incentive stock options (“ISO”), in accordance with United States tax rules, it had the effect of disqualifying the ISO tax treatment of those stock options, causing those stock options to be recharacterized as non-qualified options. For purposes of assessing the tax impact of the accounting change, we concluded that the grant date for tax purposes is the same as the measurement date for financial reporting purposes. The recharacterization of the ISOs to non-qualified status resulted in a failure to withhold certain employee payroll taxes and consequently we have recorded an adjustment to salaries and benefits, along with an adjustment to interest and financing costs for penalties and interest, based on the period of exercise. In subsequent periods in which the liabilities were legally extinguished due to statutes of limitations, the payroll taxes, interest and penalties were reversed, and recognized as a reduction in the related functional expense category in our Condensed Consolidated Statements of Operations.
Summary of the Restatement — Other Items
In addition to the stock option errors described above, we have also restated our Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2005 for the following reasons:
We use floor planning agreements for dealer financing of products purchased from distributors and resold to end-users. Historically, we classified the cash flows from our floor plan financing agreements in operating activities in our Condensed Consolidated Statements of Cash Flows. We previously treated the floor plan facility as an outsourced accounts payable function, and, therefore, considered the payments made by our floor plan facility as cash paid to suppliers under Financial Accounting Standards No. 95, “Statement of Cash Flows.”
We have now determined that when an unaffiliated finance company remits payments to our suppliers on our behalf, we should show this transaction as a financing cash inflow and an operating cash outflow. In addition, when we repay the financing company, we should present this transaction as a financing cash outflow. As a result, we have restated the accompanying Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2005 to correct this error.
Also, payments made by our lessees directly to third-party, non-recourse lenders were previously reported on our Condensed Consolidated Statements of Cash Flows as repayments of non-recourse debt in the financing section and a decrease in our investment in leases and leased equipment—net in the operating section. As these payments were not received or disbursed by us, management determined that these amounts should not be shown as cash used in financing activities and cash provided by operating activities on our Condensed Consolidated Statements of Cash Flows. Rather, these payments are now disclosed as a non-cash financing activity on our Condensed Consolidated Statements of Cash Flows.
In addition, certain corrections were made for errors noted on our Condensed Consolidated Statements of Cash Flows between the line items reserve for credit losses and changes in accounts receivable, both of which are in the operating section.
Reclassifications
We have also reclassified certain items for our June 30, 2005 Condensed Consolidated Statement of Cash Flows to conform to our presentation on our June 30, 2006 Condensed Consolidated Financial Statements. These reclassifications include: (1) certain liabilities that had been included in accounts payable—trade have been reclassified to accrued expenses and other liabilities; and (2) certain personal property taxes have been reclassified to eliminate from investment in leases and leased equipment—net and accounts payable—equipment.
Impact of the Restatement
The following tables present the effects of the restatement and reclassifications on our previously issued Condensed Consolidated Statements of Operations and the Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2005 (in thousands, except per share data):
Unaudited Condensed | | | | | Adjustments | | | | |
Consolidated Statements of Operations Three Months Ended June 30, 2005 | | As Previously Reported | | | Stock-based Compensation and Tax Impact | | | As Restated | |
| | | | | | | | | | |
Revenues: | | | | | | | | | |
| Sales of product and services | | $ | 134,870 | | | $ | - | | | $ | 134,870 | |
| Lease revenues | | | 11,294 | | | | - | | | | 11,294 | |
| Fee and other income | | | | | | | | | | | | |
| Total Revenues | | | | | | | | | | | | |
| | | | | | | | | | | | | |
Costs and Expenses: | | | | | | | | | | | | |
| Cost of sales, product and services | | | 122,107 | | | | - | | | | 122,107 | |
| Direct lease costs | | | 3,777 | | | | - | | | | 3,777 | |
| Professional and other fees | | | 947 | | | | - | | | | 947 | |
| Salaries and benefits | | | 14,794 | | | | (5 | ) | | | 14,789 | |
| General and administrative expenses | | | 4,461 | | | | - | | | | 4,461 | |
| Interest and financing costs | | | | | | | | | | | | |
| Total Costs and Expenses | | | | | | | (5 | ) | | | | |
| | | | | | | | | | | | | |
Earnings Before Provision for Income Taxes | | | 2,180 | | | | 5 | | | | 2,185 | |
| Provision for income taxes | | | | | | | | | | | | |
Net Earnings | | $ | | | | $ | | | | $ | | |
| | | | | | | | | | | | | |
Net Earnings Per Share: | | | | | | | | | | | | |
| Basic | | $ | | | | $ | | | | $ | | |
| Diluted | | $ | | | | $ | | | | $ | | |
| | | | | | | | | | | | | |
Shares Used in Computing Net Earnings Per Share: | | | | | | | | | | | | |
| Basic | | | | | | | | | | | | |
| Diluted | | | | | | | | | | | | |
| Unaudited Condensed | | | | | | | | | |
| Consolidated Statements of Cash Flows | | | | | | | | | |
| | | | | | Adjustments | | | | |
| | | As Previously Reported | | | Stock-Based Compensation | | | Floor Plan | | | Lessee Payments to Lenders | | | Other | | | As Restated | |
Three Months Ended June 30, 2005 Cash Flows From Operating Activities: | | | | | | | | | | | | | | | | | | |
| Net earnings | | $ | 1,297 | | | | 3 | | | | - | | | | - | | | | - | | | $ | 1,300 | |
| Depreciation and amortization | | | 3,989 | | | | - | | | | - | | | | - | | | | - | | | | 3,989 | |
| Reserves for credit losses | | | (40 | ) | | | - | | | | - | | | | - | | | | 230 | | | | 190 | |
| Tax benefit of stock options exercised | | | 5 | | | | - | | | | - | | | | - | | | | - | | | | 5 | |
| Impact of stock-based compensation | | | - | | | | (3 | ) | | | - | | | | - | | | | - | | | | (3 | ) |
| Deferred taxes | | | (371 | ) | | | - | | | | - | | | | - | | | | - | | | | (371 | ) |
| Payments from lessees directly to lenders— operating leases | | | (1,425 | ) | | | - | | | | - | | | | 252 | | | | - | | | | (1,173 | ) |
| Loss on disposal of property and equipment | | | 6 | | | | - | | | | - | | | | - | | | | - | | | | 6 | |
| Gain on disposal of operating lease equipment | | | (116 | ) | | | - | | | | - | | | | - | | | | - | | | | (116 | ) |
| Changes in accounts receivable—net | | | (12,839 | ) | | | - | | | | - | | | | - | | | | (230 | ) | | | (13,069 | ) |
| Changes in notes receivable | | | (231 | ) | | | - | | | | - | | | | - | | | | - | | | | (231 | ) |
| Changes in inventories | | | (849 | ) | | | - | | | | - | | | | - | | | | - | | | | (849 | ) |
| Changes in investment in leases and leased equipment—net | | | 1,751 | | | | - | | | | - | | | | (4,884 | ) | | | 6 | | | | (3,127 | ) |
| Changes in other assets | | | 321 | | | | - | | | | - | | | | - | | | | - | | | | 321 | |
| Changes in accounts payable—equipment | | | 4,113 | | | | - | | | | - | | | | - | | | | (6 | ) | | | 4,107 | |
| Changes in accounts payable—trade | | | 8,113 | | | | - | | | | (7,929 | ) | | | - | | | | 1,290 | | | | 1,474 | |
| Changes in salaries and commissions payable, accrued expenses and other liabilities | | | (11,211 | ) | | | - | | | | - | | | | - | | | | (1,290 | ) | | | (12,501 | ) |
| Net cash used in operating activities | | | (7,487 | ) | | | - | | | | (7,929 | ) | | | (4,632 | ) | | | - | | | | (20,048 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Cash Flows From Investing Activities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Proceeds from sale of operating lease equipment | | | 381 | | | | - | | | | - | | | | - | | | | - | | | | 381 | |
| Purchase of operating lease equipment | | | (12,206 | ) | | | - | | | | - | | | | - | | | | - | | | | (12,206 | ) |
| Proceeds from sale of property and equipment | | | 44 | | | | - | | | | - | | | | - | | | | - | | | | 44 | |
| Purchases of property and equipment | | | (525 | ) | | | - | | | | - | | | | - | | | | - | | | | (525 | ) |
| Net cash used in investing activities | | | (12,306 | ) | | | - | | | | - | | | | - | | | | - | | | | (12,306 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Cash Flows From Financing Activities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Borrowings: | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-recourse | | | 17,164 | | | | - | | | | - | | | | - | | | | - | | | | 17,164 | |
| Repayments: | | | | | | | | | | | | | | | | | | | | | | | | |
| Non-recourse | | | (13,536 | ) | | | - | | | | - | | | | 4,632 | | | | - | | | | (8,904 | ) |
| Purchase of treasury stock | | | (622 | ) | | | - | | | | - | | | | - | | | | - | | | | (622 | ) |
| Proceeds from issuance of capital stock, net of expenses | | | 31 | | | | - | | | | - | | | | - | | | | - | | | | 31 | |
| Net borrowings on floor plan financing | | | - | | | | - | | | | 7,929 | | | | - | | | | - | | | | 7,929 | |
| Net borrowings on lines of credit | | | 148 | | | | - | | | | - | | | | - | | | | - | | | | 148 | |
| Net cash provided by financing activities | | | 3,185 | | | | - | | | | 7,929 | | | | 4,632 | | | | - | | | | 15,746 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Effect of Exchange Rate Changes on Cash | | | (11 | ) | | | - | | | | - | | | | - | | | | - | | | | (11 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Net Decrease in Cash and Cash Equivalents | | | (16,619 | ) | | | - | | | | - | | | | - | | | | - | | | | (16,619 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Cash and Cash Equivalents, Beginning of Period | | | 38,852 | | | | - | | | | - | | | | - | | | | - | | | | 38,852 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Cash and Cash Equivalents, End of Period | | $ | 22,233 | | | | - | | | | - | | | | - | | | | - | | | $ | 22,233 | |
3. INVESTMENT IN LEASES AND LEASED EQUIPMENT—NET
Investment in leases and leased equipment—net consists of the following (in thousands):
| | | As of | |
| | | March 31, 2006 | | | June 30, 2006 | |
| Investment in direct financing and sales-type leases—net | | $ | 155,910 | | | $ | 160,783 | |
| Investment in operating lease equipment—net | | | 49,864 | | | | 51,415 | |
| | | $ | 205,774 | | | $ | 212,198 | |
INVESTMENT IN DIRECT FINANCING AND SALES-TYPE LEASES—NET
Our investment in direct financing and sales-type leases—net consists of the following (in thousands):
| | | As of | |
| | | March 31, 2006 | | | June 30, 2006 | |
| Minimum lease payments | | $ | 149,200 | | | $ | 154,010 | |
| Estimated unguaranteed residual value (1) | | | 23,804 | | | | 23,650 | |
| Initial direct costs, net of amortization (2) | | | 1,763 | | | | 1,777 | |
| Less: Unearned lease income | | | (15,944 | ) | | | (16,082 | ) |
| Reserve for credit losses | | | (2,913 | ) | | | (2,572 | ) |
Investment in direct finance and sales-type leases—net | | $ | 155,910 | | | $ | 160,783 | |
| (1) | Includes estimated unguaranteed residual values of $1,451 and $1,384 as of March 31, 2006 and June 30, 2006, respectively, for direct financing SFAS No. 140 leases which have been sold. |
| (2) | Initial direct costs are shown net of amortization of $1,786 and $1,745 as of March 31, 2006 and June 30, 2006, respectively. |
Our net investment in direct financing and sales-type leases is collateral for non-recourse and recourse equipment notes, if any.
INVESTMENT IN OPERATING LEASE EQUIPMENT—NET
Investment in operating lease equipment—net primarily represents leases that do not qualify as direct financing leases or are leases that are short-term renewals on a month-to-month basis. The components of the net investment in operating lease equipment—net are as follows (in thousands):
| | | As of | |
| | | March 31, 2006 | | | June 30, 2006 | |
| Cost of equipment under operating leases | | $ | 71,786 | | | $ | 76,038 | |
| Less: Accumulated depreciation and amortization | | | (21,922 | ) | | | (24,623 | ) |
| Investment in operating lease equipment—net | | $ | 49,864 | | | $ | 51,415 | |
4. RESERVES FOR CREDIT LOSSES
As of March 31, 2006 and June 30, 2006, our activity in our reserves for credit losses is as follows (in thousands):
| | | Accounts Receivable | | | Lease-Related Assets | | | Total | |
| Balance April 1, 2005 | | $ | 1,959 | | | $ | 3,056 | | | $ | 5,015 | |
| | | | | | | | | | | | | |
| Bad debts expense | | | 1,033 | | | | - | | | | 1,033 | |
| Recoveries | | | (308 | ) | | | - | | | | (308 | ) |
| Write-offs and other | | | (624 | ) | | | (143 | ) | | | (767 | ) |
| Balance March 31, 2006 | | $ | 2,060 | | | $ | 2,913 | | | $ | 4,973 | |
| | | | | | | | | | | | | |
| Bad debts expense | | | 591 | | | | (100 | ) | | | 491 | |
| Recoveries | | | (71 | ) | | | - | | | | (71 | ) |
| Write-offs and other | | | (16 | ) | | | (241 | ) | | | (257 | ) |
| Balance June 30, 2006 | | $ | 2,564 | | | $ | 2,572 | | | $ | 5,136 | |
5. RECOURSE AND NON-RECOURSE NOTES PAYABLE
Recourse and non-recourse obligations consist of the following:
| | | As of | |
| | | March 31, 2006 | | | June 30, 2006 | |
| | | (In Thousands) | |
| | | | | | | |
| National City Bank – Recourse credit facility of $35,000,000 expiring on July 21, 2009. At our option, carrying interest rate is either LIBOR rate plus 175–250 basis points, or the Alternate Base Rate of the higher of prime, or federal funds rate plus 50 basis points, plus 0–25 basis points of margin. The interest rate at June 30, 2006 was 6.86%. | | $ | 6,000 | | | $ | 15,000 | |
| | | | | | | | | |
| Total recourse obligations | | $ | 6,000 | | | $ | 15,000 | |
| | | | | | | | | |
| Non-recourse equipment notes secured by related investment in leases with interest rates ranging from 3.05% to 9.25% in fiscal years 2006 and the three months ended June 30, 2006 | | $ | 127,973 | | | $ | 134,095 | |
There are two components of the GE Commercial Distribution Finance Corporation (“GECDF”) credit facility: (1) a floor plan component and (2) an accounts receivable component. As of June 30, 2006, the facility agreement had an aggregate limit of the two components of $100.0 million, and the accounts receivable component had a sub-limit of $30 million as a result of a June 29, 2006 amendment that temporarily increased the aggregate limit during period from June 26, 2006 through September 21, 2006. Effective June 20, 2007, the facility with GECDF was again amended to temporarily increase the total credit facility limit to $100.0 million during the period from June 19, 2007 through August 15, 2007. On August 2, 2007, the period was extended from August 15, 2007 to September 30, 2007. Other than during the temporary increase periods described above, the total credit facility limit is $85 million. Availability under the GECDF facility may be limited by the asset value of equipment we purchase and may be further limited by certain covenants and terms and conditions of the facility. We were in compliance with these covenants as of June 30, 2006.
The facility provided by GECDF requires a guaranty of up to $10.5 million by ePlus inc. The guaranty requires ePlus inc. to deliver its annual audited financial statements by a certain date. We have not delivered the annual audited financial statements for the year ended March 31, 2007, however, GECDF has extended the delivery date to provide the financial statements through September 30, 2007. The loss of the GECDF credit facility could have a material adverse effect on our future results as we currently rely on this facility and its components for daily working capital and liquidity for our technology sales business and as an operational function of our accounts payable process.
