FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended April 5, 2006
OR
(_) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission file number 0-20022
POMEROY IT SOLUTIONS, INC.
--------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 31-1227808
- -------- ----------
(State or other jurisdiction of incorporation (IRS Employer
or organization) Identification No.)
1020 Petersburg Road, Hebron, KY 41048
--------------------------------------
(Address of principal executive offices)
(859) 586-0600
--------------
(Registrant's telephone number, including area code)
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
requirements for the past 90 days.
YES X NO
--- ---
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer Accelerated filer X Non-accelerated filer
--- --- ---
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
The number of shares of common stock outstanding as of May 5, 2006 was
12,620,469.
POMEROY IT SOLUTIONS, INC.
TABLE OF CONTENTS
Part I. Financial Information
Item 1. Financial Statements: Page
----
Consolidated Balance Sheets as of April 5,
2006 (Unaudited) and January 5, 2006 1
Consolidated Statements of Operations for
the Three Months Ended April 5, 2006 and
2005 (Unaudited) 3
Consolidated Statements of Comprehensive
Income for the Three Months Ended April 5,
2006 and 2005 (Unaudited) 4
Consolidated Statements of Cash Flows for
the Three Months Ended April 5, 2006 and
2005 (Unaudited) 5
Notes to Consolidated Financial Statements
(Unaudited) 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 14
Item 3. Quantitative and Qualitative Disclosures
about Market Risk 19
Item 4. Controls and Procedures 19
Part II. Other Information
Item 1. Legal Proceedings 21
Item 1A. Risk Factors 21
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security
Holders 21
Item 5. Other Information 21
Item 6. Exhibits 21
SIGNATURES 22
POMEROY IT SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands) April 5, January 5,
2006 2006
------------ -----------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ - $ 447
Certificates of deposit 4,712 4,668
Accounts receivable:
Trade, less allowance of $4,355 at April 5, 2006
and January 5, 2006 125,826 130,814
Vendor receivables, less allowance of $100 at
April 5, 2006 and January 5, 2006 5,504 4,952
Net investment in leases 2,515 1,998
Other 1,442 2,894
------------ -----------
Total receivables 135,287 140,658
------------ -----------
Inventories 9,977 13,665
Other 12,665 11,730
------------ -----------
Total current assets 162,641 171,168
------------ -----------
Equipment and leasehold improvements:
Furniture, fixtures and equipment 33,390 32,655
Leasehold improvements 6,907 6,796
------------ -----------
Total 40,297 39,451
Less accumulated depreciation 25,777 24,656
------------ -----------
Net equipment and leasehold improvements 14,520 14,795
------------ -----------
Net investment in leases, net of current portion 899 995
Goodwill 101,298 101,048
Intangible assets, net 3,136 3,007
Other assets 3,890 4,132
------------ -----------
Total assets $ 286,384 $ 295,145
============ ===========
<FN>
See notes to consolidated financial statements.
1
POMEROY IT SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data) April 5, January 5,
2006 2006
(Unaudited)
------------ ------------
LIABILITIES AND EQUITY
Current Liabilities:
Short-term borrowings $ 8,984 $ 15,304
Accounts payable 46,878 46,638
Deferred revenue 3,160 3,444
Employee compensation and benefits 10,206 8,039
Accrued restructuring and severance charges 5,237 5,791
Other current liabilities 8,031 11,443
------------ ------------
Total current liabilities 82,496 90,659
------------ ------------
Commitments and contingencies
Equity:
Preferred stock, $.01 par value; authorized 2,000 shares
(no shares issued or outstanding) - -
Common stock, $.01 par value; authorized 20,000 shares
(13,430 and 13,400 shares issued at April 5, 2006
and January 5, 2006, respectively) 137 135
Paid-in capital 88,747 89,126
Unearned compensation - (1,198)
Accumulated other comprehensive income 24 24
Retained earnings 124,102 125,521
------------ ------------
213,010 213,608
Less treasury stock, at cost ( 810 shares at
April 5, 2006 and January 5, 2006) 9,122 9,122
------------ ------------
Total equity 203,888 204,486
------------ ------------
Total liabilities and equity $ 286,384 $ 295,145
============ ============
<FN>
See notes to consolidated financial statements.
2
POMEROY IT SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data) Three Months Ended
--------------------------
April 5, April 5,
2006 2005
------------ ------------
(Unaudited) (Unaudited)
Product and service revenues:
Product $ 88,877 $ 111,243
Service 61,815 54,589
------------ ------------
Total revenues 150,692 165,832
------------ ------------
Cost of product and service revenues:
Product 81,985 102,424
Service 47,669 40,592
------------ ------------
Total cost of revenues 129,654 143,016
------------ ------------
Gross profit 21,038 22,816
------------ ------------
Operating expenses:
Selling, general and administrative 20,561 19,108
Rent expense 921 936
Depreciation 1,178 1,201
Amortization 156 268
Restructuring and severance charges 133 132
Other 6 1
------------ ------------
Total operating expenses 22,955 21,646
------------ ------------
Income (loss) from operations (1,917) 1,170
Interest expense, net 309 221
------------ ------------
Income (loss) before income tax (2,226) 949
Income tax expense (benefit) (807) 384
------------ ------------
Net income (loss) $ (1,419) $ 565
============ ============
Weighted average shares outstanding:
Basic 12,615 12,469
============ ============
Diluted (1) 12,615 12,717
============ ============
Earnings (loss) per common share:
Basic $ (0.11) $ 0.05
============ ============
Diluted (1) $ (0.11) $ 0.04
============ ============
<FN>
(1) Dilutive loss per common share for the three months ended April 5, 2006
would have been anti-dilutive if the number of weighted average shares
outstanding were adjusted to reflect the dilutive effect of outstanding stock
options.