Borrowings under our $35 million line of credit from National City Bank are subject to certain covenants regarding minimum consolidated tangible net worth, maximum recourse debt to net worth ratio, cash flow coverage, and minimum interest expense coverage ratio. We were in compliance with or had received amendments extending these covenants as of June 30, 2006. The borrowings are secured by our assets such as leases, receivables, inventory, and equipment. Borrowings are limited to our collateral base, consisting of equipment, lease receivables and other current assets, up to a maximum of $35 million. In addition, the credit agreement restricts, and under some circumstances prohibits, the payment of dividends.
The National City Bank facility requires the delivery of our Audited and Unaudited Financial Statements, and pro forma financial projections, by certain dates. We have not delivered the following documents as required by Section 5.1 of the facility: (a) annual Audited Financial Statements for the year ended March 31, 2007; (b) “Projections” for our fiscal year ended March 31, 2008; and (c) quarterly Unaudited Financial Statements for the quarters ended June 30, 2006, September 30, 2006, and December 31, 2006. We entered into the following amendments which have extended the delivery date requirements for these documents: a First Amendment dated July 11, 2006, a Second Amendment dated July 28, 2006, a third Amendment dated August 30, 2006, a Fourth Amendment dated September 27, 2006, a Fifth Amendment dated November 15, 2006, a Sixth Amendment dated January 11, 2007, a Seventh Amendment dated March 15, 2007, an Eighth Amendment dated June 27, 2007 and a Ninth Amendment dated August 22, 2007. As a result of the amendments, the agents agreed, inter alia, to extend the delivery date to November 30, 2007.
We believe we will receive additional extensions from our lenders, if needed, regarding our requirement to provide financial statements as described above through the date of delivery of the documents. However, we cannot guarantee that we will receive additional extensions.
6. RELATED PARTIES
We lease 50,322 square feet for use as our principal headquarters from Norton Building 1, LLC. The annual rent is $19.50 per square foot for the first year, with a rent escalation of three percent per year for each year thereafter. Phillip G. Norton is the Trustee of Norton Building 1, LLC and is Chairman of the Board, President, and CEO of ePlus inc. The lease is at or below market taking into consideration the rental charges and the ability to terminate the lease. During the three months ended June 30, 2006 and June 30, 2005, rent paid to the Landlord was $233,385 and $219,263 respectively.
During the three months ended June 30, 2005, we reimbursed the landlord for certain construction costs in the amount of $280,163 which will be amortized over the lease term. There was no such reimbursement during the three months ended June 30, 2006. The capitalized reimbursement is included in property and equipment—net on our Condensed Consolidated Balance Sheets.
7. COMMITMENTS AND CONTINGENCIES
Litigation
We have been named a defendant in three lawsuits and one bankruptcy adversary proceeding concerning a lessee named Cyberco Holdings, Inc. (“Cyberco”), which was perpetrating a fraud related to installment sales that were assigned to various lenders and were non-recourse to us. Two of the suits have been resolved, and two are pending.
In one of the lawsuits, filed on January 4, 2005, an underlying lender, GMAC Commercial Finance, L.L.C. (“GMAC”), sought approximately $10,646,230. On July 24, 2006, we settled the case for a $6,000,000 payment by us to GMAC, which we have recorded in the period ended March 31, 2006.
In the second lawsuit, which was filed on May 10, 2005, another underlying lender, Banc of America Leasing and Capital, LLC (“BoA”) sought repayment from ePlus Group, inc. of approximately $3,062,792 plus interest and attorneys’ fees. The case went to trial, and a final judgment in favor of BoA was entered on February 6, 2007. We recorded $4,081,697, representing $3,025,000 verdict, $871,232 in attorneys’ fees and $185,465 in interest and other costs in the fiscal year ended March 31, 2006. We have recorded an additional $36,033 in interest in the quarter ended June 30, 2006.
The third non-bankruptcy lawsuit was filed on November 3, 2006 by BoA against ePlus inc., seeking to enforce a guaranty in which ePlus inc. guaranteed ePlus Group, inc.’s obligations to BoA relating to the Cyberco transaction. ePlus Group has already paid to BoA the judgment in the second lawsuit referenced above. The suit seeks attorneys' fees BoA incurred in ePlus' appeal of BoA's suit against ePlus Group referenced above, expenses that may be incurred in a bankruptcy adversary proceeding relating to Cyberco, attorneys' fees incurred by BoA in defending a pending suit by ePlus Group against BoA, and any other costs or fees relating to any of the described matters. The trial is scheduled to begin November 20, 2007. We are vigorously defending the suit. We cannot predict the outcome of the suit against ePlus inc. We believe a loss is not probable, and we have not accrued for this matter.
In the bankruptcy adversary proceeding, which was filed on December 7, 2006, Cyberco’s bankruptcy trustee is seeking approximately $775,000 as alleged preferential transfers. Discovery has commenced. We cannot predict the outcome of this litigation. We dispute that we are liable, believe we have strong defenses to the claims and intend to vigorously defend against them. We believe a loss is not probable, and we have not accrued for this matter.
On December 11, 2006, ePlus inc. and SAP America, Inc. and its German parent, SAP AG (collectively, “SAP”) entered into a Patent License and Settlement Agreement (the “Agreement”) to settle a patent lawsuit between the companies which we filed on April 20, 2005. Under the terms of the Agreement, we will license to SAP our existing patents, together with those developed and/or acquired by us within the next five years, in exchange for a one-time cash payment to us of $17,500,000, which was paid by SAP on January 16, 2007. In addition, SAP has agreed not to pursue legal action against us for patent infringement as to any of our current lines of business on any of SAP’s patents for a period of five years. The Agreement also provides for general release, indemnification for its violation, and dismisses the existing litigation with prejudice.
On January 18, 2007, a stockholder derivative action related to stock option practices was filed in the United States District Court for the District of Columbia. The complaint names ePlus inc. as nominal defendant, and personally names eight individual defendants who are directors and/or executive officers of ePlus. The complaint alleges violations of federal securities law and state law claims for breach of fiduciary duty, waste of corporate assets and unjust enrichment. We are currently preparing a response to the plaintiff’s amended complaint. The Amended Complaint seeks monetary damages from the individual defendants and that we take certain corrective actions relating to option grants and corporate governance, and attorneys' fees. No amount has been accrued for this matter.
We are also engaged in other ordinary and routine litigation incidental to our business. While we cannot predict the outcome of these various legal proceedings, management believes that a loss is not probable and no amount has been accrued for these matters.
Regulatory and Other Legal Matters
As discussed in more detail in Note 2, “Restatement of Consolidated Financial Statements,” to our Unaudited Condensed Consolidated Financial Statements in June 2006, the Audit Committee commenced an Investigation of stock option grants by us since our IPO in 1996. In August 2006, the Audit Committee voluntarily contacted and advised the staff of the SEC of its Investigation and the Audit Committee’s preliminary conclusion that a restatement will be required. The SEC opened an informal inquiry and we cooperated with the staff. No amount has been accrued for this matter.
We are currently engaged in a dispute with the government of the District of Columbia (“DC”) regarding personal property taxes on property we financed for our customers. DC is seeking approximately $508,000 plus interest and penalties, relating to property we financed for our customers. We believe the tax is owed by our customers, and are seeking resolution in DC’s Office of Administrative Hearings. We cannot predict the outcome of this matter. While management does not believe this matter will have a material effect on our financial condition and results of operations, resolution of this dispute is ongoing.
8. EARNINGS PER SHARE
Basic and diluted income per share amounts are determined in accordance with the provisions of SFAS No. 128, Earnings Per Share. Basic income per share is computed using the weighted average number of shares of common stock outstanding for the period. Diluted income per share is computed using the weighted average number of shares of common stock, adjusted for the dilutive effect of potential common stock. Potential common stock, computed using the treasury stock method or the if-converted method, includes options.
The following table provides a reconciliation of the numerators and denominators used to calculate basic and diluted net income per common share as disclosed in our Condensed Consolidated Statement of Operations for the three months ended June 30, 2005 and 2006.
| | | Three Months Ended | |
| | | June 30, | |
| | | 2005 | | | 2006 | |
| | | As restated (1) | | | | |
| | | (in thousands, except per share data) | |
| | | | | | | |
| Net income available to common shareholders—basic and diluted | | $ | 1,300 | | | $ | 1,953 | |
| | | | | | | | | |
| Weighted average common shares outstanding—basic | | | 8,546 | | | | 8,207 | |
| In-the-money options exercisable under stock compensation plans | | | 533 | | | | 516 | |
| Weighted average common shares outstanding—diluted | | | 9,079 | | | | 8,723 | |
| | | | | | | | | |
| Income per common share: | | | | | | | | |
| Basic | | $ | 0.15 | | | $ | 0.24 | |
| Diluted | | $ | 0.14 | | | $ | 0.22 | |
| (1) | See Note 2, “Restatement of Consolidated Financial Statements.” |
9. STOCK REPURCHASE
On November 17, 2004, a purchase program was authorized by our Board. This program authorized the repurchase of up to 3,000,000 shares of our outstanding common stock over a period of time ending no later than November 17, 2005 and was limited to a cumulative purchase amount of $7,500,000. On March 2, 2005, our Board approved an increase, from $7,500,000 to $12,500,000, for the maximum total cost of shares that could be purchased, which expired November 17, 2005. On November 18, 2005, the Board authorized a new stock repurchase program of up to 3,000,000 shares with a cumulative purchase limit of $12,500,000.
During the three months ended June 30, 2006, we repurchased 209,000 shares of our outstanding common stock for $2.9 million, whereas during the three months ended June 30, 2005, we repurchased 55,000 shares for $0.6 million. Since the inception of our initial repurchase program on September 20, 2001, and as of June 30, 2006, we had repurchased 2,978,990 shares of our outstanding common stock at an average cost of $11.04 per share for a total of $32.9 million. As of June 30, 2006, a maximum purchase amount of $7,856,187 and up to 603,904 shares were available under the stock repurchase program that expired November 17, 2006.
10. STOCK-BASED COMPENSATION
Adoption of SFAS No. 123R
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” or SFAS No. 123R. SFAS No. 123R replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB 25, “Accounting for Stock Issued to Employees,” and subsequently issued stock option related guidance. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. Entities are required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide services in exchange for the award (usually the vesting period). The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models. If an equity award is modified after the grant date, incremental compensation expense will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.
On April 1, 2006, we adopted SFAS No. 123R and elected the modified-prospective transition method. We have recognized compensation expense equal to the fair values for the unvested portion of share-based awards at April 1, 2006 over the remaining period of service, as well as compensation expense for those share-based awards granted or modified on or after April 1, 2006 over the vesting period based on the grant-date fair values using the straight-line method. The fair values were estimated using the Black-Scholes option pricing model. For those awards granted prior to the date of adoption, compensation expense is recognized on an accelerated basis based on the grant-date fair value amount as calculated for pro forma purposes under SFAS No. 123.
Stock Option Plans
We issued only incentive and non-qualified stock option awards and, except as noted below, each grant was issued under one of the following five plans: (1) the 1996 Stock Incentive Plan (the “1996 SIP”), (2) Amendment and Restatement of the 1996 Stock Incentive Plan (the “Amended SIP”) (collectively the “1996 Plans”), (3) the 1998 Long-Term Incentive Plan (the “1998 LTIP”), (4) Amendment and Restatement of the 1998 Long-Term Incentive Plan (2001) (the “Amended LTIP (2001)”) or (5) Amendment and Restatement of the 1998 Long-Term Incentive Plan (2003) (the “Amended LTIP (2003)”). A summary of the plans are detailed below. All the stock option plans require the use of the previous trading day's closing price when the grant date falls on a date the stock was not traded.
In addition, at the IPO, there were 245,000 options issued that were not part of any plan, but issued under various employment agreements.
1996 Stock Incentive Plan
The allowable number of outstanding shares under this plan was 155,000. On September 1, 1996, the Board of Directors (the “Board”) adopted this plan, and it was effective on November 8, 1996 when the SEC declared our Registration Statement on Form S-1 effective in connection with our IPO on November 20, 1996. The 1996 SIP is comprised of an Incentive Stock Option Plan, a Nonqualified Stock Option Plan, and an Outside Director Stock Option Plan. Each of the components of the 1996 Plans provided that options would only be granted after execution of an Option Agreement. Except for the number of options awarded to directors, the salient provisions of the 1996 SIP are identical to the Amended SIP, which is more fully described below.
With regard to director options, the 1996 Outside Director Stock Option Plan provided for 10,000 options to be granted to each non-employee director upon completion of the IPO, and 5,000 options to be granted to each non-employee director on the anniversary of each full year of his or her service as a director of ePlus. As with the other components of the 1996 Plans, the director options would be granted only after execution of an Option Agreement.
Amendment and Restatement of 1996 Stock Incentive Plan
The 1996 SIP was amended via an Amendment and Restatement of 1996 Stock Incentive Plan. The primary purpose of the amendment was to increase the aggregate number of shares allocated to the plan by making the shares available a percentage (20%) of total shares outstanding rather than a fixed number.
The Amended SIP also provided for an employee stock purchase plan, and permitted the Board to establish other restricted stock and performance-based stock awards and programs. The Amended SIP was adopted by the Board and became effective on May 14, 1997, subject to approval at the annual shareholders' meeting that fall. The Amended SIP was adopted by shareholders at the annual meeting on September 30, 1997.
1998 Long-Term Incentive Plan
The 1998 LTIP was adopted by the Board on July 28, 1998, which is its effective date, and approved by the shareholders on September 16, 1998. The allowable number of shares under the 1998 LTIP is 20% of the outstanding shares, less shares previously granted and shares purchased through our employee stock purchase program. The 1998 LTIP shares many characteristics of the earlier plans. It continues to specify that options shall be priced at not less than fair market value. The 1998 LTIP consolidated the preexisting plans and made the Compensation Committee of the Board responsible for its administration. In addition, the 1998 LTIP eliminated the language of the 1996 Plans that “options shall be granted only after execution of an Option Agreement.” Thus, while the 1998 LTIP does require that grants be evidenced in writing, the writing is not a condition precedent to the grant of the award.
Another change to note is the modification of the LTIP as it relates to options awarded to directors. Under the 1998 LTIP, instead of being awarded on the anniversary of the director’s service, the options are to be automatically awarded the day after the annual shareholders meeting to all directors in service as of that day. It also permits for discretionary option awards to directors.
Amended and Restated 1998 Long-Term Incentive Plan
Minor amendments were made to the 1998 LTIP on April 1, April 17 and April 30, 2001. The amendments change the name of the plan from the 1998 Long-Term Incentive Plan to the Amended and Restated 1998 Long-Term Incentive Plan referred to herein as Amended LTIP (2001). In addition, provisions were added “to allow the Compensation Committee to delegate to a single board member the authority to make awards to non-Section 16 insiders, as a matter of convenience,” and to provide that “no option granted under the Plan may be exercisable for more than ten years from the date of its grant.”
The Amended LTIP (2001) was amended on July 15, 2003 by the Board and approved by the stockholders on September 18, 2003 referred to herein as Amended LTIP (2003). Primarily, the amendment modified the aggregate number of shares available under the plan to 3,000,000. Although the language varies somewhat from earlier plans, it permits the Board or Compensation Committee to delegate authority to a committee of one or more directors who are also officers of the corporation to award options under certain conditions. The Amended LTIP (2003) replaced all the prior plans, is our current plan and covers option grants for employees, executives and outside directors.
As of June 30, 2006, a total of 2,809,174 shares of common stock have been reserved for issuance upon exercise of options granted under the Amended LTIP (2003).
Stock-Based Compensation Expense
Prior to the adoption of SFAS No. 123R, we accounted for stock-based compensation expense under APB 25 and related interpretations and disclosed certain pro forma net income and EPS information as if we had applied the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” Accordingly, we measured compensation expense based upon the intrinsic value on the measurement date, calculated as the difference between the fair value of the common stock and the relevant exercise price.
In accordance with SFAS No. 123R, we recognized $254 thousand of stock-based compensation expense ($148 thousand net of tax) for the three months ended June 30, 2006. As of June 30, 2006, there was $2.3 million of unrecognized compensation expense related to non-vested options. This expense is expected to be fully recognized over the next 3 years. In addition, we previously presented deferred compensation as a separate component of stockholders’ equity. In accordance with SFAS No. 123R, upon adoption, we also reclassified the balance in deferred compensation to additional paid-in-capital on our Condensed Consolidated Balance Sheet.
The following pro forma table illustrates the impact on net earnings and EPS had we applied the fair value expense recognition provisions of SFAS No. 123 for the three months ended June 30, 2005 (in thousands, except per share data).
| | | Three Months Ended June 30, 2005 | |
| | | As Restated (1) | |
| Net earnings, as reported | | $ | 1,300 | |
| Adjustment for: APB 25 intrinsic value of stock-based compensation, net of tax | | | (3 | ) |
| Adjustment for: SFAS No. 123 stock-based compensation expense, net of tax | | | (169 | ) |
| Net earnings, pro forma | | $ | 1,128 | |
| | | | | |
| Basic earnings per share, as reported | | $ | 0.15 | |
| Basic earnings per share, pro forma | | $ | 0.13 | |
| Diluted earnings per share, as reported | | $ | 0.14 | |
| Diluted earnings per share, pro forma | | $ | 0.12 | |
| (1) | See Note 2, “Restatement of Consolidated Financial Statements.” |
Stock Option Activity
During the three months ended June 30, 2005 and 2006, there were no options granted. A summary of stock option activity during the three months ended June 30, 2006 is as follows:
| | | Number of Shares | | | Exercise Price Range | | | Weighted Average Exercise Price | | Weighted Average Contractual Life Remaining | | | | |
| | | | | | | | | | | | | | | |
| Outstanding, April 1, 2006 | | | 1,999,911 | | | $ | 6.23 - $17.38 | | | $ | 9.93 | | | | | | |
| Options granted | | | - | | | | | | | | | | | | | | |
| Options exercised | | | (154,018 | ) | | $ | 6.40 - $10.75 | | | $ | 7.23 | | | | | | |
| Options forfeited | | | - | | | | | | | | | | | | | | |
| Outstanding, June 30, 2006 | | | 1,845,893 | | | $ | 6.23 - $17.38 | | | $ | 10.52 | | | 3.7 | | | $ | 3,413,093 | |
Vested or expected to vest at June 30, 2006 | | | 1,395,893 | | | | | | | $ | 9.88 | | | 3.9 | | | $ | 3,413,093 | |
| Exercisable, June 30, 2006 | | | 1,405,893 | | | | | | | $ | 9.87 | | | 3.8 | | | $ | 3,413,093 | |
Additional information regarding options outstanding as of June 30, 2006 is as follows:
| | | | Options Outstanding | | | Options Exercisable | |
Range of Exercise Prices | | | Options Outstanding | | | Weighted Avg. Exercise Price per Share | | | Weighted Avg. Contractual Life Remaining | | | Options Exercisable | | | Weighted Avg. Exercise Price per Share | |
| | | | | | | | | | | | | | | | | |
| $ | 6.23 - $9.00 | | | | 914,486 | | | $ | 7.72 | | | | 3.8 | | | | 914,486 | | | $ | 7.72 | |
| $ | 9.01 - $13.50 | | | | 720,400 | | | | 12.20 | | | | 3.2 | | | | 280,400 | | | | 11.60 | |
| $ | 13.51 - $17.38 | | | | 211,007 | | | | 16.91 | | | | 4.8 | | | | 211,007 | | | | 16.91 | |
| $ | 6.23 - $17.38 | | | | 1,845,893 | | | $ | 10.52 | | | | 3.7 | | | | 1,405,893 | | | $ | 9.87 | |
We issue shares from our authorized but unissued common stock to satisfy stock option exercises.
A summary of nonvested option activity is presented below:
| | | Number of Shares | | | Weighted-Average Grant Date Fair Value | |
| Nonvested at March 31, 2006 | | | 440,500 | | | $ | 7.45 | |
| Granted | | | - | | | | | |
| Vested | | | (500 | ) | | | 10.29 | |
| Forfeited | | | - | | | | | |
| Nonvested at June 30, 2006 | | | 440,000 | | | $ | 7.45 | |
11. SEGMENT REPORTING
We manage our business segments on the basis of the products and services offered. Our reportable segments consist of our traditional financing business unit and technology sales business unit. The financing business unit offers lease-financing solutions to corporations and governmental entities nationwide. The technology sales business unit sells information technology (“IT”) equipment and software and related services primarily to corporate customers on a nationwide basis. The technology sales business unit also provides Internet-based business-to-business supply-chain-management solutions for information technology and other operating resources. We evaluate segment performance on the basis of segment net earnings.
Both segments utilize our proprietary software and services throughout the organization. Sales and services and related costs of e-procurement software are included in the technology sales business unit. Income relative to services generated by our proprietary software and services is included in the financing business unit.
The accounting policies of the segments are the same as those described in Note 1, "Organization and Summary of Significant Accounting Policies," of the Notes to Consolidated Financial Statements contained in our Annual Report on Form 10-K for the fiscal year ended March 31, 2006. Corporate overhead expenses are allocated on the basis of employee headcount. Certain items have been reclassified for the three months ended June 30, 2005 to conform to the three months ended June 30, 2006 presentation. Amounts are presented in thousands.
| | | Financing Business Unit | | | Technology Sales Business Unit | | | Total | |
| | | | | | | | | | |
| Three months ended June 30, 2005 (as restated) | | | | | | | | | |
| Sales of product and services | | $ | 703 | | | $ | 134,167 | | | $ | 134,870 | |
| Lease revenues | | | 11,294 | | | | - | | | | 11,294 | |
| Fee and other income | | | 486 | | | | 3,154 | | | | 3,640 | |
| Total revenues | | | 12,483 | | | | 137,321 | | | | 149,804 | |
| Cost of sales | | | 753 | | | | 121,354 | | | | 122,107 | |
| Direct lease costs | | | 3,777 | | | | - | | | | 3,777 | |
| Selling, general and administrative expenses | | | 5,106 | | | | 15,091 | | | | 20,197 | |
| Segment earnings | | | 2,847 | | | | 876 | | | | 3,723 | |
| Interest and financing costs | | | 1,496 | | | | 42 | | | | 1,538 | |
| Earnings before income taxes | | $ | 1,351 | | | $ | 834 | | | $ | 2,185 | |
| Assets | | $ | 258,129 | | | $ | 105,621 | | | $ | 363,750 | |
| | | | | | | | | | | | | |
| Three months ended June 30, 2006 | | | | | | | | | | | | |
| Sales of product and services | | $ | 920 | | | $ | 174,573 | | | $ | 175,493 | |
| Lease revenues | | | 11,332 | | | | - | | | | 11,332 | |
| Fee and other income | | | 208 | | | | 2,637 | | | | 2,845 | |
| Total revenues | | | 12,460 | | | | 177,210 | | | | 189,670 | |
| Cost of sales | | | 659 | | | | 155,703 | | | | 156,362 | |
| Direct lease costs | | | 5,024 | | | | - | | | | 5,024 | |
| Selling, general and administrative expenses | | | 4,576 | | | | 18,369 | | | | 22,945 | |
| Segment earnings | | | 2,201 | | | | 3,138 | | | | 5,339 | |
| Interest and financing costs | | | 1,960 | | | | 35 | | | | 1,995 | |
| Earnings before income taxes | | $ | 241 | | | $ | 3,103 | | | $ | 3,344 | |
| Assets | | $ | 275,197 | | | $ | 143,175 | | | $ | 418,372 | |
Included in the Financing Business Unit above are inter-segment accounts payable of $143 thousand and $2,064 thousand for the three months ended June 30, 2005 and 2006, respectively. Included in the Technology Sales Business Unit above are inter-segment accounts receivable of $143 thousand and $2,064 thousand for the three months ended June 30, 2005 and 2006, respectively.
12. SUBSEQUENT EVENT
Effective at the opening of business on July 20, 2007, our common stock was delisted from The Nasdaq Global Market due to non-compliance with financial statement reporting requirements. Specifically, in determining to delist our common stock, Nasdaq cited the delay of more than one year from the final due date for the filing of our fiscal year 2006 Annual Report on Form 10-K with the SEC. Although we filed our fiscal year 2006 Form 10-K with the SEC on August 16, 2007, the following requisite periodic reports must also be filed with the SEC in order for us to be eligible to be relisted on Nasdaq: this Form 10-Q; the Forms 10-Q for the quarters ended September 30, 2006 and December 31, 2006; the fiscal year 2007 Form 10-K; and the Form 10-Q for the quarter ended June 30, 2007.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our results of operations and financial condition should be read in conjunction with our Condensed Consolidated Financial Statements and the related Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report, and our Annual Report on Form 10-K for the year ended March 31, 2006. Operating results for interim periods are not necessarily indicative of results for an entire year.
Results of Audit Committee Review; Restatement of Consolidated Financial Statements
In this Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, we have restated our Condensed Consolidated Statements of Operations and Cash Flows for the three months ended June 30, 2005 for the effects of errors discussed in Note 2, “Restatement of Consolidated Financial Statements” to our Unaudited Condensed Consolidated Financial Statements.
Previously filed Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q affected by the restatement will not be amended. Accordingly, previously issued financial statements and related reports of our independent registered public accounting firm should not be relied on.
Our decision to restate the previously issued Condensed Consolidated Financial Statements for the effects of errors in accounting for stock options was based on the findings of the Audit Committee Investigation of our historical stock option granting practices and related accounting. See our Annual Report on Form 10-K for the year ended March 31, 2006 for further discussion.
Cautionary Language About Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain statements that are, or may be deemed to be, “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are made in reliance upon the protections provided by such acts for forward-looking statements. Such statements are not based on historical fact, but are based upon numerous assumptions about future conditions that may not occur. Forward-looking statements are generally identifiable by use of forward-looking words such as “may,” “will,” “should,” “intend,” “estimate,” “believe,” “expect,” “anticipate,” “project” and similar expressions. Readers are cautioned not to place undue reliance on any forward-looking statements made by or on our behalf. Any such statement speaks only as of the date the statement was made. We do not undertake any obligation to publicly update or correct any forward-looking statements to reflect events or circumstances that subsequently occur, or of which we hereafter become aware. Actual events, transactions and results may materially differ from the anticipated events, transactions or results described in such statements. Our ability to consummate such transactions and achieve such events or results is subject to certain risks and uncertainties. Such risks and uncertainties include, but are not limited to, the matters set forth below.
Although we have been offering IT financing since 1990 and direct marketing of IT products since 1997, our comprehensive set of solutions—the bundling of our direct IT sales, professional services and financing with our proprietary software—has been available since 2002. Consequently, we may encounter some of the challenges, risks, difficulties and uncertainties frequently faced by companies providing new and/or bundled solutions in an evolving market. Some of these challenges relate to our ability to:
| · | manage the diverse product set of rapidly-evolving solutions in highly-competitive markets; |
| · | increase the total number of users of bundled services by cross-selling within our customer base and gain new customers; |
| · | adapt to meet changes in markets and competitive developments; |
| · | maintain and increase advanced professional services by retaining highly-skilled personnel and vendor certifications; |
| · | integrate with external IT systems including those of our customers and vendors; and |
| · | continue to update our software and technology to enhance the features and functionality of our products. |
We cannot be certain that our business strategy will be successful or that we will successfully address these and other challenges, risks and uncertainties. For a further list and description of various risks, relevant factors and uncertainties that could cause future results or events to differ materially from those expressed or implied in our forward-looking statements, see the “Risk Factors” and “—Results of Operations” sections contained elsewhere in this document, as well as our Annual Report on Form 10-K for the fiscal year ended March 31, 2006, any subsequent Reports on Form 10-Q and Form 8-K and other filings with the SEC.
Discussion and Analysis Overview
The following discussion and analysis of our results of operations and financial condition gives effect to the restatement discussed in Note 2, “Restatement of Consolidated Financial Statements” to our Unaudited Condensed Consolidated Financial Statements and should be read in conjunction with our Unaudited Condensed Consolidated Financial Statements and the related Notes included elsewhere in this report.
Our results of operations are susceptible to fluctuations for a number of reasons, including, without limitation, customer demand for our products and services, supplier costs, interest rate fluctuations and differences between estimated residual values and actual amounts realized related to the equipment we lease. Operating results could also fluctuate as a result of the sale of equipment in our 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.
We currently derive the majority of our revenue from sales and financing of information technology and other assets. We have expanded our product and service offerings under our comprehensive set of solutions which represent the continued evolution of our original implementation of our e-commerce products entitled ePlusSuite. The expansion to our bundled solution is a framework that combines our IT sales and professional services, leasing and financing services, asset management software and services, procurement software, and electronic catalog content management software and services.
We expect to expand or open new sales locations and hire additional staff for specific targeted market areas in the near future whenever we can find both experienced personnel and qualified geographic areas.
As a result of our acquisitions and expansion of sales locations, our historical results of operations and financial position may not be indicative of our future performance over time.
Critical Accounting Policies
SALES OF PRODUCT AND SERVICES. We adhere to guidelines and principles of sales recognition described in SAB No. 104, “Revenue Recognition,” issued by the staff of the SEC. Under SAB No. 104, sales are recognized when the title and risk of loss are passed to the customer, there is persuasive evidence of an arrangement for sale, delivery has occurred and/or services have been rendered, the sales price is fixed and determinable and collectibility is reasonably assured. Using these tests, the vast majority of our sales represent product sales recognized upon delivery; however, we make an adjustment for our sales that have FOB Shipping Point terms.
From time to time, in the sales of product and services, we may enter into contracts that contain multiple elements. Sales of services currently represent a small percentage of our sales. For services that are performed in conjunction with product sales and are completed in our facilities prior to shipment of the product, sales for both the product and services are recognized upon shipment. Sales of services that are performed at customer locations are recorded as sales of product or services when the services are performed. If the service is performed at a customer location in conjunction with a product sale or other service sale, we recognize the sale in accordance with SAB No. 104 and EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Accordingly, in an arrangement with multiple deliverables, we recognize sales for delivered items only when all of the following criteria are satisfied:
| · | the delivered item(s) has value to the client on a stand-alone basis; |
| · | there is objective and reliable evidence of the fair value of the undelivered item(s); and |
| · | if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in our control. |
We sell certain third-party service contracts and software assurance or subscription products for which we evaluate whether the subsequent sales of such services should be recorded as gross sales or net sales in accordance with the sales recognition criteria outlined in SAB No. 104, EITF 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent,” and FASB Technical Bulletin 90.1, “Accounting for Separately Priced Extended Warranty and Product Contracts.” We must determine whether we act as a principal in the transaction and assume the risks and rewards of ownership or if we are simply acting as an agent or broker. Under gross sales recognition, the entire selling price is recorded in sales of product and services and our costs to the third-party service provider or vendor is recorded in cost of sales, product and services. Under net sales recognition, the cost to the third-party service provider or vendor is recorded as a reduction to sales resulting in net sales equal to the gross profit on the transaction and there is no cost of sales.
In accordance with EITF 00-10, “Accounting for Shipping and Handling Fees and Costs,” we record freight billed to our customers as sales of product and services and the related freight costs as a cost of sales, product and services.
VENDOR CONSIDERATION. We receive payments and credits from vendors, including consideration pursuant to volume sales incentive programs, volume purchase incentive programs and shared marketing expense programs. Vendor consideration received pursuant to volume sales incentive programs is recognized as a reduction to costs of sales, product and services in accordance with EITF Issue No. 02-16, “Accounting for Consideration Received from a Vendor by a Customer (Including a Reseller of the Vendor’s Products).” Vendor consideration received pursuant to volume purchase incentive programs is allocated to inventories based on the applicable incentives from each vendor and is recorded in cost of sales, product and services, as the inventory is sold. Vendor consideration received pursuant to shared marketing expense programs is recorded as a reduction of the related selling and administrative expenses in the period the program takes place only if the consideration represents a reimbursement of specific, incremental, identifiable costs. Consideration that exceeds the specific, incremental, identifiable costs is classified as a reduction of cost of sales, product and services.