See notes to consolidated financial statements.
3
POMEROY IT SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands) Three Months Ended
--------------------------
April 5, April 5,
2006 2005
----------- -------------
(Unaudited) (Unaudited)
Net income (loss) $ (1,419) $ 565
Other comprehensive income:
Foreign currency translation adjustment, net of tax - 102
----------- -------------
Comprehensive income (loss) $ (1,419) $ 667
=========== =============
<FN>
See notes to consolidated financial statements.
4
POMEROY IT SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) Three Months Ended
------------ ----------
April 5, April 5,
2006 2005
------------ ----------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Net income (loss) $ (1,419) $ 565
Adjustments to reconcile net income (loss) to net cash
from operating activities:
Depreciation 1,178 1,201
Amortization 156 268
Stock option and restricted stock compensation 609 -
Restructuring and severance charges 133 132
Deferred income taxes 468 2,126
Loss on disposal of fixed assets 5 1
Changes in working capital accounts, net of
effects of acquisitions:
Accounts receivable 5,839 21,740
Inventories 3,465 350
Other current assets (1,205) 1,804
Net investment in leases (373) 226
Accounts payable 240 (15,718)
Deferred revenue (284) (460)
Income tax payable (43) (2,213)
Employee compensation and benefits 2,167 (3,103)
Other, net (4,014) (1,986)
------------ ----------
Net operating activities 6,922 4,933
------------ ----------
Cash flows from investing activities:
Capital expenditures (682) (325)
Proceeds from sale of fixed assets - 6
Purchases of certificates of deposit (44) (15)
Payment for covenant not-to-compete (285) -
Acquisition of businesses (250) (547)
------------ ----------
Net investing activities (1,261) (881)
------------ ----------
Cash flows from financing activities:
Proceeds from (repayments of) short-term borrowings (6,320) (18,569)
Payments of acquisition notes payable - (662)
Proceeds from exercise of stock options
and related tax benefit 49 1,999
Proceeds from employee stock purchase plan 163 -
------------ ----------
Net financing activities (6,108) (17,232)
------------ ----------
Effect of exchange rate changes on cash and cash equivalents - 102
------------ ----------
Change in cash and cash equivalents (447) (13,078)
Cash and cash equivalents:
Beginning of period 447 13,108
------------ ----------
End of period $ - $ 30
============ ==========
<FN>
See notes to consolidated financial statements.
5
POMEROY IT SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("US GAAP") for interim financial information and with the instructions to
Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by US GAAP for
complete financial statements. Except as disclosed herein, there has been
no material change in the information disclosed in the notes to
consolidated financial statements included in the Company's Annual Report
on Form 10-K for the year ended January 5, 2006. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
necessary for a fair presentation of the interim periods have been made.
The results of operations for the three-month period ended April 5, 2006
are not necessarily indicative of the results that may be expected for
future interim periods or for the year ending January 5, 2007.
2. Recent Accounting Pronouncements
There are currently no accounting standards which will be adopted by the
Company in a future period and for which the potential effect on the
Company's financial position and results of operations is expected to be
material.
3. Cash and Short-Term Borrowings
The Company has a $165.0 million Syndicated Credit Facility Agreement with
GE Commercial Distribution Finance. The credit facility has a three-year
term and its components include a maximum of $75.0 million for inventory
financing and a revolver, collateralized primarily by accounts receivable,
of up to $110.0 million. The credit facility also provides a letter of
credit facility of $5.0 million. Interest on outstanding borrowings under
the credit facility is payable monthly based on the LIBOR rate and a
pricing grid. This credit facility expires June 28, 2007.
The Company maintains a sweep account with its bank whereby daily cash
receipts are automatically transferred as payment towards balances
outstanding under the Company's credit facility. As of April 5, 2006, the
Company had an outstanding balance under the Company's credit facility of
$9.0 million, including $1.4 million of overdrafts on the Company's books
in accounts at a participant bank on the credit facility. As of January 5,
2006, the Company had an outstanding balance under the Company's credit
facility of $15.3 million.
Under the terms of the credit facility, the Company is subject to various
financial covenants including maintenance of a minimum level of tangible
net worth, a minimum fixed charge coverage ratio, a maximum ratio of total
funded indebtedness to EBITDA, and a maximum net loss after tax. As of
April 5, 2006, Pomeroy was not in compliance with certain financial
covenants of its credit facility. The company is currently in the process
of obtaining a waiver of such noncompliance from its lenders.
4. Stock-Based Compensation
Prior to January 6, 2006, the Company accounted for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to
Employees". Accordingly, compensation cost for stock options was measured
as the excess, if any, of the quoted market price of the Company's common
stock at the date of grant over the amount an employee must pay to acquire
the stock. The Company previously adopted SFAS No. 123 for disclosure
purposes and for non-employee stock options.