SOFTWARE SALES AND RELATED COSTS. Revenue from hosting arrangements is recognized in accordance with EITF 00-3, “Application of AICPA Statement of Position 97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware.” Our hosting arrangements do not contain a contractual right to take possession of the software. Therefore, our hosting arrangements are not in the scope of SOP 97-2, “Software Revenue Recognition,” and require that allocation of the portion of the fee allocated to the hosting elements be recognized as the service is provided. Currently, the majority of our software revenue is generated through hosting agreements and is included in fee and other income on our Condensed Consolidated Statements of Operations.
Revenue from sales of our software is recognized in accordance with SOP 97-2, as amended by SOP 98-4, “Deferral of the Effective Date of a Provision of SOP 97-2,” and SOP 98-9, “Modification of SOP 97-2 With Respect to Certain Transactions.” We recognize revenue when all the following criteria exist: (1) there is persuasive evidence that an arrangement exists; (2) delivery has occurred; (3) no significant obligations by us related to services essential to the functionality of the software remain with regard to implementation; (4) the sales price is determinable; and (5) and it is probable that collection will occur. Revenue from sales of our software is included in fee and other income on our Condensed Consolidated Statements of Operations.
At the time of each sale transaction, we make an assessment of the collectibility of the amount due from the customer. Revenue is only recognized at that time if management deems that collection is probable. In making this assessment, we consider customer creditworthiness and assess whether fees are fixed or determinable and free of contingencies or significant uncertainties. If the fee is not fixed or determinable, revenue is recognized only as payments become due from the customer, provided that all other revenue recognition criteria are met. In assessing whether the fee is fixed or determinable, we consider the payment terms of the transaction and our collection experience in similar transactions without making concessions, among other factors. Our software license agreements generally do not include customer acceptance provisions. However, if an arrangement includes an acceptance provision, we record revenue only upon the earlier of (1) receipt of written acceptance from the customer or (2) expiration of the acceptance period.
Our software agreements often include implementation and consulting services that are sold separately under consulting engagement contracts or as part of the software license arrangement. When we determine that such services are not essential to the functionality of the licensed software and qualify as “service transactions” under SOP 97-2, we record revenue separately for the license and service elements of these agreements. Generally, we consider that a service is not essential to the functionality of the software based on various factors, including if the services may be provided by independent third parties experienced in providing such consulting and implementation in coordination with dedicated customer personnel. If an arrangement does not qualify for separate accounting of the license and service elements, then license revenue is recognized together with the consulting services using either the percentage-of-completion or completed-contract method of contract accounting. Contract accounting is also applied to any software agreements that include customer-specific acceptance criteria or where the license payment is tied to the performance of consulting services. Under the percentage-of-completion method, we may estimate the stage of completion of contracts with fixed or “not to exceed” fees based on hours or costs incurred to date as compared with estimated total project hours or costs at completion. If we do not have a sufficient basis to measure progress towards completion, revenue is recognized upon completion of the contract. When total cost estimates exceed revenues, we accrue for the estimated losses immediately. The use of the percentage-of-completion method of accounting requires significant judgment relative to estimating total contract costs, including assumptions relative to the length of time to complete the project, the nature and complexity of the work to be performed, and anticipated changes in salaries and other costs. When adjustments in estimated contract costs are determined, such revisions may have the effect of adjusting, in the current period, the earnings applicable to performance in prior periods.
We generally use the residual method to recognize revenues from agreements that include one or more elements to be delivered at a future date when evidence of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements (e.g., maintenance, consulting and training services) based on vendor-specific objective evidence (“VSOE”) is deferred and the remaining portion of the arrangement fee is allocated to the delivered elements (i.e., software license). If evidence of the fair value of one or more of the undelivered services does not exist, all revenues are deferred and recognized when delivery of all of those services has occurred or when fair values can be established. We determine VSOE of the fair value of services revenue based upon our recent pricing for those services when sold separately. VSOE of the fair value of maintenance services may also be determined based on a substantive maintenance renewal clause, if any, within a customer contract. Our current pricing practices are influenced primarily by product type, purchase volume, maintenance term and customer location. We review services revenue sold separately and maintenance renewal rates on a periodic basis and update our VSOE of fair value for such services to ensure that it reflects our recent pricing experience, when appropriate.
Maintenance services generally include rights to unspecified upgrades (when and if available), telephone and Internet-based support, updates and bug fixes. Maintenance revenue is recognized ratably over the term of the maintenance contract (usually one year) on a straight-line basis and is included in fee and other income on our Condensed Consolidated Statements of Operations.
When consulting qualifies for separate accounting, consulting revenues under time and materials billing arrangements are recognized as the services are performed. Consulting revenues under fixed-price contracts are generally recognized using the percentage-of-completion method. If there is a significant uncertainty about the project completion or receipt of payment for the consulting services, revenue is deferred until the uncertainty is sufficiently resolved. Consulting revenues are classified as fee and other income on our Condensed Consolidated Statements of Operations.
Training services include on-site training, classroom training and computer-based training and assessment. Training revenue is recognized as the related training services are provided and is included in fee and other income on our Condensed Consolidated Statements of Operations.
SALES OF LEASED EQUIPMENT. Sales of leased equipment consist of sales of equipment subject to an existing lease, under which we are a lessor, including any underlying financing related to the lease. Sales of equipment subject to an existing lease are recognized when constructive title passes to the purchaser.
LEASE CLASSIFICATION. The manner in which lease finance transactions are characterized and reported for accounting purposes has a major impact upon reported revenue and net earnings. Lease accounting methods critical to our business are discussed below.
We classify our lease transactions in accordance with Statement of Financial
Accounting Standards ("SFAS")SFAS No. 13, "Accounting"Accounting for Leases," as: (1) direct financing; (2) sales-type; or (3) operating leases. Revenues and expenses between accounting periods for each lease term will vary depending upon the lease classification.
As a result of these three classifications of leases for accounting purposes, the revenues resulting from the "mix" of lease classifications during an accounting period will affect the profit margin percentage for such period and such profit margin percentage generally increases as revenues from direct financing and sales-type leases increase. Should a lease be financed, the interest expense declines over the term of the financing as the principal is reduced.
For financial statement purposes, we present revenue from all three classifications in lease revenues, and costs related to these leases in direct lease costs.
DIRECT FINANCING AND SALES-TYPE LEASES. Direct financing and sales-type leases transfer substantially all benefits and risks of equipment ownership to the customer. A lease is a direct financing or sales-type lease if the creditworthiness of the customer and the collectabilitycollectibility of lease payments are reasonably certain, no important uncertainties surround the amount of unreimbursable costs yet to be incurred, and it meets one of the following criteria: (1) the lease transfers ownership of the equipment to the customer by the end of the lease term; (2) the lease contains a bargain purchase option; (3) the lease term at inception is at least 75% of the estimated economic life of the leased equipment; or (4) the present value of the minimum lease payments is at least 90% of the fair market value of the leased equipment at the inception of the lease.
Direct financing leases are recorded as investment in direct financing leases and leased equipment—net upon acceptance of the equipment by the customer. At the commencement of the lease, unearned lease income is recorded that represents the amount by which the gross lease payments receivable plus the estimated unguaranteed residual value of the equipment exceeds the equipment cost. Unearned lease income is recognized, using the interest method, as lease revenue over the lease term.
Sales-type leases include a dealer profit or loss that is recorded by the lessor
at the inceptionupon acceptance of the
lease.equipment by the lessee. The dealer's profit or loss represents the difference, at the inception of the lease, between the present value of minimum lease payments computed at the interest rate implicit in the lease and
itsthe cost or carrying
amount.amount of the equipment (less the present value of the unguaranteed residual value) plus any initial direct costs. Interest earned on the present value of the lease payments and residual value is recognized over the lease term using the interest method.
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OPERATING LEASES. All leases that do not meet the criteria to be classified as direct financing or sales-type leases are accounted for as operating leases. Rental amounts are accrued on a straight-line basis over the lease term and are recognized as lease revenue. Our cost of the leased equipment is recorded on the balance sheet as investment in leases and leased equipmentequipment—net and is depreciated on a straight-line basis over the lease term to our estimate of residual value. Revenue, depreciation expense and the resulting profit for operating leases are recorded on a straight-line basis over the life of the lease.
Lease revenues consist of rentals due under operating leases and amortization of unearned income on direct financing and sales-type leases. Equipment under operating leases is recorded at cost on the balance sheet as investment in leases and leased equipmentequipment—net and depreciated on a straight-line basis over the lease term to our estimate of residual value. For the periods subsequent to the lease term, where collectabilitycollectibility is certain, revenue is recognized on an accrual basis. Where collectabilitycollectibility is not reasonably assured, revenue is recognized upon receipt of payment from the lessee.
RESIDUAL VALUES. Residual values represent our estimated value of the equipment at the end of the initial lease term. The residual values for direct financing and sales-type leases are included as part of the investment in direct financing and sales-type leases. The residual values for operating leases are included in the leased equipment's net book value and are reported in the investment in leases and leased equipment.equipment—net. The estimated residual values will vary, both in amount and as a percentage of the original equipment cost, and depend upon several factors, including the equipment type, manufacturer's discount, market conditions and the term of the lease.
We evaluate residual values on a quarterly basis and record any required changes in accordance with SFAS No. 13, paragraph 17.d., in which impairments of residual value, other than temporary, are recorded in the period in which the impairment is determined. Residual values are affected by equipment supply and demand and by new product announcements by manufacturers. In accordance with
accounting principles generally accepted in the United States of America,
residual value estimates are adjusted downward when such assets are impaired.
We seek to realize the estimated residual value at lease termination through:mainly through (1) renewal or extension of the original lease; (2) the sale of the equipment either to the lessee or on the secondary market; or (3) lease of the equipment to a new customer. The difference between the proceeds of a sale and the remaining estimated residual value is recorded as a gain or loss in lease revenues when title is transferred to the lessee, or if the equipment is sold on the secondary market, in sales of product and services and cost of sales, product and services when title is transferred to the buyer.
INITIAL DIRECT COSTS. Initial direct costs related to the origination of direct financing or operating leases are capitalized and recorded as part of the net investment in direct financing leases, or net operating lease equipment, and are amortized over the lease term.
OTHER SOURCES OF REVENUE. Amounts charged for hosting arrangements in which the customer accesses the programs from an ePlus-hostedePlus-hosted site and does not have possession of the software, and for Procure+, our procurement software package, are recognized as services are rendered. Amounts charged for Manage+, our asset management software service, are recognized on a straight-line basis over the period the services are provided. In addition, other sources of revenue are derived from: (1) income from events that occur after the initial sale of a financial asset; (2) re-marketingremarketing fees; (3) brokerage fees earned for the placement of financing transactions; (4) agent fees received from various manufacturers in the IT reseller business unit; (5) settlement fees related to disputes or litigation; and (6) interest and other miscellaneous income. These revenues are included in fee and other income inon our condensed consolidated statementsCondensed Consolidated Statements of earnings.
RESERVEOperations.
RESERVES FOR CREDIT LOSSES. The reservereserves for credit losses isare maintained at a level believed by management to be adequate to absorb potential losses inherent in our lease and accounts receivable portfolio. Management's determination of the adequacy of the reserve is based on an evaluation of historical credit loss experience, current economic conditions, volume, growth, the composition of the
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lease portfolio and other relevant factors. The reserve is increased by provisions for potential credit losses charged against income. Accounts are either written off or written down when the loss is both probable and determinable, after giving consideration to the customer's financial condition, the value of the underlying collateral and funding status (i.e., discounted on a non-recourse or recourse basis). Our allowance also includes consideration of uncollectible vendor receivables which arise from vendor rebate programs and other promotions.
CAPITALIZATION OF COSTS OF SOFTWARE FOR INTERNAL USE. We have capitalized certain costs for the development of internal-use software under the guidelines of SOP 98-1, "Accounting"Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.Use." These capitalized costs are included in the accompanying condensed consolidated balance sheetsCondensed Consolidated Balance Sheets as a component of property and equipment - equipment—net. Capitalized costs, net of amortization, totaled $615,526
and $639,896 and$0.6 million as of March 31, 20052006 and December 31, 2005, respectively.
June 30, 2006.
CAPITALIZATION OF COSTS OF SOFTWARE TO BE MADE AVAILABLE TO CUSTOMERS. In accordance with SFAS No. 86, "Accounting"Accounting for Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," software development costs are expensed as incurred until technological feasibility has been established, at such time such costs are capitalized until the product is made available for release to customers. These capitalized costs are included in the accompanying condensed
consolidated balance sheetsCondensed Consolidated Balance Sheets as a component of other assets. We had $1,193,657$1.0 million and $1,001,955$0.9 million of capitalized costs, net of amortization, as of March 31, 20052006 and June 30, 2006, respectively.
SHARE-BASED PAYMENT. In December 31, 2005, respectively.
RESULTS OF OPERATIONS -2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” or SFAS No. 123R. SFAS No. 123R replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB 25, “Accounting for Stock Issued to Employees,” and subsequently issued stock option related guidance. This statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. We are required to apply SFAS No. 123R to all awards granted, modified or settled as of the beginning of the annual fiscal reporting period that begins after June 15, 2005. We have analyzed the impact of SFAS No. 123R and have adopted SFAS No. 123R as of April 1, 2006. We are using the modified-prospective and the straight-line method. As described in Note 2, “Restatement of Consolidated Financial Statements” to the Unaudited Condensed Consolidated Financial Statements, we are restating prior fiscal periods within this Form 10-Q principally to reflect additional non-cash stock-based compensation expense relating to adjustments arising from the determinations of our Audit Committee in its review relating to our historical statements.
Results of Operations — Three and Nine Months Ended December 31, 2005June 30, 2006 Compared to Three and Nine Months Ended December 31, 2004
TotalJune 30, 2005
Revenues. We generated total revenues generated by us during the three-month periodthree months ended December 31,
2005 were $163,073,618June 30, 2006 of $189.7 million compared to revenues of $147,650,267 in$149.8 million during the comparable
period in the prior fiscal year,three months ended June 30, 2005, an increase of 10.4%26.6%. The increase is primarily the result of increased sales of product and leased equipment. Total revenues
generated by us during the nine-month period ended December 31, 2005 were
$487,120,137 compared to revenues of $407,534,700 in the comparable period in
the prior fiscal year, an increase of 19.5%.services. Our revenues are composed of sales leases,of product and services, lease revenues, and fee and other revenue,income, and may vary considerably from period to period. See
"POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS."
Sales of product revenuesand services increased 30.1% to $175.5 million for the three months ended June 30, 2006 compared to $134.9 million generated during the three months ended June 30, 2005 and represented 92.5% and 90.0% of total revenue respectively. The increase was a result of higher sales within our technology sales business unit subsidiaries primarily due to organic growth within our existing customer base.
Sales of product and services are generated primarily through our technology sales business unit subsidiaries. Sales of product and services consist primarily of sales of new equipment and service engagements. Many customers purchase from us using a contract vehicle known as a Master Purchase Agreement ("MPA"(“MPA”) in which the terms and conditions of our relationship are stipulated. Some MPAs contain pricing
arrangements known as cost plus arrangements. However, the MPAs do not contain purchase volume commitments and most have 30 day termination for convenience clauses. In addition, many of our customers place orders using purchase orders without an MPA in place. There is no guarantee that our sales of product and services volume can be maintained or increased.
Sales of product represented 89.8% and 90.6% of total revenue for the three
months ended December 31, 2005 and December 31, 2004, respectively. Sales of
product increased 9.5% to $146,384,576 during the three-month period ended
December 31, 2005, as compared to $133,728,559 in the comparable period in the
prior fiscal year. Our top ten customers accounted for 33.1% of sales of product
for the quarter ended December 31, 2005, as compared to 25.6% for the same
period in the prior fiscal year. For the nine-month period ended December 31,
2005, sales of product increased 21.1% to $440,663,026 from $363,762,423
generated in the comparable period in the prior fiscal year. The increase was a
result of higher sales within our technology sales business unit subsidiaries
primarily due to organic growth within our existing customer base and due to an
addition of approximately 245 customers during the quarter ended December 31,
2005.
A substantial portion of our sales of product
and services is from sales of Hewlett Packard and CISCO products, which
representsrepresented approximately
29.0%23.8% and
23.0%,27.0% of sales, respectively, for the
quarterthree months ended
December 31,June 30, 2006, and represented approximately 27.9% and 25.1% of sales, respectively, for the three months ended June 30, 2005.
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Included in the sales of product and services in our technology sales business unit are certain service revenues that are bundled with sales of equipment and are integral to the successful delivery of such equipment. Our service engagements are generally governed by Statements of Work and/or Master Service Agreements. They are primarily fixed fee, however, some agreements are time and materials or estimates. We realized a gross margin on sales of product and services of 10.0%10.9% and 9.8% for9.5% during the three and nine months ended December 31,June 30, 2006 and June 30, 2005, respectively, and 9.6% and
10.3% for the three and nine months ended December 31, 2004, respectively. Our gross margin on sales of product and services is affected by the mix and volume of products sold and competitive pressure in the marketplace.
Our lease
Lease revenues increased 23.4%0.3% to $13,758,427$11.3 million for the three-month periodthree months ended December 31, 2005 compared to $11,147,094 in the comparable period in the
prior fiscal year. For the nine-month period ended December 31, 2005, lease
revenues increased 5.0% to $36,968,881 compared to $35,213,926 during the
comparable period in the prior fiscal year. For bothJune 30, 2006 over the three and nine month
periods themonths ended June 30, 2005. Our net investment in leased assets was $212.2 million as of June 30, 2006, an 8.0% increase from $196.4 million as of June 30, 2005. The increase in lease revenue is predominantlypredominately due to an increase in our operating lease portfolio combined with a rise in the sale of leased equipment.
portfolio.
For the three months ended December 31, 2005,June 30, 2006, fee and other income increased
5.6% to $2,930,615 as compared to $2,774,614 inwas $2.8 million, a decrease of 21.8% over the comparable period in the
prior fiscal year. For the ninethree months ended December 31, 2005,June 30, 2005. The decrease in fee and other income increased 10.9%is partly attributable to $9,488,230, as compared to $8,558,351 in the comparable period in the prior fiscal year. This is a resultcompletion of an increase incertain professional services,service contracts predominately consulting, programming, hosting and procurement services provided by our technology business unit. Fee and other income includes revenues from adjunct services and fees, including broker and agent fees, support fees, warranty reimbursements, monetary settlements arising from disputes and litigation and interest income. Our fee and other income includescontain earnings from certain transactions thatwhich are in our normal course of business, but there is no guarantee that future transactions of the same nature, size or profitability will occur. Our ability to consummate 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.
Costs and Expenses. For the three months ended December 31, 2005,June 30, 2006, cost of sales, product and services increased 9.0%28.1% to $131,734,303$156.4 million as compared to $120,892,787 in$122.1 million for the comparable period in the
prior fiscal year. This is primarily attributablethree months ended June 30, 2005. The increase corresponds to the correlating increase in sales of product. Forproduct and services of 30.1% from the nine monthsquarter ended December 31,June 30, 2005 cost ofto the quarter ended June 30, 2006, primarily due to an increase in sales product increased 21.8% to $397,564,106 as compared to $326,396,119 in the
comparable period in the prior fiscal year.
from our technology sales business unit.
A significant reduction in cost of sales is generated through
vendor consideration programs provided by manufacturers. The programs are generally governed by our reseller authorization level with the manufacturer. The authorization level we achieve and maintain governs what types of product we can resell as well as such items as pricing received, funds provided for the marketing of these products and other special promotions. These authorization levels are achieved by us through sales volume, certifications held by sales executives or engineers and/or
requirements as the manufacturers may specify.contractual commitments by us. The authorizations are costly to maintain and these programs continually change and there is no guarantee of future reductions of costs provided by these
vendor consideration programs. We currently maintain the following authorization levels with our major manufacturers:
Manufacturer Manufacturer Authorization Level
- ------------------------------- --------------------------------------------
Hewlett Packard HP Platinum/VPA (National)
Cisco Systems Cisco Gold DVAR (National)
Microsoft Microsoft Gold (National)
Sun Microsystems Sun iForce Strategic Partner (National)
IBM IBM Platinum (National)
Lenovo Lenovo Platinum (National)
Network Appliance, Inc. NetApp Platinum
Citrix Systems, Inc. Citrix Gold (National)
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Our direct
Manufacturer | Manufacturer Authorization Level |
| Hewlett Packard | HP Platinum/VPA (National) |
| Cisco Systems | Cisco Gold DVAR (National) |
| Microsoft | Microsoft Gold (National) |
| Sun Microsystems | Sun iForce Strategic Partner (National) |
| IBM | IBM Platinum (National) |
| Lenovo | Lenovo Platinum (National) |
| Network Appliance, Inc. | NetApp Platinum (Elite) |
| Citrix Systems, Inc. | Citrix Gold (National) |
Direct lease costs increased 54.9% and 42.3% to $4,741,811 and $12,335,86433.0% during the three- and nine-month periodsthree months ended December 31, 2005, respectively,June 30, 2006 as compared to the comparable periodsthree months ended June 30, 2005. The largest component of direct lease costs is depreciation expense for operating leased equipment. Our investment in the prior fiscal year. The increase is
the resultoperating leases increased 25.7% as of an increase in lease depreciation, specifically depreciation on
the larger volume of operating lease assets for this period.
June 30, 2006 as compared to June 30, 2005.
Professional and other fees increased for the three-month periodthree months ended December
31,June 30, 2006 increased 35.8% as compared to the three months ended June 30, 2005, over the previous year by 310.4%, or $1,863,775. The increase for the
three-month period is primarily due to increased expenses of $0.2 million for litigation related to the bankruptcy of Cyberco Holdings, Inc. and the related non-bankruptcy lawsuit filed with BoA as discussed in Part II, Item 1, “Legal Proceedings.” In addition, we incurred additional expenses of $0.2 million related to our pursuitreview of patent-infringement litigation against SAP America, Inc.accounting guidance regarding stock option grants since our IPO in 1996 and SAP AG, which
was filed in April 2005. In the three-month period ended December 31, 2004,
there was no expense related to patent-infringement litigation due to our
deferral of the expense as a result of our settlement of the patent-infringement
litigation against Ariba Inc. in the subsequent quarter. In the three month
period ended December 31, 2005, the expense related to patent-infringement
litigation was $1,600,130.
In the nine-month period ended December 31, 2005, professional and other fees
increased 0.1%, or $7,334 from the comparable period in the prior fiscal year.
Although legal expenses increased for the nine-month period ending December 31,
2005, there was a reduction in expenses for outside services. This reduction was
due to payments made to Manchester Technologies, Inc. during the nine-month
period ending December 31, 2004 for professional services rendered by people
that became our employees in a subsequent period, as well as a transition team
that was involved in the purchase of Manchester Technologies, Inc. In the
nine-month period ended December 31, 2004 and December 31, 2005, the expense
related to patent-infringement litigation was $1,053,625, and $2,411,586,
respectively.
resulting impact.
Salaries and benefits expenses increased 9.1% and 13.6% to $15,677,592 and
$45,482,831,17.0% during the three and nine-month periodsmonths ended December 31, 2005,
respectively, as compared toJune 30, 2006 over the same periods in the prior fiscal year.three months ended June 30, 2005. These increases are due in part to an increase in benefit costs and an increase in the average number of employees. We employed approximately 670697 people as of December
31, 2005,June 30, 2006, as compared to 632651 people at December 31, 2004.
Our generalas of June 30, 2005.
General and administrative expenses increased 2.3%decreased 2.4% to $4,468,922$4.4 million during the three months ended December 31, 2005,June 30, 2006 as compared to the same period in the
prior fiscal year. For the ninethree months ended December 31, 2005, generalJune 30, 2005. The decrease is due to a slight reduction in depreciation and administrative expensesamortization expense relating to property and equipment and increased 6.8%efficiency in spending controls to $13,905,504enhance productivity and profits.
Interest and financing costs increased 29.8% to $2.0 million during the three months ended June 30, 2006 as compared to the same
period in the prior fiscal year. The year-to-date increases are largely due to
expenses relating to higher sales volume and depreciation costs for new capital
acquisitions.
Interest and financing costs incurred by us for the three and nine-month periodsmonths ended December 31, 2005 increased 20.2% and 20.6% to $1,950,431 and $5,202,926,
respectively.June 30, 2005. This is partiallyprimarily due to an increase in ourincreasing non-recourse debt portolio from $125,185,660 on December 31, 2004 to $134,411,118 on December 31,
2005. Additionally, interestportfolio and increasing debt rates on new debt have been slowly increasing
during this period. Interest and financing costs include interest costs on our
lease-specific and general working capital indebtedness.
Our provisionfinancings. Non-recourse notes payable increased 4.8% to $134.1 million as of June 30, 2006 as compared to March 31, 2006.
Provision for Income Taxes. Provision for income taxes decreasedincreased $0.5 million to $824,701$1.4 million during the three months ended June 30, 2006 from $0.9 million during the three months ended June 30, 2005, primarily due to higher earnings. Our effective income tax rates for the three months ended December 31,June 30, 2006 and 2005 from $1,122,680were 41.6% and 40.5%, respectively.
Net Earnings. The foregoing resulted in a 50.3% increase in net earnings for the three months ended December 31, 2004,
reflecting effective income tax rates of 40.5% and 41.0%, respectively. Our
provision for income taxes decreased to $3,013,540 for the nine-month period
ended December 31, 2005 from $4,062,401 for the nine-month period ended December
31, 2004. This decrease was due to reduced pre-tax earnings.
The foregoing resulted in an 25.0% decrease in net earnings to $1,211,599 for
the three-month period ended December 31, 2005June 30, 2006 as compared to the same period in
the prior fiscal year and a 24.3% decrease in net earnings to $4,427,298 for the
nine-month periodthree months ended December 31,June 30, 2005.
Basic and fully diluted earnings per common share were
$0.15$0.24 and
$0.14$0.22, respectively, for the three months ended
December 31, 2005,
respectively,June 30, 2006, as compared to
$0.18$0.15 and
$0.17$0.14, respectively, for the three months ended
December
31, 2004, respectively.June 30, 2005. Basic and diluted weighted average common shares outstanding for the three months ended
December 31, 2005June 30, 2006 were
8,215,2218,207,369 and
8,890,948,8,723,439, respectively. For the three months ended
December 31, 2004,June 30, 2005, the basic
and diluted weighted average shares outstanding were 8,957,280 and 9,375,666,
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respectively. Basic and fully diluted earnings per common share were $0.53 and
$0.49 for the nine months ended December 31, 2005, as compared to $0.65 and
$0.62 for the nine months ended December 31, 2004. Basic and diluted weighted average common shares outstanding forwere 8,545,744 and 9,078,604, respectively. The number of common shares outstanding decreased due to our repurchases of our common stock.
Liquidity and Capital Resources
During the ninethree months ended December 31, 2005
were 8,411,268 and 8,992,035, respectively. For the nine months ended December
31, 2004, the basic and diluted weighted average shares outstanding were
8,933,702 and 9,358,693, respectively.
LIQUIDITY AND CAPITAL RESOURCES
During the nine-month period ended December 31, 2005,June 30, 2006, we used cash in operating
activitiesflows from operations of $19,100,796$36.5 million and used cash inflows from investing activities of $22,855,644.$4.8 million. Cash flows generatedprovided by financing activities amounted to $20,428,979$43.1 million during the same period. The effect of exchange rate changes during the period generatedprovided cash flows of $92,144.$0.1 million. The net effect of these cash flows was a net decreaseincrease in cash and cash equivalents of $21,435,317$1.9 million during the nine-month period.three months ended June 30, 2006. During the same period, our total assets increased $22,116,447,$44.4 million, or 6.1%.11.9%, primarily as the result of increases in our accounts receivable and inventory. The cash
balance at December 31, 2005 was $17,416,397increase in inventory is due to orders from clients that required staging and rollout schedules that delayed shipment and an increase in inventory in transit that have FOB shipping point terms. The increase in accounts receivable of $26.7 million as of June 30, 2006 as compared to $38,851,714 at March 31, 2005. The decline of the cash balance2006 is a result of the need for additional
working capital due to highera 21.8% increase in total sales volumeduring the same period. Our cash and lease portfolio growth.
Accounts receivable increased from $93,555,462cash equivalents balance as of June 30, 2006 was $22.6 million as compared to $20.7 million as of March 31, 2005, to
$120,003,176 as of December 31, 2005, an increase of 28.3%. This is primarily
the result of a 24.9% increase in sales of product over the three-month period
ended December 31, 2005 compared to the three-month period ended March 31, 2005.
Inventories increased 73.5% to $3,671,913 as of December 31, 2005, from
$2,116,885 as of March 31, 2005. This increase was a result of sales orders in
the configuration process from several of our large customers.
Our debt2006.
Debt financing activities typically provide approximately 80% to 100% of the purchase price of the equipment we purchased by us for lease to our customers. Any balance of the purchase price (our equity investment in the equipment) must generally be financed by cash flowflows from our operations, the sale of the equipment leased to third parties or other internal means. Although we expect that the credit quality of our leases and our residual return history will continue to allow us to obtain such financing, no assurances can be given that such financing will be available, onat acceptable terms, or at all. The financing necessary to support our leasing activities has principally been provided by non-recourse and recourse borrowings. Historically, we have obtained recourse and non-recourse borrowings from banks and finance companies. Non-recourse financings are loans whose repayment is the responsibility of a specific customer, although we may make representations and warranties to the lender regarding the specific contract or have ongoing loan servicing obligations. Under a non-recourse loan, we borrow from a lender an amount based on the present value of the contractually committed lease payments under the lease at a fixed rate of interest, and the lender secures a lien on the financed assets. When the lender is fully repaid from the lease payment,payments, the lien is released and all further rental or sale proceeds are ours. We are not liable for the repayment of non-recourse loans unless we breach our representations and
warranties in the loan agreements. The lender assumes the credit risk of each lease, and itstheir only recourse, upon default by the lessee, is against the lessee and the specific equipment under lease. Each transaction is specifically approved and done solely at the lender’s discretion. During the nine-month periodthree months ended December 31, 2005,June 30, 2006, our lease-related non-recourse debt portfolio increased 17.0%4.8% to $134,411,118.
$134.1 million as compared to March 31, 2006.
Whenever possible and desirable, we arrange for equity investment financing which includes selling assets, including the residual portions, to third parties and financing the equity investment on a non-recourse basis. We generally retain customer control and operational services, and have minimal residual risk. We usually reservepreserve the right to share in remarketing proceeds of the equipment on a subordinated basis after the investor has received an agreed to return on itstheir investment.
Our "Accounts payable - equipment"
Accounts payable—equipment represents equipment costs that have been placed on a lease schedule, but for which
the Company haswe have not yet paid. The balance of unpaid equipment cost can vary depending on vendor terms and the
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timing of lease originations. As of December 31, 2005,June 30, 2006, we had $5,961,928$8.5 million of unpaid equipment cost, as compared to $8,965,022 at$7.7 million as of March 31, 2005.
Our "Accounts payable - trade"2006.
Accounts payable—trade increased 34.4%16.3% to $22.4 million as of June 30, 2006 from $54,751,962 to $73,604,506
due$19.2 million as of March 31, 2006. This increase is primarily related to an increase in sales of product and services and, consequently, an increase in cost of goods sold, product and services from our technology business unit.
Accounts payable—floor plan increased 42.3% to $66.5 million as of June 30, 2006 from $46.7 million as of March 31, 2006. This increase is primarily due to a rise in purchases subsequently increasedsales of product and services from our trade payables.
Our "Accruedtechnology business unit that we transacted through our floor plan facility with GECDF.