The Company adopted Statement of Financial Accounting Standards No. 123(R)
(SFAS 123R) effective January 6, 2006. SFAS 123R requires the Company to
measure the cost of employee services received in exchange for an award of
equity instruments and recognize this cost over the period during which the
employee is required to provide the services. The Company has adopted SFAS
123R using the modified prospective method and, therefore, results for
periods prior to January 6, 2006 have not been restated.
6
The table below illustrates the effect of stock compensations expense on
the periods presented as if the Company had always applied the fair value
method:
Three months Ended
April 5,
(In thousands, except per share data) 2006 2005
----------- -----------
Income (loss) before stock compensation expense $ (1,064) $ 565
Stock compensation expense included in net income (loss) (355) -
----------- -----------
Net income (loss) $ (1,419) 565
===========
Pro forma stock compensation expense (1,092)
-----------
Pro forma net loss $ (527)
===========
Basic earnings (loss) per common share:
Income (loss) before stock compensation expense $ (0.08) $ 0.05
Stock compensation expense included in net income (loss) (0.03) -
----------- -----------
Net income (loss) $ (0.11) 0.05
===========
Pro forma stock compensation expense (0.09)
-----------
Pro forma net loss $ (0.04)
===========
Diluted earnings (loss) per common share:
Income (loss) before stock compensation expense $ (0.08) $ 0.04
Stock compensation expense included in net income (loss) (0.03) -
----------- -----------
Net income (loss) $ (0.11) 0.04
===========
Pro forma stock compensation expense (0.08)
-----------
Pro forma net loss $ (0.04)
===========
No stock-based compensation was capitalized into inventory or fixed assets. The
approximate unvested stock option expense as of April 5, 2006, which will be
recorded as expense in future periods, is $1,051. The weighted average time
over which this expense will be recorded is approximately 28.5 months. Expense
for the quarter ended April 5, 2006 and estimated expense for future periods is
net of the effect of estimated forfeitures of 18.5%.
The Company estimates the fair value of each option on the date of grant using
the Black-Scholes option pricing model. The Company has elected the simplified
method to calculate the expected life of stock awards as permitted under SFAS
123R. This method calculates an expected term based on the midpoint between the
vesting date and the end of the contractual term of the stock award. The
weighted-average assumptions listed below were used for grants made in the three
months ended April 5, 2006 and 2005:
Three months ended Three months ended
April 5, 2006 April 5, 2005
Expected volatility 52.63% 38.25%
Risk-free interest rate 4.72% 3.75%
Expected life (years) 2.42 3.95
Dividend yield 0.00% 0.00%
Information related to all stock options for the quarter ended April 5, 2006 is
shown in the table below:
7
Weighted-Average
Weighted-Average Remaining Contractual
Shares Exercise Price Term
Outstanding at
January 5, 2006 2,926,503 $ 13.31
Granted 233,000 $ 9.40
Forfeitures (442,673) $ 13.94
Exercised (6,667) $ 7.07
----------
Outstanding at April
5, 2006 2,710,163 $ 12.89 2.85 years
==========
Exercisable at April
5, 2006 2,321,256 $ 13.07 2.65 years
==========
Information related to unvested stock options for the quarter ended April 5,
2006 is shown in the table below:
Weighted-Average Weighted-Average
Grant-Date Remaining Contractual
Shares Fair Value Term
Outstanding
unvested stock
options at January 5,
2006 416,794 $ 4.63
Granted 233,000 $ 3.42
Vested (218,358) $ 3.70
Forfeitures (42,529) $ 4.73
----------
Outstanding
unvested stock
options at April 5,
2006 388,907 $ 4.43 4.02 years
==========
The Company did not issue any restricted shares in the quarter ended
April 5, 2006. Such shares are valued based on the quoted price of the
Company's stock on the date of grant and recorded as compensation expense
over the related vesting period, which is generally four years.
Compensation cost, net of an estimated forfeiture rate of 18.5%, related to
previously-issued restricted shares totaled $52 thousand during the three
months ended April 5, 2006. No similar expense was recorded during the
three months ended April 5, 2005. In connection with the adoption of SFAS
123R, unearned compensation aggregating $1,146 associated with
previously-issued restricted shares has been reclassified to paid-in
capital in the accompanying consolidated balance sheet as of April 5, 2006.
5. Earnings per Common Share
The following is a reconciliation of the number of shares used in the basic
EPS and diluted EPS computations:
(in thousands, except per share data)
8
Three Months Ended April 5,
------------------------------------------------
2006 2005
----------------------- -----------------------
Per Share Per Share
Shares Amount Shares Amount
---------- ----------- ---------- -----------
Basic EPS 12,615 $ (0.11) 12,469 $ 0.05
Effect of dilutive
stock options -* -* 248 (0.01)
--------- ----------- ---------- -----------
Diluted EPS 12,615 $ (0.11) 12,717 $ 0.04
========= =========== ========== ===========
* Not presented herein since effect on loss per common share is
anti-dilutive for the three months ended April 5, 2006.
6. Treasury Stock
On March 31, 2006, the Board of Directors of the Company authorized a
program to repurchase up to 500,000 shares, but no more than $5.0 million.
The Company intends to effect such repurchases, if any, in compliance with
Rule 10b-18 under the Securities Exchange Act of 1934. The acquired shares
will be held in treasury or cancelled. The Company anticipates financing
the repurchase program out of working capital. No such shares have been
repurchased as of April 5, 2006. This stock redemption program was approved
to remain in place and in full force/effect for a period of 18 months.
7. Goodwill and Long-Lived Assets
Intangible assets with definite lives are amortized over their estimated
useful lives. The following table provides a summary of the Company's
intangible assets with definite lives as of April 5, 2006 and January 5,
2006:
(in thousands)
Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Amount Amortization Amount Amount Amortization Amount
4/5/2006 4/5/2006 4/5/2006 1/5/2006 1/5/2006 1/5/2006
----------------------------------- --------- ------------- ---------
Amortized intangible assets:
Covenants not-to-compete $ 2,309 $ 1,875 $ 434 $ 2,024 $ 1,859 $ 165
Customer lists 2,877 1,154 1,723 2,877 1,061 1,816
Other intangibles 1,268 289 979 1,268 242 1,026
--------- ------------- --------- --------- ------------- ---------
Total amortized intangibles $ 6,454 $ 3,318 $ 3,136 $ 6,169 $ 3,162 $ 3,007
========= ============= ========= ========= ============= =========
Amortized intangible assets are being amortized over periods ranging from 1
to 15 years for covenants not-to-compete, 7 to 15 years for customer lists
and 7 years for other intangibles. For the quarter ended April 5, 2006,
amortization expense related to intangible assets was $156 thousand. For
the quarter ended April 5, 2005, amortization expense related to intangible
assets was $268 thousand.
Projected future amortization expense related to intangible assets with
definite lives is as follows:
9
(in thousands)
Fiscal Years:
2006 $ 518
2007 674
2008 651
2009 587
2010 408
2011+ 298
---------
Total $ 3,136
=========
The change of the net carrying amount of goodwill for the three months
ended April 5, 2006 is as follows:
(in thousands)
Net carrying amount as of 1/6/06 $ 101,048
Goodwill recorded during first quarter 250
---------
Net carrying amount as of 4/5/06 $ 101,298
=========
As part of its goodwill impairment testing, the Company reviews various
factors, such as the market price of the Company's common stock, discounted
cash flows from projected earnings and values for comparable companies to
determine whether impairment exists. The Company has worked with a
valuation firm to assess goodwill impairment and has determined there is
impairment. The second step of the goodwill impairment test is not yet
complete. The Company recognized a charge of $16.0 million as a reasonable
estimate of the impairment loss in its fiscal 2005 financial statements.
The actual impairment loss, once determined by the Company, may differ
significantly from this estimate. Any adjustment to this estimated
impairment loss based on the completion of the measurement of the
impairment loss will be recognized in the subsequent reporting period as a
change in estimate.
During the first quarter of fiscal 2006, the Company recorded $250 thousand
of goodwill which was associated with a payment related to an earn-out
agreement related to a prior acquisition.
8. Supplemental Cash Flow Disclosures
Supplemental disclosures with respect to cash flow information and non-cash
investing and financing activities are as follows:
(in thousands)
Three Months Ended April 5,
-------------------------------
2006 2005
------------- ----------------
Interest paid $ 373 $ 286
============= ================
Income taxes paid $ 89 $ 527
============= ================
Adjustment to purchase price
of acquired assets and goodwill $ - $ (558)
============= ================
Business combinations accounted for
as purchases:
Assets acquired $ - $ -
Liabilities (assumed)/paid 250 547
------------- ----------------
Net cash paid $ 250 $ 547
============= ================
9. Litigation
10
There are various legal actions arising in the normal course of business
that have been brought against the Company. Management believes these
matters will not have a material adverse effect on the Company's financial
position or results of operations.
10. Segment Information
Effective in the fourth quarter of 2005, the Company re-aligned its
business segments and operating segments into one business segment, which
includes both product and service offerings. The Company follows the
provisions of SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information." This statement establishes standards for the
reporting of information about operating segments in annual and interim
financial statements. Operating segments are defined as components of an
enterprise for which separate financial information is available that is
evaluated regularly by the chief operating decision maker(s) in deciding
how to allocate resources and in assessing performance. The Company's
operating segments have similar economic characteristics and therefore can
be aggregated into one reporting segment. Two or more operating segments
may be aggregated into a single operating segment if the segments are
similar in each of the following areas: (1) the nature of the products and
services (2) the nature of the production processes (3) the type of class
of customer for the products and service and (4) the nature of the
regulatory environment.
Prior to fiscal year 2005, the Company disclosed three reporting segments:
products, services and leasing. Monthly income statements were generated
and reviewed by management for both the products and service businesses for
decision making purposes. The segment reporting (product and services) are
no longer reviewed by management on a regular basis and required
significant manual work to develop the information solely for quarterly
external financial statement reporting purposes.
During the fourth quarter of 2005, the Company realigned its management and
reporting responsibilities into functional lines: Sales, Service
Operations, Finance and Administrative. The Company also aligned sales and
service delivery into five domestic geographic regions and finance and
administration is centralized. Each of the geographic regions sell both
products and services and each geographic region has similar economic
characteristics. As a result the Company now reports one reportable segment
and the information in this report has been revised to reflect the
Company's current segment reporting.
11. Reclassifications
Certain reclassifications of prior period amounts have been made to conform
to the current period presentation.
12. Restructuring and Severance Charges
During the first quarter of fiscal 2006 and during fiscal 2005, the Company
recorded severance charges totaling $0.1 million and $0.9 million (of which
$0.1 million was recorded in the first quarter of fiscal 2005),
respectively, resulting primarily from a re-alignment of the structure of
the Company's organization.