Accrued expenses and other liabilities"liabilities includes deferred income and amounts collected and payable, such as sales taxes and lease rental payments due to third parties. As of December 31, 2005,June 30, 2006, we had $17,396,264$36.9 million of accrued expenses and other liabilities.
liabilities as compared to $33.3 million as of March 31, 2006, an increase of 10.6%.
Based on past performance and current expectations, we believe that our cash and cash equivalents, available borrowings based on continued compliance and/or waivers under our credit facilities, and cash generated from operations will satisfy our working capital needs, capital expenditures, stock repurchases, commitments, acquisitions and other liquidity requirements associated with our existing operations through at least the next 12 months.
Credit Facility -— Leasing Business
- ----------------------------------
Working capital for our leasing business is provided through a credit facility which wasis currently contractually scheduled to expire on July 21, 2006.10, 2009. On September 26, 2005, we terminated our $45,000,000$45 million credit facility and simultaneously entered into a new coterminous, $35,000,000$35 million credit facility. Participating in this facility are Branch Banking and Trust Company ($15,000,000)15 million) and National City Bank ($20,000,000)20 million) as agent.agents. The ability to borrow under this facility is limited to the amount of eligible collateral at any given time. The credit facility has full recourse to us and is secured by a blanket lien against all of our assets such as chattel paper (including leases), receivables, inventory and equipment and the common stock of all wholly-owned subsidiaries.
The credit facility contains certain financial covenants and certain restrictions on, among other things, our ability to make certain investments, and sell assets or merge with another company. Borrowings under the credit facility bear interest at London Interbank Offered Rates ("LIBOR"(“LIBOR”) plus an applicable margin or, at our option, the Alternate Base Rate ("ABR"(“ABR”) plus an applicable margin. The ABR is the higher of the Agent bank'sagent bank’s prime rate or Federal Funds rate plus 0.5%. The applicable margin is determined based on our recourse funded debt ratio and can range from 1.75% to 2.50% for LIBOR loans and from 0.0% to 0.25% for ABR loans. As of December 31, 2005,June 30, 2006, we had an outstanding balance of $7.0$15.0 million on the facility.
facility, as recorded in recourse notes payable on our Condensed Consolidated Balance Sheets.
In general, we use the National City Bank facility to pay the cost of equipment to be put on lease, and we repay borrowings from the proceeds of: (1) long-term, non-recourse, fixed rate financing which we obtain from lenders after the underlying lease transaction is finalizedfinalized; or (2) sales of leases to third parties. The loss of this credit facility could have a material adverse effect on our future results as we may have to use this facility for daily working capital and liquidity for our leasing business. The availability of the credit facility is subject to a borrowing base formula that consists of inventory, receivables, purchased assets and lease assets. Availability under the credit facility may be limited by the asset value of the equipment purchased by us or by terms and conditions in the credit facility agreement. If we are unable to sell the equipment or unable to finance the equipment on a permanent basis within a certain time period, the availability of credit under the facility could be diminished or eliminated. The credit facility contains covenants relating to minimum tangible net worth, cash flow coverage ratios, maximum debt to equity ratio, maximum guarantees of subsidiary obligations, mergers and acquisitions and asset sales. We were in compliance with or had received amendments extending these covenants as of June 30, 2006.
The National City Bank facility requires the delivery of our Audited and Unaudited Financial Statements, and pro-forma financial projections, by certain dates. We have not delivered the following documents as required by Section 5.1 of the facility: (a) annual Audited Financial Statements for the year ended March 31, 2007; (b) “Projections” for our fiscal year ended March 31, 2008; and (c) quarterly Unaudited Financial Statements for the quarters ended June 30, 2006, September 30, 2006, December 31, 2005.
2006 and June 30, 2007. We entered into the following amendments which have extended the delivery date requirements for these documents: a First Amendment dated July 11, 2006, a Second Amendment dated July 28, 2006, a Third Amendment dated August 30, 2006, a Fourth Amendment dated September 27, 2006, a Fifth Amendment dated November 15, 2006, a Sixth Amendment dated January 11, 2007, a Seventh Amendment dated March 12, 2007, an Eighth Amendment dated June 27, 2007 and a Ninth Amendment dated August 22, 2007. As a result of the amendments, the agents agreed, inter alia, to extend the delivery date requirements of the documents above through November 30, 2007.
We believe we will receive additional extensions from our lender, if needed, regarding our requirement to provide financial statements as described above through the date of delivery of the documents. However, we cannot guarantee that we will receive additional extensions.
Credit Facility -— Technology Business
- -------------------------------------
ePlus
Our subsidiary, ePlus Technology, inc., has a financing facility from GE Commercial Distribution
Finance Corporation ("GECDF")GECDF to finance its working capital requirements for inventories and accounts receivable. There are two components of this facility: (1) a floor plan componentcomponent; and (2) an accounts receivable component. The principal
amounts outstandingAs of June 30, 2006, the facility had an aggregate limit of the two components may not exceed, inof $100.0 million as a result of a June 29, 2006 amendment that temporarily increased the aggregate $75limit during the period from June 26, 2006 through September 21, 2006. Effective June 20, 2007, the facility with GECDF was again amended to temporarily increase the total credit facility limit to $100.0 million during the period from June 19, 2007 through August 15, 2007. On August 2, 2007, the period was extended from August 15, 2007 to September 30, 2007. Other than during the temporary increase periods described above, the total credit facility limit is $85.0 million. However, theThe accounts receivable component has a sub-limit of $20$30.0 million. Availability under the GECDF facility may be limited by the asset value of equipment we purchase and may be further limited by certain covenants and terms and conditions of the facility. We were in compliance with these covenants as of December 31, 2005.
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On July 22, 2005, the GECDF facility was modified to include a temporary credit
limit increase of up to $25 million to a maximum balance of $75 million through
July 31, 2005 after which the seasonal uplift period began which increased limit
was $75 million. On November 14, 2005, the facility agreement was amended to
eliminate the seasonal uplift period and permanently increase the aggregate
limit of the two components to $75 million, which includes a sub-limit of the
accounts receivable component of $20 million.
June 30, 2006.
The facility provided by GECDF requires a guaranty of up to $10,500,000$10.5 million by ePlusePlus inc. The guaranty requires ePlus inc. deliver its annual audited financial statements by a certain date. We have not delivered the annual audited financial statements for the year ended March 31, 2007, however, GECDF has extended the delivery date to provide the financial statements through September 30, 2007. We believe we will receive additional extensions from our lender, if needed, regarding our requirement to provide financial statements as described above through the date of delivery of the documents. However, we cannot guarantee that we will receive additional extensions. The loss of the GECDF credit facility could have a material adverse effect on our future results as we currently rely on this facility and its components for daily working capital and liquidity for our technology sales business and isas an operational function of our accounts payable process.
Floor Plan Component
The traditional business of ePlusePlus Technology, inc. as a seller of computer technology, related peripherals and software products is financed through a floor plan component in which interest expense for the first thirty- to forty-five days, in general, is not charged but is paid by the
manufacturer/distributor.charged. The floor plan liabilities are recorded as accounts payable - trade,payable—floor plan on our Condensed Consolidated Balance Sheets, as they are normally repaid within the thirty- to forty-five day time-frametime frame and represent an assigned accounts payable originally generated with the manufacturer/distributor. If the thirty- to forty-five day obligation is not paid timely, interest is then assessed at stated contractual rates.
The respective floor plan component credit limits and actual outstanding balances were as follows:
Maximum Maximum
Credit Limit at Balance as of Credit Limit at Balance as of
March 31, 2005 March 31, 2005 December 31, 2005 December 31, 2005
- --------------------------------------------------------------------------------
$ 75,000,000 $ 32,978,262 $ 75,000,000 $ 41,510,745
follows (in thousands):
Maximum Credit Limit at March 31, 2006 | | | Balance as of March 31, 2006 | | | Maximum Credit Limit at June 30, 2006 | | | Balance as of June 30, 2006 | |
| $ | 75,000 | | | $ | 46,689 | | | $ | 100,000 | | | $ | 66,455 | |
Accounts Receivable Component
In addition to
Included within the floor plan component, ePlusePlus Technology, inc. has an accounts receivable component from GECDF. AtGECDF, which has a revolving line of credit. On the due date of the invoices financed onby the floor plan component, the invoices are paid by the Accounts Receivable
Component.accounts receivable component of the credit facility. The balance on the Accounts Receivable Componentaccounts receivable component is then reduced by collectionspayments from our customers into a lockbox and our available cash. The outstanding balance under the accounts receivable component is recorded as recourse notes payable.
payable on our Condensed Consolidated Balance Sheets.
The respective accounts receivable component credit limits and actual outstanding balances were as follows:
Maximum Maximum
Credit Limit at Balance asfollows (in thousands):
Maximum Credit Limit at March 31, 2006 | | | Balance as of March 31, 2006 | | | Maximum Credit Limit at June 30, 2006 | | | Balance as of June 30, 2006 | |
| $ | 20,000 | | | $ | 0 | | | $ | 30,000 | | | $ | 0 | |
Performance Guarantees
In the normal course of
Credit Limit at Balance as of
March 31, 2005 March 31, 2005 December 31, 2005 December 31, 2005
- --------------------------------------------------------------------------------
$ 15,000,000 $ 6,263,471 $ 20,000,000 $ 0
In some circumstances, mostly with state governments,business, we may provide certain customers with
performance guarantees,
of our performance, which are generally backed by surety
bonds that typically range from $50,000 to $500,000.bonds. In general, we would only be liable for the amount of these guarantees in the event of default in the performance of our obligations. We are in compliance with the performance obligations under all service contracts for which there is a performance guarantee, and we believe that any liability incurred in connection with these guarantees would not have a material adverse effect on our
consolidated resultsCondensed Consolidated Statements of
operations or financial position.
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On November 17, 2004, a stock purchase program was authorized by our Board of
Directors. This program authorized the repurchase of up to 3,000,000 shares of
our outstanding common stock over a period of time ending no later than November
17, 2005 and was limited to a cumulative purchase amount of $7,500,000. On March
2, 2005, our Board of Directors approved an increase, from $7,500,000 to
$12,500,000, for the maximum total cost of shares that could be purchased. Our
Board of Directors authorized another stock repurchase program effective
November 17, 2005 for the repurchase of up to 3,000,000 shares of our
outstanding common stock, over a twelve-month period ending November 17, 2006,
with a cumulative purchase limit of $12,500,000.
During the three months ended December 31, 2005 and 2004, we repurchased 276,756
and 19,032 shares of our outstanding common stock for $3,656,118 and $208,705,
respectively. During the nine months ended December 31, 2005 and 2004, we
repurchased 447,056 and 58,032 shares of our outstanding common stock for
$5,732,329 and $701,257, respectively. Since the inception of our initial
repurchase program on September 20, 2001, and as of December 31, 2005, we had
repurchased 2,672,956 shares of our outstanding common stock at an average cost
of $10.71 per share for a total of $28,620,209.
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
Operations.
Potential Fluctuations in Quarterly Operating Results
Our future quarterly operating results and the market price of our common stock may fluctuate. In the event our 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 our common 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 IT reseller, or software competitor, or major customers or vendors of ours.
Our quarterly results of operations are susceptible to fluctuations for a number of reasons, including, without limitation,but not limited to, reduction in IT spending, our entry into the e-commerce market, any reduction of expected residual values related to the equipment under our leases, timing and mix of specific transactions and other factors. See "Part II. Other Information -Part I, Item 1A. Risk Factors."1A, “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended March 31, 2006. Quarterly operating results could also fluctuate as a result of our sale of equipment in our 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.
We believe that comparisons of quarterly results of our operations are not necessarily meaningful and that results for one quarter should not be relied upon as an indication of future performance.
22
Item
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and Qualitative Disclosures About Market Risk
Although a substantial portion of our liabilities are non-recourse, fixed interest rate instruments, we are reliant upon lines of credit and other financing facilities, thatwhich are subject to fluctuations in interest rates. These instruments, which are denominated in U.S. Dollars, were entered into for other than trading purposes are denominated
in U.S. Dollars, and, with the exception of amounts drawn under the National City Bank and GE Commercial Distribution Finance CorporationGECDF facilities, bear interest at a fixed rate. Because the interest rate on these instruments is fixed, changes in interest rates will not directly impact our cash flows. Borrowings under the National City facility bear interest at a market-based variable rate, based on a rate selected by us and GE Commercial Distribution Finance
Corporation facilitiesdetermined at the time of borrowing. Borrowings under the GECDF facility bear interest at a market-based variable rate. Due to the relatively short nature of the interest rate periods, we do not expect our operating results or cash flow to be materially affected by changes in market interest rates. As of December 31, 2005,June 30, 2006, the aggregate fair value of our recourse borrowings approximated their carrying value.
During the year ended March 31, 2003, we began transacting business in Canada. As a result, we have entered into lease contracts and non-recourse, fixed interest rate financing denominated in Canadian Dollars. To date, Canadian operations have been insignificant and we believe that potential fluctuations in currency exchange rates will not have a material effect on our financial position.
Item
Item 4. CONTROLS AND PROCEDURES
Controls and Procedures
Background of Restatement
As previously disclosed, our CEO received a letter, dated June 20, 2006, from a stockholder raising concerns about 450,000 options awarded in 2004 to our four senior officers (“2004 Options”). On June 21, 2006, our CEO forwarded the letter to the Chairman of the Audit Committee. On June 23, 2006, the Audit Committee commenced a voluntary investigation of the issues raised concerning the 2004 Options. Subsequently, the Audit Committee Investigation was expanded to cover all our stock option grants since our IPO in 1996 and the historical practices related to stock option grants. The Audit Committee retained independent legal counsel, who in turn retained forensic accountants, to assist in the Investigation.
With the assistance of independent counsel, the Audit Committee obtained and reviewed corporate books and records relating to option grants since our IPO, including relevant stock option plans, option agreements, minutes and written consents of our Board and Compensation Committee, relevant public filings and other available documentation. In addition, independent counsel for the Audit Committee reviewed a large volume of potentially relevant emails and electronic documents and interviewed 28 individuals, many on multiple occasions. The Audit Committee’s independent counsel developed an exhaustive search term list, which was applied to electronic data retrieved. Approximately 79 gigabytes of electronic data was located and reviewed. The Audit Committee met frequently throughout the course of its Investigation.
On August 11, 2006, we filed a Form 8-K which disclosed that based on its review and assessment, the Audit Committee preliminarily concluded that the appropriate measurement dates for determining the accounting treatment for certain stock options we granted differ from the recorded measurement dates used in preparing our Consolidated Financial Statements. The Audit Committee further determined that certain stock option grants or modifications of stock option grants that were not in accordance with our stock-based compensation plans should have been accounted for using variable plan accounting for the duration of the options. As a result, non-cash stock-based compensation expense should have been recorded with respect to these stock option grants. Accordingly, it was further disclosed that we would restate our previously issued financial statements for the fiscal years ended March 31, 2004 and 2005, as well as previously reported interim financial information, to reflect additional non-cash charges for stock-based compensation expense and the related tax effects in certain reported periods. We further disclosed that for the above-stated reasons, certain of our prior financial statements and the related reports from our independent registered public accountants, earnings statements and press releases, and similar communications issued by us should no longer be relied upon.
The Audit Committee Investigation, and our internal review, identified certain errors in the ways in which we accounted for certain option grants. We concluded that we (1) used incorrect measurement dates for the accounting of certain stock options, (2) had not properly accounted for certain modifications of stock options, and (3) had incorrectly accounted for certain stock options that required by Rule 13a-15(b) under the Securitiesapplication of the variable accounting method. We determined revised measurement dates for those option grants with incorrect measurement dates and Exchange Actrecorded stock-based compensation expense to the extent that the fair market value of 1934, as
amended ("Exchange Act"),our stock on the revised measurement date exceeded the exercise price of the stock option, in accordance with APB 25 and related FASB interpretations. Additionally, we carried out an evaluation,restated both basic and diluted weighted average shares outstanding for changes in measurement dates resulting from the Investigation. The combination of recording stock-based compensation expense and restating our weighted average shares outstanding have resulted in restated basic and diluted EPS.