During fiscal 2004, in connection with certain strategic initiatives, the
Company recorded restructuring and severance charges aggregating $1.0
million. The restructuring and severance charges were associated with
legacy Pomeroy costs of facilities and processes that have or will become
duplicative or redundant as Alternative Resources Corporation ("ARC")
operations are integrated into the Company. These costs consisted of
facility closing and involuntary employee reduction severance costs of $576
thousand and $400 thousand, respectively. These costs were accounted for
under FAS 146, "Accounting for Costs Associated with Exit or Disposal
Activities," and were included as a charge to the results of operations for
the year ended January 5, 2005. Any subsequent changes to the estimates of
executing the currently approved plans of restructuring will be reflected
in current results of operations.
The Company also recorded during fiscal 2004 a non-recurring, one-time
charge for severance in the amount of $1.447 million related to the
resignation of David B. Pomeroy II as CEO of the Company. Mr. Pomeroy will
continue to serve as Chairman of the Board of the Company.
11
As of April 5, 2006, the restructuring and severance charge accrual,
consisted of the following:
Severance Facility Total
(in thousands) consolidation
-------------------------------------
Accrual balance at January 5, 2006 $ 876 $ 125 $1,001
Charges accrued 133 - 133
Cash payments (322) (51) (373)
-------------------------------------
Accrual balance at April 5, 2006 $ 687 $ 74 $ 761
=====================================
Also, the Company's management recorded a restructuring charge liability in
connection with the ARC acquisition to eliminate certain duplicative
activities and reduced facility requirements. As a result, approximately
$6.4 million of costs were recorded as part of the liabilities assumed in
the ARC acquisition in October 2004. The restructuring charge consisted of
costs of vacating duplicative leased facilities of ARC and severance costs
associated with exiting activities. These costs are accounted for under
EITF 95-3, "Recognition of Liabilities in Connection with Purchase Business
Combinations." These costs were recognized as a liability assumed in the
purchase business combination and included in the allocation of the cost to
acquire ARC. Changes to the estimates primarily for acquired leases
included in the currently approved plans of restructuring through July 23,
2005 were recorded as an increase or decrease in goodwill, with any
increases in estimates thereafter charged to operations.
Facility
(in thousands) consolidation
---------------
Total intial liability $ 3,715
Adjustments of initial liability 2,165
Cash payments (1,159)
---------------
Liability balance at January 5, 2006 4,721
Cash payments (278)
---------------
Liability balance at April 5, 2006 $ 4,443
===============
Additionally, as part of the acquisition of ARC, the Company acquired the
remaining obligations of ARC's existing restructuring plan, which was
initially recorded by ARC in fiscal 2002. The total obligations assumed in
connection with this restructuring plan was $1.5 million at July 23, 2004.
As of April 5, 2006, the balance of the ARC fiscal 2002 accrued
restructuring costs recorded consisted of the following:
(in thousands)
Fiscal 2002 Restructuring Charge
Facility Other
consolidations charges Total
-------------------------------------
Total liability as of July 23, 2004 $ 756 $ 696 $ 1,452
Adjustment of initial liability 100 - 100
Cash payments (812) (671) (1,483)
Balance at January 5, 2006 44 25 69
Cash payments (33) (3) (36)
-------------------------------------
Balance at April 5, 2006 $ 11 $ 22 $ 33
=====================================
12
13. Subsequent Event
An amended 2002 Outside Directors' Stock Incentive Plan will be submitted
to the Company's shareholders for approval on June 20, 2006. The proposed
amendments include a provision to permit the issuance of restricted stock
to the Company's outside directors and a reduction in the number of shares
available for issuance under the plan.
13
ITEM 2-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Special Cautionary Notice Regarding Forward-Looking Statements
--------------------------------------------------------------
Certain of the matters discussed under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations" regarding financial
results constitute forward-looking statements. These statements related to
future events or our future financial performance and involve known and unknown
risks, uncertainties and other factors that may cause our markets' actual
results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by such forward looking statements. These
risks and other factors you should specifically consider include but are not
limited to: changes in customer demands or industry standards, adverse or
uncertain economic conditions, loss of key personnel, litigation, the nature and
volume of products and services anticipated to be delivered, the mix of the
products and services businesses, the type of services delivered, the ability to
successfully attract and retain customers, sell additional products and service
to existing customers, the ability to maintain a broad customer base to avoid
dependence on any single customer, the need to successfully attract and retain
outside consulting services, new acquisitions by the Company, terms of vendor
agreements and certification programs and the assumptions regarding the ability
to perform thereunder, the ability to implement the company's best practices
strategies, the ability to manage risks associated with customer projects,
existing market and competitive conditions including the overall demand for IT
products and services, and the ability to attract and retain technical and other
highly skilled personnel. In some cases, you can identify forward-looking
statements by such terminology such as "may", "should", "expects", "plans",
"anticipates", "believes", "estimates", "predicts", "potential", "continue",
"projects", "intends", "prospects", "priorities", or negative of such terms or
other comparable terminology. These statements are only predictions. Actual
events or results may differ materially.