We adopted a methodology for determining the most likely appropriate accounting measurement dates for all stock option grants. We reviewed all available documentation and considered all facts and circumstances for each award and attempted to identify the date at which the award was most likely authorized and approved and the recipient, number of shares and price were determined with finality.
Disclosure Controls and Procedures
Management, under the supervision and with the participation of our management, including our Chief Executive
OfficerCEO and our Chief Financial Officer of(“CFO”), evaluated the effectiveness of designour disclosure controls and operationprocedures (as defined in Rules 13a-15(e) or 15d-15(e) promulgated under the Exchange Act), as of the end of the period covered by this report. Based on that evaluation, which included the findings of our Audit Committee as part of its review of our historical stock option granting practices and the adjustments to our Condensed Consolidated Financial Statements resulting from that review and classification errors in our Condensed Consolidated Statements of Cash Flows, our CEO and CFO have concluded that our disclosure controls and procedures as of June 30, 2006 were not effective at the endreasonable assurance level due to the existence of material weaknesses in our internal control over financial reporting. Specifically, we did not maintain effective controls over the determination of the quarter
covered byaccounting measurement dates for our granting of stock option awards, modifications of stock options awards and the classification of certain cash flows.
To address these control weaknesses, we performed additional analysis and other procedures in order to prepare our Condensed Consolidated Financial Statements in accordance with U.S. GAAP.
Restatement for Stock Option Grants
In making this report. Based upon that evaluation, our Chief Executive Officer
and our Chief Financial Officerdetermination, we concluded that our disclosure controls over the application of accounting policies related to the determination of the measurement date of stock options were ineffective to ensure that these policies complied with U.S. GAAP. Specifically, the deficiency in our controls over the application of our stock option accounting policies failed to identify errors in our financial statements, which resulted in adjustments to our Condensed Consolidated Financial Statements. A detailed discussion of the correction of these errors and the impact of the adjustment to our Consolidated Financial Statements is included in the “Explanatory Note” immediately preceding Part I, “Financial Information” in this Form 10-Q and in Note 2, “Restatement of Consolidated Financial Statements” to our Unaudited Condensed Consolidated Financial Statements.
Management is committed to remediation of the control deficiencies that constitute the material weaknesses described above by implementing changes to our internal control over financial reporting. For stock option grants, management has implemented improvements in our internal control over financial reporting suggested as a result of the Audit Committee Investigation into stock option granting practices, with the exception of adopting a new Long-Term Incentive Plan, which we plan to present to stockholders in our next proxy statement. In addition, management has established procedures to consider the ongoing effectiveness of both the design and operation of our internal control over financial reporting.
We have implemented a number of significant changes and improvements in our internal control over financial reporting since June 30, 2006. Based on the Stock Option Grant Policy and Procedure Recommendations adopted by our Board, our CEO and CFO have taken the responsibility to implement changes and improvements in our internal control over financial reporting and remediate the control deficiencies that gave rise to the material weaknesses. Specifically, these changes include:
| · | We now require that all option grants be effective and priced as of the date approved or at a predetermined date certain in the future, in accordance with the applicable plan and the terms of the grant. |
| · | The Stock Incentive Committee (“SIC”) was discontinued and all decisions regarding stock options will be made by the Compensation Committee or the full Board. |
| · | Each option grant shall be approved at an in-person or telephonic meeting of the Compensation Committee or full Board. Option grants shall not be approved by unanimous written consent. |
| · | We now require systematic authorization for option grants to ensure that all option transactions adhere to our plans and stated policies. All such transactions must be accurately reflected in our books and records and have appropriate supporting documentation. Determinations of the Compensation Committee and/or the Board regarding options must be implemented in an accurate and timely manner. |
| · | We have established a policy to issue options only during a specified window each year, immediately after release of the Form 10-K for the prior year or after quarterly earnings reports, with narrow exceptions for new employees and other special circumstances as determined by the Compensation Committee or the Board. |
| · | Each option granted must specify all material terms of any options granted, including date of grant, exercise price, vesting schedule, duration, breakdown of ISOs versus non-qualified stock options, and any other terms the Compensation Committee or the Board deems appropriate. |
| · | All Forms 4 must be filed within two business days of any grant. |
| · | Option agreements for executive officers must be in the form on file with the SEC. |
| · | All option agreements must be signed contemporaneously with each grant. |
| · | The Compensation Committee will in its discretion engage independent outside counsel to obtain legal advice on issues that are significant and not ministerial rather than relying on company counsel for advice on such matters. |
| · | The Compensation Committee must be advised of the accounting and reporting impact of each grant. |
| · | We will strengthen our Internal Audit function by: (i) having the Internal Audit function report directly to the Audit Committee; (ii) implementing appropriate enhancements to our independent monitoring of financial controls, including specifically the monitoring of stock options and compensation issues; and (iii) implementing appropriate additional compliance training for our employees and management. |
| · | Our general counsel must review all proposed grants to ensure that all legal requirements have been met; and |
| · | We shall adopt a new long-term incentive plan to effectuate these recommendations. We will ensure that the new plan is accurately described in public filings. |
Restatement of Condensed Consolidated Statements of Cash Flows
In addition, we concluded that our controls over the application of accounting policies related to preparing our Condensed Consolidated Statements of Cash Flows were ineffective to ensure that these policies complied with U.S. GAAP. Specifically, the deficiency in our controls over the preparation of our Condensed Consolidated Statements of Cash Flows failed to identify errors in our financial statements, which resulted in adjustments to our Condensed Consolidated Financial Statements. A detailed discussion of the correction of these errors and the impact of the adjustment to our Consolidated Financial Statements is included in the “Explanatory Note” immediately preceding Part I, “Financial Information” in this Form 10-Q.
We use floor planning agreements for dealer financing of products purchased from distributors and resold to end-users. Historically, we classified the cash flows from our floor plan financing agreements in operating activities in our Consolidated Statements of Cash Flows. We previously treated the floor plan facility as an outsourced accounts payable function, and, therefore, considered the payments made by our floor plan facility as cash paid to suppliers under Financial Accounting Standards No. 95, “Statement of Cash Flows.”
We have now determined that when an unaffiliated finance company remits payments to our suppliers on our behalf, we should show this transaction as a financing cash inflow and an operating cash outflow. In addition, when we repay the financing company, we should present this transaction as a financing cash outflow. As a result, we have restated the accompanying Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2005 to correct this error.
The restatement also includes a separate line item on the Condensed Consolidated Balance Sheets for the accounts payable related to our floor plan financing agreements which had previously been included in accounts payable—trade and a restatement of payments made by our floor plan facility to our suppliers from cash flows provided by operating activities to cash flows provided by financing activities.
Also, payments made by our lessees directly to third-party, non-recourse lenders were previously reported on our Condensed Consolidated Statements of Cash Flows as repayments of non-recourse debt in the financing section and a decrease in our investment in leases and leased equipment—net in the operating section. As these payments were not received or disbursed by us, management determined that these amounts should not be shown as cash used in financing activities and cash provided by operating activities on our Condensed Consolidated Statements of Cash Flows. Rather, these payments are effectivenow disclosed as a non-cash financing activity on our Condensed Consolidated Statements of Cash Flows.
In addition, certain corrections were made for errors noted on our Condensed Consolidated Statements of Cash Flows between the line items reserves for credit losses and changes in alerting them, on a timely basis,accounts receivable, both of which are in the operating section. See the impact of corrections in Note 2, “Restatement of Consolidated Financial Statements” to material
information relatingour Unaudited Condensed Consolidated Financial Statements contained elsewhere in this document.
We have discussed the accounting restatements described above with the Audit Committee of the Board. We are working with the Audit Committee to us (including our consolidated subsidiaries)identify and implement corrective actions, where required, to be includedimprove the effectiveness of our internal control over financial reporting and to remediate the control deficiencies that gave rise to the material weakness. Specifically, these changes include enhancements of systems, accounting and review procedures and communications among our staff.
Change in our periodic SEC filings.
Internal Control over Financial Reporting
There have
not been
no significantany changes in our internal
controlscontrol over financial reporting during the
most recent fiscal quarter
ended June 30, 2006, that have materially affected, or are reasonably likely to materially affect, our internal
controlscontrol over financial reporting.
Disclosure controls and procedures are our controls and other procedures that
are designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms. Disclosure controls and procedures include, without limitation, controls
and procedures designed to ensure that information required to be disclosed by
us in the reports that we file or submit under the Exchange Act is accumulated
and communicated to our management, including our Chief Executive Officer and
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure.
23
PART II. OTHER INFORMATION
Item
Item 1. Legal Proceedings
Cyberco Related Matters
We arehave been involved in three lawsuitsseveral matters described below, arising from four separate leasing schedules
withinstallment sales to a lesseecustomer named Cyberco Holdings, Inc. ("Cyberco"(“Cyberco”). Two of the lawsuits arising from this matter have been resolved. The Cyberco principals were allegedly perpetrating a scam.scam, which victimized several dozen leasing and lending institutions. Five Cyberco principals have pled guilty to criminal conspiracy and/or related charges including bank fraud, mail fraud and money laundering. Cyberco, related affiliates, and at least one principal are in Chapter 7 bankruptcy, and nobankruptcy. No future lease payments are expected. The first two lawsuits, bothexpected from Cyberco, and at this time, the bankruptcy estate is anticipated to have insignificant funds.
In a bankruptcy adversarial complaint filed on December 7, 2006 in the U.S.D.C.United States Bankruptcy Court for the Western District of Michigan, the bankruptcy trustee filed a claim against ePlus Group, inc. seeking payments of approximately $775,000 as alleged preferential transfers. We retained none of those payments, and instead forwarded them to the appropriate assignees of the underlying sales. Of the $775,000 in payments, approximately $200,000 was forwarded to Banc of America Leasing and Capital, LLC (“BoA”) and the remainder was forwarded to GMAC Commercial Finance, LLC (“GMAC”). Subsequent to its filing suit against us, the trustee added BoA and GMAC as defendants. We intend to vigorously defend these claims.
On January 4, 2005 we filed suit in the United States District Court for the Southern District of New York involve three of the schedules, which we had assigned on a
non-recourse basis to GMAC Commercial Finance, LLC ("GMAC"). On January 4, 2005,
GMAC filed suit against us seeking repayment of the underlying non-recourse
promissory note, which is approximately $10,646,000. The same day, we filed suit
against GMAC,our insurance carrier, Travelers Property Casualty Company of America ("Travelers") and
Banc of America Leasing and Capital, LLC ("BoA"(“Travelers”), seeking a declaratory judgment that any potential liability for claims made against us by GMAC or BoA, which are described below, is covered by our liabilityinsurance policy with Travelers,
and that we have no liability to GMAC or BoA. The two cases have been
administratively consolidated, and we subsequently dismissed BoA from the suit.Travelers. On February 9, 2006, the court granted summary judgment for Travelers, determining that our claim was not covered by our insurance policies. We are
preparing an appealA final judgment was entered on or about October 25, 2006, and we timely appealed to the United States Court of that decision.Appeals for the Second Circuit. The ultimate decision on insurance coverage will apply to the claims filed against us by both byunderlying lenders, GMAC and by BoA. OurWe believe that our position asserting insurance coverage is correct, but we cannot predict the outcome of our appeal.
On January 4, 2005, GMAC filed suit, against GMAC is proceeding, andwhich we expect that this springremoved to the court will set a
trial dateUnited States District Court for the remaining issues.Southern District of New York, against ePlus Group, inc. seeking repayment of three promissory notes underlying our non-recourse assignment of Cyberco’s loan payments. GMAC’s suit sought approximately $10,646,000, plus interest. The thirdsuit was settled on July 24, 2006 for $6,000,000 in cash, which we paid on July 25, 2006.
On May 10, 2005, BoA filed a lawsuit which stems from the remaining schedule between Cyberco and
us, is between BoA and usagainst ePlus Group, inc. in the Circuit Court for Fairfax County, Virginia. We
soldBoA funded one of the schedule toCyberco sales in exchange for assignment of the payment stream. After Cyberco went into bankruptcy, BoA under a Program Agreement. BoA seekssought to recover its loss of approximately $3,063,000.$3,062,792 plus interest. On September 14, 2006, a jury awarded BoA $3,025,000 plus interest. On or about February 6, 2007, a final judgment was entered, which also awarded BoA $871,232 in attorneys’ fees. We paid the total judgment, including interest and fees, of $4,258,237 in two payments, the last of which was made on June 15, 2007.
In addition, BoA filed a lawsuit against ePlus inc. on November 3, 2006 in the Circuit Court for Fairfax County, Virginia, seeking to enforce a guaranty in which ePlus inc. guaranteed ePlus Group, inc.’s obligations to BoA relating to the Cyberco transaction. ePlus Group has already paid to BoA the judgment in the Fairfax County lawsuit referenced above. The bulksuit seeks attorneys' fees BoA incurred in ePlus' appeal of discoveryBoA's suit against ePlus Group referenced above, expenses that may be incurred in a bankruptcy adversary proceeding relating to Cyberco, attorneys' fees incurred by BoA in defending a pending suit by ePlus Group against BoA, and any other costs or fees relating to any of the described matters. The trial is expectedscheduled to begin in
February 2006.November 20, 2007. We are rigorously asserting our defensevigorously defending the suit. We cannot predict the outcome of this suit.
On January 12, 2007, ePlus Group, inc. filed a complaint against BoA in this lawsuit andthe Superior Court of California, County of San Diego, seeking relief on matters not adjudicated in the Virginia state court action described above. While we believe that we have no liabilitya basis for our claims to BoA.
We also settled a fourth lawsuit (unrelatedrecover certain of our losses related to the Cyberco matter, above)we cannot predict whether we will be successful in our claim for damages, whether any award ultimately received will exceed the costs incurred to pursue this quarter. matter or how long it will take to bring this matter to resolution.
On or about NovemberJune 22, 2002, General Electric Capital Corporation
("GECC")2007, ePlus Group, inc. and two other entities victimized by Cyberco filed suit in the United States District Court for the Western District of Michigan against us in state court in New York, whichThe Huntington National Bank. The complaint alleges counts of aiding and abetting fraud, aiding and abetting conversion, and statutory conversion. While we removedbelieve that we have a basis for our claims to recover certain of our losses related to the U.S.D.C.Cyberco matter, we cannot predict whether we will be successful in our claim for damages, whether any award ultimately received will exceed the costs incurred to pursue this matter or how long it will take to bring this matter to resolution.
Other Matters
On January 18, 2007 a stockholder derivative action related to stock option practices was filed in the United States District Court for the Southern District of New York. GECC allegedColumbia. The complaint names ePlus inc. as nominal defendant, and personally names eight individual defendants who are directors and/or executive officers of ePlus. The complaint alleges violations of federal securities law and state law claims for breach of fiduciary duty, waste of corporate assets and unjust enrichment. The Amended Complaint seeks monetary damages from the individual defendants and that we were
liabletake certain corrective actions relating to it under a non-recourse loan between ouroption grants and GECC's respective
predecessors-in-interest. GECC's complaint demanded $2,632,830, plus interest,
late chargescorporate governance, and attorneys' fees. We are currently preparing a response to the plaintiff’s amended complaint.
On or about March 23, 2005,December 11, 2006, ePlus inc. and SAP America, Inc. and its German parent, SAP AG (collectively, “SAP”) entered into a Patent License and Settlement Agreement (the “Agreement”) to settle a patent lawsuit between the court denied
GECC's motion for summary judgment. On or about January 7, 2006,companies which we filed on April 20, 2005. Under the suit was
settled. The terms of the settlement provided that ePlus payAgreement, we will license to GECC $12,000,
and there was no concession of liability by either party.