14
RESULTS OF OPERATIONS
The following table sets forth for the periods presented information derived
from our consolidated statements of operations expressed as a percentage of
product and service revenues:
Three Three
Months Months
ended ended
------------------------
April 5, April 5,
2006 2005
------------------------
(Unaudited) (Unaudited)
Product and service revenues:
Product 59.0% 67.1%
Service 41.0% 32.9%
----------- -----------
Total revenues 100.0% 100.0%
----------- -----------
Cost of product and service revenues:
Product 54.4% 61.7%
Service 31.6% 24.5%
----------- -----------
Total cost of revenues 86.0% 86.2%
----------- -----------
Gross profit 14.0% 13.8%
----------- -----------
Operating expenses:
Selling, general and administrative 13.6% 11.5%
Rent expense 0.6% 0.6%
Depreciation 0.8% 0.7%
Amortization 0.1% 0.2%
Restructuring and severance charges 0.1% 0.1%
Other 0.0% 0.0%
----------- -----------
Total operating expenses 15.2% 13.1%
----------- -----------
Income (loss) from operations -1.2% 0.7%
Interest expense, net 0.2% 0.1%
----------- -----------
Income (loss) before income tax -1.4% 0.6%
Income tax expense (benefit) -0.5% 0.3%
----------- -----------
Net income (loss) -0.9% 0.3%
=========== ===========
15
POMEROY IT SOLUTIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TOTAL PRODUCT AND SERVICE REVENUES. Total product and service revenues decreased
$15.1 million, or 9.1%, to $150.7 million in the first quarter of fiscal 2006
from $165.8 million in the first quarter of fiscal 2005. Product sales decreased
$22.3 million, or 20.1%, to $88.9 million in the first quarter of fiscal 2006
from $111.2 million in the first quarter of fiscal 2005. The decrease in product
sales is primarily attributable to several large sales in the first quarter of
fiscal 2005 which were not repeated in first quarter of fiscal 2006 due to
delaying IT spending and one-time project deployments. Service revenues
increased $7.2 million, or 13.2%, to $61.8 million in the first quarter of
fiscal 2006 from $54.6 million in the first quarter of fiscal year 2005. This
increase in service revenues relates primarily to new service agreements entered
into during the latter part of 2005.
GROSS PROFIT. Gross profit decreased $1.8 million, or 7.9%, to $21.0 million in
the first quarter of fiscal 2006 from $22.8 million in the first quarter of
fiscal 2005. The decrease resulted primarily from the decrease in product sales.
Gross profit, as a percentage of total revenues, increased to 14.0% in the first
quarter of fiscal 2006 as compared to 13.8% in the first quarter of fiscal 2005.
This increase in gross margin percentage resulted primarily from a higher
proportion of service revenues to total revenues in the first quarter of fiscal
2006 as compared to the same period in fiscal 2005.
OPERATING EXPENSES. Operating expenses increased $1.3 million, or 6.0%, to $22.9
million in the first quarter of fiscal 2006 from $21.6 million in the first
quarter of fiscal 2005. Expressed as a percentage of total product and service
revenues, operating expenses increased to 15.2% in the first quarter of fiscal
2006 from 13.1% in the first quarter of fiscal 2005. The increase is primarily
attributable to increased fees from outside consultants associated with late
filings and restatements of fiscal 2005 quarterly financial statements ($0.5
million) and increased costs associated with employee health benefits ($0.4
million). Operating expenses were also increased as a result of in the first
quarter of fiscal 2006 for stock option and restricted stock compensation of
$0.6 million. No comparable expense was recognized in the first quarter of
fiscal 2005.
INCOME (LOSS) FROM OPERATIONS. Income (loss) from operations decreased $3.1
million to a loss of $(1.9) million in the first quarter of fiscal 2006 from
operating income of $1.2 million in the first quarter of fiscal 2005. The
Company's operating margin decreased to (1.2)% in the first quarter of fiscal
2006 as compared to 0.7% in the first quarter of fiscal 2005. This decrease is
a result of the decrease in revenues and the increase in operating expenses as
described above.
INTEREST EXPENSE. Net interest expense was $0.3 million during the first
quarter of fiscal 2006 as compared to $0.2 million during the first quarter of
fiscal 2005. This increase in net interest expense was a result of increased
borrowings under our credit facility and higher interest rates.
INCOME TAXES. The Company's effective income tax rate was a benefit of 36.3% in
the first quarter of fiscal 2006 compared to expense of 40.5% in the first
quarter of fiscal 2005. This decrease was principally related to permanent
taxable items which reduced the percentage of benefit recorded in the first
quarter of fiscal 2006.
NET INCOME (LOSS). Net income (loss) decreased $2.0 million to a net loss of
$1.4 million in the first quarter of fiscal 2006 from net income of $0.6 million
in the first quarter of fiscal 2005 due to the factors described above.
16
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $6.9 million in the first three months
of fiscal 2006. Cash used in investing activities was $1.3 million, which
included $0.2 million for prior year acquisitions and $0.7 million for capital
expenditures. Cash used in financing activities was $6.1 million, which included
$6.3 million for repayment of short-term borrowings, offset by $0.2 million of
proceeds from exercise of stock options and employee stock purchase plan.
The amount of cash derived from operating activities will vary based on a number
of business factors which may change from time to time, including terms of
available financing from vendors, downturns in the Company's business and/or
downturns in the businesses of the Company's customers. However, a growth or
decline in services revenue in conjunction with a change in the proportion of
services revenue to total revenue is an underlying driver of operating cash flow
during the period of growth because a majority of the Company's service revenue
is generated based upon the billings of the Company's technicians. The cash
outlay for these labor/payroll costs is incurred bi-weekly with each pay period.
The invoicing for the service is generated on various billing cycles as dictated
by the customers, and the respective cash inflow typically follows within 30 to
60 days of invoice date, which may be as long as 60 to 120 days from the time
the services are performed. This differs from product revenue in that the time
period between the time that the Company incurs the cost to purchase the
products and collects the revenue from its customer is typically shorter,
usually from 0 to 60 days, and the Company primarily orders inventory for a
particular customer rather than stocking large amounts of inventory. The
Company anticipates an increase in service revenue and in the proportion of
service revenue to total revenue which, if it occurs, may result in a
significant decrease in cash flows from operating activities during periods of
significant growth or periods of excess technical capacity. In addition,
certain services, primarily outsourcing contracts for the Company's Life Cycle
Services, require that the Company maintain a specific parts inventory for
servicing the customer; thus, an increase or decrease in the type of services
provided can impact inventory levels and operating cash flows.
Cash flows provided by operating activities in the three months ended April 5,
2006 were $6.9 million as compared to cash flows provided by operating
activities of $4.9 million for the corresponding period of fiscal 2005. The
increase in cash flows from operating activities in the first three months of
2006 compared to the first three months of 2005 resulted primarily from the
timing of payments on accounts payable, offset by timing of receipts on accounts
receivable as well as a decrease in inventories and deferred income taxes and an
increase in employee compensation and benefits liability. These increases in
cash were offset somewhat by a decrease in cash from changes in items classified
as other, net.
A significant part of Pomeroy's inventories are financed by floor plan
arrangements with third parties. At April 5, 2006, these lines of credit totaled
$76.0 million, including $75.0 million with GE Commercial Distribution Finance
("GECDF") and $1.0 million with IBM Credit Corporation ("ICC"). Borrowings under
the GECDF floor plan arrangements are made on thirty-day notes. Borrowings
under the ICC floor plan arrangements are made on fifteen-day notes. All such
borrowings are secured by the related inventory. Financing on substantially all
of the arrangements is interest free due to subsidies by manufacturers. Overall,
the average interest rate on these arrangements is less than 1.0%. The Company
classifies amounts outstanding under the floor plan arrangements as accounts
payable.
The Company has a $165.0 million Syndicated Credit Facility Agreement with
GECDF. The credit facility has a three-year term and its components include a
maximum of $75.0 million for inventory financing as described above and a
revolving line of credit, collateralized primarily by accounts receivable, of up
to $110.0 million; provided that the total amount outstanding at any time under
the inventory financing facility and the revolving line of credit may not exceed
$165.0 million. The credit facility also provides a letter of credit facility
of $5.0 million. The interest rate under the credit facility is based on the
London InterBank Offering Rate ("LIBOR") and a pricing grid. As of April 5,
2006, the adjusted LIBOR rate was 7.08%. This credit facility expires June 28,
2007.
As of April 5, 2006, the Company had an outstanding balance under the Company's
credit facility of $9.0 million, including $1.4 million of overdrafts on the
Company's books in accounts at a participant bank on the credit facility. As of
January 5, 2006, the Company had an outstanding balance under the Company's
credit facility of $15.3 million. The credit facility is collateralized by
substantially all of the assets of Pomeroy, except those assets that
collateralize certain other financing arrangements. Under the terms of the
credit facility, Pomeroy is subject to various financial covenants. As of April
5, 2006, the Company was not in compliance with certain of such financial
covenants. The company is currently in the process of obtaining a waiver of such
noncompliance from its lenders.
17
Pomeroy believes that the anticipated cash flow from operations and current
financing arrangements will be sufficient to satisfy Pomeroy's capital
requirements for the next twelve months. Historically, Pomeroy has financed
acquisitions using a combination of cash, deferred earn-out payments, shares of
its Common Stock and seller financing. Pomeroy anticipates that future
acquisitions will be financed in a similar manner.
On March 31, 2006, the Board of Directors of the Company authorized a program to
repurchase up to 500,000 shares, but no more than $5.0 million. The Company
intends to effect such repurchases, if any, in compliance with Rule 10b-18 under
the Securities Exchange Act of 1934. The acquired shares will be held in
treasury or cancelled. The Company anticipates financing the repurchase program
out of working capital. No such shares have been repurchased as of April 5,
2006. This stock redemption program was approved to remain in place and in full
force/effect for a period of 18 months.
18
ITEM 3-QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to interest rate risk primarily through its credit
facility with GECDF. Due to the Company's current debt position, the Company
did not experience a material impact from interest rate risk for the first
quarter of fiscal 2006.
Currently, the Company does not have any significant financial investments for
trading or other speculative purposes or to manage interest rate exposure.
ITEM 4-CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures (as defined in Rules
13(a)-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934, as amended
(the "Exchange Act")) designed to provide reasonable assurance that the
information required to be reported in its Exchange Act filings is recorded,
processed, summarized and reported within the time periods specified and
pursuant to the regulations of the Securities and Exchange Commission, including
controls and procedures designed to ensure that this information is accumulated
and communicated to the Company's management, including its Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. It should be noted that, because of inherent
limitations, the Company's disclosure controls and procedures, however well
designed and operated, can provide only reasonable, and not absolute, assurance
that the objectives of the disclosure controls and procedures are met.