Item 1A. Risk Factors
Certain statements contained in this Form 10-Q, other periodic reports filedSAP our existing patents, together with those developed and/or acquired by us under the Securities Exchange Act of 1934, as amended, and any other written
or oral statements made by us or on our behalf are "forward-looking statements"
within the meaningnext five years, in exchange for a one-time cash payment of Section 27A$17,500,000, which was paid by SAP on January 16, 2007. In addition, SAP has agreed not to pursue legal action against us for patent infringement as to any of our current lines of business on any of SAP’s patents for a period of five years. The Agreement also provides for general release, indemnification for its violation, and dismisses the existing litigation with prejudice.
We are currently engaged in a dispute with the government of the
Securities ActDistrict of
1933Columbia (“DC”) regarding personal property taxes on property we financed for our customers. DC is seeking approximately $508,000, plus interest and
21E ofpenalties, relating to property we financed for our customers. We believe the
Securities Exchange Act of 1934. Such statements are not based on historical
fact, but are based upon numerous assumptions about future conditions that may
not occur. Forward-looking statements are generally identifiable by the use of
forward-looking words such as "may," "will," "should," "intend," "estimate,"
"believe," "expect," "anticipate," "project," and similar expressions. Readers
are cautioned not to place undue reliance on any forward-looking statements made
by us or on our behalf. Any such statement speaks only as the date the statement
was made. Actual events, transactions and results may materially differ from the
anticipated events, transactions, or results described in such statements. Our
ability to consummate such transactions and achieve such events or resultstax is
subject to certain risks and uncertainties. Such risks and uncertainties
include, but are not limited to the matters set forth below.
Our traditional businesses of equipment leasing and financing and technology
sales have the following risks, among others, which are described in our 2005
Form 10-K:
- we may not be able to realize our entire investment in the equipment
we lease;
24
- we depend on creditworthy customers and may not have reserved
adequately for credit losses;
- capital spendingowed by our customers, may decrease;
- we doand are seeking resolution in DC’s Office of Administrative Hearings. We cannot predict the outcome of this matter. While management does not believe this matter will have long-term supplya material effect on our financial condition and results of operations, resolution of this dispute is ongoing.
There can be no assurance that these or guaranteed price agreement with our
vendors. In addition, we doany existing or future litigation arising in the ordinary course of business or otherwise will not have guaranteed purchase volume
commitments from our customers;
- direct marketing to end-users, rather than through reseller such as
ourselves, by manufacturers such as Hewlett Packard, IBM, and Lenovo
may affect future sales. Many competitors compete principally on the
basis of price and may have lower costs than us and, therefore,
current gross margins may not be maintainable;
- inventory and accounts receivable financing may not be available;
- our earnings may fluctuate;
- we are dependent upon our current management team;
- we are dependent upon the reliability of our information,
telecommunication and other systems, which are used for sales,
distribution, marketing, purchasing, inventory management, order
processing, customer service and general accounting functions.
Interruption of our information systems, Internet or
telecommunications systems could have a material adverse effect on our business, consolidated financial condition, cash flows orposition, results of operations;
- despite the non-recourse nature of the loans financing our activities,
non-recourse lendersoperations or cash flows.
There have
not been any material changes in the
past, and currently, brought suit
when the underlying transaction turns out poorlyrisk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the
lenders, such
as in the case of a suit recently resolved in our favor when the
lessee of equipment filed a bankruptcy petition and the bankruptcy
court ruled there was no true lease. We have vigorously defended such
cases in the past and will do so in the future and believe investors
should be aware that such suits are normal risks, and the cost of
defense are normal costs, of our leasing activities;
- we have the potential to acquire entities with either unknown
liabilities, fraud, cultural or business environment issues or that
may not have adequate internal controls as required by Section 404 of
the Sarbanes-Oxley Act of 2002 or that we may not fully understand
their business;
- our disclosure controls and procedures and our internal controls over
financial reporting may not be effective to detect all errors or to
detect and deter wrongdoing, fraud or improper activities in all
instances;
- treating stock options and employee stock purchase plan participation
as a compensation expense could significantly impair our ability to
maintain profitability; and
- our assessment as to the adequacy of our internal controls over
financial reporting as required by Section 404 of the Sarbanes-Oxley
Act of 2002 may cause our operating expenses to increase thus
affecting our business, financial condition, cash flows or results of
operations. In addition, if we are unable to certify the adequacy of
our internal controls and our independent auditors are unable to
attest thereto, investors could lose confidence in the reliability of
our financial statements, which could result in a decrease in the
value of our common stock.
Our eECM model, introduced in May 2002, has had a limited operating history.
Although we have been in the business of financing and selling information
technology equipment since 1990, we will encounter some of the challenges,
risks, difficulties and uncertainties frequently encountered by early-stage
companies using new and unproven business models in rapidly evolving markets.
Some of these challenges relate to our ability to:
25
- increase the total number of users of eECM services;
- adapt to meet changes in our markets and competitive developments; and
- continue to update our technology to enhance the features and
functionality of our suite of products.
We cannot be certain that our business strategy will be successful or that it
will successfully address these and other challenges, risks and uncertainties.
Over the longer term, we expect to derive more revenues from our asset
management, procurement and electronic catalog content software, which is
unproven. We expect to incur expenses that may negatively impact profitability.
We also expect to incur significant sales and marketing, research and
development, and general and administrative expenses in connection with the
development of this area of our business. As a result, we may incur significant
expenses, which may have a material adverse effect on our future operating
results as a whole.
Broad and timely acceptance of our asset management, procurement and electronic
catalog content software, which is important to our future success, is subject
to a number of significant risks. These risks include:
- the electronic commerce business-to-business solutions market is
highly competitive;
- the system's ability to support large numbers of buyers and suppliers
is unproven;
- significant enhancement of the features and services of our software
applications may be needed to achieve initial widespread commercial
and continued acceptance of the systems;
- the pricing model may not be acceptable to customers;
- if we are unable to develop and increase volume from our software
applications, it is unlikely that we will ever achieve or maintain
profitability in this business;
- businesses that have already made substantial up-front payments for
e-commerce solutions may be reluctant to replace their current
solution and adopt our solution;
- our ability to adapt to a new market that is characterized by rapidly
changing technology, evolving industry standards, new product
announcements and established competition; and
- we may be unable to protect our intellectual property rights or face
claims from third parties for infringement of their products or incur
significant costs to protect our patents which may effect our
earnings.
26
Itemfiscal year ended March 31, 2006.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information regarding our purchases of ePlus inc. common stock during the fiscal quarter ended June 30, 2006:
| Period | | Total number of shares purchased (1) | | | Average price paid per share | | | Total number of shares purchased as part of publicly announced plans or programs | | | Maximum number of shares that may yet be purchased under the plans or programs | |
| | | | | | | | | | | | | |
| April 1, 2006 through April 30, 2006 | | | 62,400 | | | $ | 14.32 | | | | 62,400 | | | | 688,704 | (2) |
| May 1, 2006 through May 31, 2006 | | | 122,900 | | | $ | 13.69 | | | | 122,900 | | | | 599,104 | (3) |
| June 1, 2006 through June 30, 2006 | | | 23,700 | | | $ | 13.64 | | | | 23,700 | | | | 603,904 | (4) |
Total number of| (1) | All shares purchased Maximum number
Total number as part of of shares that may
of shares Average publicly yet be purchased
purchased price per announced plans under the plans
Period (1) share or programs or programs
- -------------------------------------------------------------------------------------------------------------------------
April 1, 2005 through April 30, 2005 30,000 $ 11.20 30,000 621,212 acquired were in open-market purchases. |
(2)
May 1, 2005 through May 31, 2005 25,000 $ 11.97 25,000 557,577 (3)
June 1, 2005 through June 30, 2005 - $ 12.45 - 536,342 (4)
July 1, 2005 through July 31, 2005 49,300 $ 12.70 49,300 476,890 (5)
August 1, 2005 through August 31, 2005 20,000 $ 12.86 20,000 450,693 (6)
September 1, 2005 through September 30, 2005 46,000 $ 12.76 46,000 409,293 (7)
October 1, 2005 through October 31, 2005 230,685 $ 13.27 230,685 166,335 (8)
November 1, 2005 through November 17, 2005 19,051 $ 13.76 19,051 141,384 (9)
November 18, 2005 through Novembeer 30, 2006 2,800 $ 14.27 2,800 873,163 (10)
December 1, 2005 through December 31, 2005 24,220 $ 13.99 24,220 866,318 (11)
|
(1) All shares acquired were in open-market purchases.
(2) The share purchase authorization in place for the month ended April 30, 20052006 had purchase limitations on both the number of shares (3,000,000) as well as a total dollar cap ($12,500,000). As of April 30, 2005,2006, the remaining authorized dollar amount to purchase shares was $6,960,058$9,862,236 and, based on April's average price per share of $11.204,
621,212 represents$14.320, the maximum number of shares that may yet be purchased.
purchased is 688,704. |
| (3) | The share purchase authorization in place for the month ended May 31, 20052006 had purchase limitations on both the number of shares (3,000,000) as well as a total dollar cap ($12,500,000). As of May 31, 2005,2006, the remaining authorized dollar amount to purchase shares was $6,675,308$8,179,568 and, based on May's average price per share of $11.972,
557,577 represents$13.653, the maximum number of shares that may yet be purchased.
purchased is 599,104. |
| (4) | The share purchase authorization in place for the month ended June 30, 20052006 had purchase limitations on both the number of shares (3,000,000) as well as a total dollar cap ($12,500,000). As of June 30, 2005,2006, the remaining authorized dollar amount to purchase shares was $6,675,308$7,856,187 and, based on June's average price per share of $12.446,
536,342 represents$13.009, the maximum number of shares that may yet be purchased.
(5) The share purchase authorization in place for the month ended July 31, 2005 had purchase limitations on both the
number of shares (3,000,000) as well as a total dollar cap ($12,500,000). As of July 31, 2005, the remaining
authorized dollar amount to purchase shares was $6,056,503 and, based on July's average price per share of $12.700,
476,890 represents the maximum shares that may yet be purchased.
(6) The share purchase authorization in place for the month ended August 31, 2005 had purchase limitations on both the
number of shares (3,000,000) as well as a total dollar cap ($12,500,000). As of August 31, 2005, the remaining
authorized dollar amount to purchase shares was $5,796,808 and, based on August's average price per share of
$12.862, 450,693 represents the maximum shares that may yet be purchased.
(7) The share purchase authorization in place for the month ended September 30, 2005 had purchase limitations on both
the number of shares (3,000,000) as well as a total dollar cap ($12,500,000). As of September 30, 2005, the
remaining authorized dollar amount to purchase shares was $5,221,348 and, based on September's average price per
share of $12.757, 409,293 represents the maximum shares that may yet be purchased.
(8) The share purchase authorization in place for the month ended October 31, 2005 had purchase limitations on both the
number of shares (3,000,000) as well as a total dollar cap ($12,500,000). As of October 31, 2005, the remaining
authorized dollar amount to purchase shares was $2,207,597 and, based on October's average price per share of
$13.272, 166,335 represents the maximum shares that may yet be purchased.
(9) The share purchase authorization in place during the period of November 1-17, 2005 had purchase limitations on both
the number of shares (3,000,000) as well as a total dollar cap ($12,500,000). As of November 17, 2005, the remaining
authorized dollar amount to purchase shares was $1,945,422 and, based on this period's average price per share of
$13.761, 141,384 represents the maximum shares that may yet be purchased.
(10) The share purchase authorization in place beginning November 18, 2005 had purchase limitations on both the number of
shares (3,000,000) as well as a total dollar cap ($12,500,000). For the period of November 18-30, 2005, the
remaining authorized dollar amount to purchase shares was $12,460,034 and, based on this period's average price per
share of $14.274, 873,163 represents the maximum shares that may yet be purchased.
(11) The share purchase authorization in place for the month ended December 31, 2005 had purchase limitations on both the
number of shares (3,000,000) as well as a total dollar cap ($12,500,000). As of December 31, 2005, the remaining
authorized dollar amount to purchase shares was $12,119,788 and, based on December's average price per share of
$13.990, 866,318 represents the maximum shares that may yetpurchased is 603,904. |
On November 17, 2004, a stock purchase program was authorized by our Board. This program authorized the repurchase of up to 3,000,000 shares of our outstanding common stock over a period of time ending no later than November 17, 2005 and was limited to a cumulative purchase amount of $7.5 million. On March 2, 2005, our Board approved an increase, from $7.5 million to $12.5 million, for the maximum total cost of shares that could be purchased.
ItemOn November 18, 2005 our Board authorized a new stock repurchase program for the repurchase of up to 3,000,000 shares of our outstanding common stock, over a twelve-month period ending November 17, 2006, with a cumulative purchase limit of $12.5 million.
During the three months ended June 30, 2006, we repurchased 209,000 shares of our outstanding common stock for $2.9 million, whereas during the three months ended June 30, 2005, we repurchased 55,000 shares for $0.6 million. Since the inception of our initial repurchase program on September 20, 2001, and as of June 30, 2006, we had repurchased 2,978,990 shares of our outstanding common stock at an average cost of $11.04 per share for a total of $32.9 million.
Item 3. Defaults Upon Senior Securities
Not Applicable
Item
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item
Item 5. Other Information
Item 6. EXHIBITS
Exhibits Exhibit No. | | Exhibit Description
- ----------- -------------------
3.1 Certificate of Incorporation of the Company, filed August 27, 1996 (Incorporated herein by reference to Exhibit
3.1 to the Company's Quarterly Report on Form 10-Q for the period ended December 31, 2002).
3.2 Certificate of Amendment of Certificate of Incorporation of the Company, filed December 31, 1997 (Incorporated
herein by reference to Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the period ended December
31, 2002).
3.3 Certificate of Amendment of Certificate of Incorporation of the Company, filed October 19, 1999 (Incorporated
herein by reference to Exhibit 3.3 to the Company's Quarterly Report on Form 10-Q for the period ended December
31, 2002).
3.4 Certificate of Amendment of Certificate of Incorporation of the Company, filed May 23, 2002 (Incorporated
herein by reference to Exhibit 3.4 to the Company's Quarterly Report on Form 10-Q for the period ended December
31, 2002).
3.5 Certificate of Amendment of Certificate of Incorporation of the Company, filed October 1, 2003 (Incorporated
herein by reference to Exhibit 3.5 to the Company's Quarterly Report on Form 10-Q for the period ended
September 30, 2003).
3.6 Bylaws of the Company, as amended to date (Incorporated herein by reference to Exhibit 3.5 to the Company's
Quarterly Report on Form 10-Q for the period ended December 31, 2002).
10.8 Amendment and Restated 1998 Long-Term Incentive Plan (Incorporated herein by reference to Exhibit 10.8 to
the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2003).
|
| 31.1 | | Certification of the Chief Executive Officer of ePlusePlus inc. pursuant to the Securities Exchange Act Rules 13a-14(a) and 15d-14(a). |
| 31.2 | | Certification of the Chief Financial Officer of ePlusePlus inc. pursuant to the Securities Exchange Act Rules 13a-14(a) and 15d-14(a).
32.1 Statement |
| 32 | | Certification of the Chief Executive Officer and Chief Financial Officer of ePlusePlus inc. pursuant to 18 U.S.C. ss.§ 1350.
32.2 Statement of the Chief Financial Officer of ePlus inc. pursuant to 18 U.S.C. ss. 1350.
|
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
ePlus inc.
Date: February 14, 2006 /s/ PHILLIP G. NORTON
---------------------------------------------
By: Phillip G. Norton, Chairman of the Board,
President and Chief Executive Officer
Date: February 14, 2006 /s/ STEVEN J. MENCARINI
---------------------------------------------
By: Steven J. Mencarini
Chief Financial Officer
29
| ePlus inc. |
| |
| |
Date: September 20, 2007 | /s/ PHILLIP G. NORTON | |
| By: Phillip G. Norton, Chairman of the Board, |
| President and Chief Executive Officer |
| |
| |
| |
Date: September 20, 2007 | /s/ STEVEN J. MENCARINI | |
| By: Steven J. Mencarini, Chief Financial Officer |