As described in Item 9A of the Company's Annual Report on Form 10-K for the year
ended January 5, 2006, the Company reported that it identified four material
weaknesses in its internal control over financial reporting. As a result, the
Company's management, including its Chief Executive Officer and Chief Financial
Officer, concluded that as of January 5, 2006, the Company's disclosure controls
and procedures were not effective at a reasonable level of assurance, based on
the evaluation of these controls and procedures required by Exchange Act Rules
13(a)-15(e) or 15(d)-15(e).
As of April 5, 2006, the four material weaknesses have not been remediated.
Accordingly, the Company's Chief Executive Officer and Chief Financial Officer
concluded that, as of April 5, 2006, the Company's disclosure controls and
procedures were not effective in providing reasonable assurance that information
required to be disclosed by us in reports we file or submit under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in the SEC's forms and rules. Despite these material weaknesses, the
financial statements reported on Form 10-Q for the fiscal quarter ended April 5,
2006, fairly present, in all material respects, the consolidated financial
condition and results of operations of the Company.
MATERIAL WEAKNESSES REMEDIATION PLANS:
Management is committed to the remediation of the four material weaknesses as
well as the continued improvement of the Company's overall internal controls
over financial reporting. Management has been developing remediation plans for
each of the four identified material weaknesses. The Company currently is
executing a remediation plan for each of the material weaknesses set forth below
that includes the following:
Actions Relating to Maintaining Effective Control Over The Accrual of
---------------------------------------------------------------------------
Service Billing Calculations and Service Revenue Recognition.
------------------------------------------------------------------
- We are assessing our service revenue and expense recognition processes
and procedures. While we have taken certain actions to address this
material weakness, additional time and planning will be necessary
before the Company can finalize a remediation plan. The Company's goal
is to have the remediation completed during the fourth quarter of 2006
or earlier.
19
Actions Relating to Maintaining Effective Control Over Financial Close
---------------------------------------------------------------------------
and Reporting Process.
-------------------------
- During the fourth quarter of 2005, we began hiring additional
accounting personnel. We hired an individual with a CPA and SEC
reporting experience to manage our SEC reporting function. The Company
also hired additional Sarbanes-Oxley resources. The Company will
continue to expand the finance organization that will include the
creation of a Financial Planning and Analysis department during 2006.
We will continue to develop standard accounting policies and
procedures over non-routine general ledger accounts during 2006. We
have developed and implemented more structured and meaningful general
ledger account reconciliations that now reflect reconciling items that
will lead to more timely resolution and proper account
classifications. A detailed finance organization training plan on
financial controls, policies and procedures, account reconciliations,
GAAP and SEC disclosure checklists will be implemented during the
second quarter of 2006.
Actions Related to Maintaining Effective Control Over Computer Applications
---------------------------------------------------------------------------
Used in Financial Reporting.
-------------------------------
- The Company has expanded and will continue to improve our information
technology systems. The Company hired a CIO during the first quarter
of 2006. The Company has developed and implemented controls over
system changes and upgrades. In addition, the Company is addressing
the necessary changes that will address and resolve the issues
associated with computer applications that have improper system access
rights. Our remediation of these control weaknesses will be addressed
throughout the year and should be finalized during the fourth quarter
of 2006 or earlier.
Actions Related to Maintaining Effective Controls Over the Payroll Process.
---------------------------------------------------------------------------
- We have implemented new payroll policies and procedures for timely
notification of terminated employees. The Company will continue to
improve the internal controls over payroll during 2006 by implementing
additional procedures that will hold one-up managers accountable and
responsible for timely notifications of terminated employees.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
The Company's remediation plan for three of the four material weaknesses has not
been in place long enough to show meaningful results. It is expected, however,
that the remediation of these four material weaknesses will significantly
improve the Company's internal controls over financial reporting during the
latter part of 2006 and beyond.
20
PART II - OTHER INFORMATION
ITEM 1-LEGAL PROCEEDINGS
There are various legal actions arising in the normal course of business that
have been brought against the Company. Management believes these matters will
not have a material adverse effect on the Company's financial position or
results of operations.
ITEM 1A-RISK FACTORS
NONE
ITEM 2-UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On March 31, 2006, the Board of Directors of the Company authorized a program to
repurchase up to 500,000 shares, but no more than $5.0 million. The Company
intends to effect such repurchases, if any, in compliance with Rule 10b-18 under
the Securities Exchange Act of 1934. The acquired shares will be held in
treasury or cancelled. The Company anticipates financing the repurchase program
out of working capital. No such shares have been repurchased as of April 5,
2006. This stock redemption program was approved to remain in place and in full
force/effect for a period of 18 months.
During the fiscal quarter ended April 5, 2006, the Company did not pay any cash
dividends. Pomeroy has no plans to pay cash dividends in the foreseeable future,
and the payment of such dividends is restricted under Pomeroy's current credit
facility. Under such credit facility, cash dividends and stock redemptions are
limited to $5 million annually.
ITEM 3-DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4-SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5-OTHER INFORMATION
None
ITEM 6-EXHIBITS
(a) Exhibits
31.1 Section 302 CEO Certification
31.2 Section 302 CFO Certification
32.1 Section 906 CEO Certification
32.2 Section 906 CFO Certification
21
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
POMEROY IT SOLUTIONS, INC.
--------------------------
(Registrant)
Date: May 15, 2006 By: /s/ Kevin G. Gregory
---------------------
----------------------------------------
Kevin G. Gregory
Senior Vice President and Chief
Financial Officer
22