UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended January 5, 2007
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 (I.R.S. Employer
of incorporation or organization) Identification No.)
1020 Petersburg Road, Hebron, Kentucky 41048
- -------------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (859) 586-0600
--------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $.01
----------------------------
(Title of class)
Indicate by checkmark if the registrant is well-known seasoned issuer, as
defined in rule 405 of the Securities Act
YES NO X
----- -----
Indicate by checkmark if the registrant is not required to file reports pursuant
to section 13 or section 15(d) of the Act.
YES NO X
----- -----
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of the registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
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 aggregate market value of voting stock of the Registrant held by
non-affiliates was approximately $55.0 million as of July 5, 2006.
The number of shares of common stock outstanding as of February 28, 2007 was
12,355,703.
DOCUMENTS INCORPORATED BY REFERENCE
Part of Form 10-K Into Which Portions of Documents
Document Are Incorporated
- -------- ----------------
Definitive Proxy Statement for the 2007 Part III
Annual Meeting of Stockholders to be
filed with the Securities and Exchange
Commission on or before May 5, 2007.
POMEROY IT SOLUTIONS, INC.
FORM 10-K
YEAR ENDED JANUARY 5, 2007
TABLE OF CONTENTS
PART I Page
----
Item 1. Business 1
Item 1A. Risk Factors 7
Item 1B. Unresolved Staff Comments 11
Item 2. Properties 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters 11
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk 25
Item 8. Financial Statements and Supplementary Data 25
Item 9. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure 26
Item 9A. Controls and Procedures 26
Item 9B. Other Information 29
PART III
Item 10. Directors, Executive Officers and Corporate Governance 29
Item 11. Executive Compensation 29
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 29
Item 13. Certain Relationships and Related Transactions, and Director Independence 29
Item 14. Principal Accountant Fees and Services 29
PART IV
Item 15. Exhibits and Financial Statement Schedules 30
SIGNATURES Senior Vice President, Chief Financial Officer 36
Directors 36
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
--------------------------------------------------------------
Certain of the matters discussed under the captions "Business", "Properties",
"Legal Proceedings", "Market for Registrant's Common Equity, Related Stockholder
Matters" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" may constitute forward-looking statements for purposes of
the Securities Act of 1933 and the Securities Exchange Act of 1934, as amended,
and as such may involve known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of the Company
to be materially different from future results, performance or achievements
expressed or implied by such forward-looking statements. Important factors that
could cause the actual results, performance or achievements of the Company to
differ materially from the Company's expectations are disclosed in this document
and in documents incorporated herein by reference, including, without
limitation, those statements made in conjunction with the forward-looking
statements under "Business", "Properties", "Legal Proceedings", "Market for
Registrant's Common Equity, Related Stockholder Matters" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the factors discussed under "Risk Factors". All written or oral forward-looking
statements attributable to the Company are expressly qualified in their entirety
by such factors.
PART I
ITEM 1. BUSINESS
COMPANY OVERVIEW
Pomeroy IT Solutions, Inc. is a national information technology ("IT") solutions
provider with a comprehensive portfolio of consulting, infrastructure and
lifecycle services. Our mission is to provide customers with increased
efficiencies, decreased costs, and the ability to maximize their existing IT
investments. We are committed to our customers, our employees and our
shareholders and aim to consistently meet and exceed their expectations.
OUR SOLUTION-FOCUSED COMPANY
- ------------------------------
Pomeroy seeks to understand the strategic goals of customers' organizations as
well as the specific challenges faced by IT executives. Through this
collaborative approach, the Company's sales and technical teams can combine the
right people, partners, technologies and methodologies to deliver solutions that
meet those goals and challenges.
The Company takes advantage of its low-cost business model and scalability to
deliver the most economical, flexible solutions to its customers. Ultimately,
this allows our customers to reinvest savings into their organizations.
OUR GROWTH STRATEGY
- ---------------------
Pomeroy's growth strategy is to gain share in existing markets, expand
geographical coverage, and increase the breadth and depth of our service
offerings. Pomeroy will continue to focus on increasing higher margin services,
increasing the percentage of recurring revenue, controlling operating expenses
and maintaining a strong balance sheet.
Key elements of this strategy are to:
- be the low cost provider of the complete solutions which are
developed, integrated and managed for its customers,
- expand service offerings particularly in the higher end services
and networking areas,
- expand offerings and grow the customer base through strategic
acquisitions, and
- maintain and enhance technical expertise by hiring and training
highly qualified technicians and systems engineers.
Pomeroy's sales are generated primarily by its 130 person direct sales and sales
support personnel. Pomeroy's business strategy is to provide its customers
with a comprehensive portfolio of product and service offerings. The Company
believes that its ability to combine competitive pricing of computer hardware,
software and related products with comprehensive higher margin services allows
it to compete effectively against a variety of competitors, including
independent dealers, superstores, mail order and direct sales by manufacturers.
With many businesses seeking
1
assistance to optimize their information technology investments, Pomeroy is
using its resources to assist customers in their decision-making, project
implementation and management of IT capital.
OUR SERVICES
- -------------
Pomeroy delivers premier IT services to enterprise clients, small and mid-size
businesses, and government entities. Leveraging 25 years of strong technology
services background and industry leading partnerships, Pomeroy's core
competencies span IT Outsourcing and Out-tasking, Supply Chain Management,
Consulting and Systems Integration and Program and Resource Management.
IT OUTSOURCING AND OUT-TASKING services that help clients optimize the
various elements of distributed computing environments. Encompassing the
complete IT lifecycle, services include desktop and mobile computing,
server and network environments, and are multi-vendor in scope. The
capabilities in this portfolio are: Help Desk, IT hardware management and
support, software support, network support and mobile product support.
SUPPLY CHAIN MANAGEMENT services that are designed to help organizations
procure and distribute IT systems. These services wrap around Web-order
management, provisioning, configuration assurance, image management,
systems integration, warehousing logistics, and distribution. This
portfolio is comprised of: product acquisition, product distribution, asset
management, advanced integration, end-of-life services, software licensing
and logistics.
CONSULTING AND SYSTEMS INTEGRATION services help clients plan, design,
deploy, and manage high-performance, high-availability technology
infrastructures. The capabilities in this portfolio focus on: High
Performance/Blade server technologies, storage technologies, network and IP
technologies, information security, and Microsoft technologies.
PROGRAM AND RESOURCE MANAGEMENT services, support clients' project
resources, ensures compliance and success for a complete project, and
serves as a dynamic repository for program data, standards, methodologies,
lessons learned, and best practices.
Many solutions offered by Pomeroy span all four portfolios, providing innovative
technologies and the highest level of technical expertise that enable clients to
leverage existing IT investments, reduce risks associated with new technology
adoption, and minimize on-going operational costs. These solutions include:
HELP DESK SERVICES: Pomeroy manages Help Desk services from entry-level and
off-hour coverage packages to customized offerings based on specific client
service level agreements (SLA) and reporting requirements. Pomeroy offers
help desk and ITIL support consulting to assist clients in optimizing
internal support processes. Partnering with self-help and self-healing
e-support vendors, the company helps clients implement and manage
Web-enabled user-managed support.
HARDWARE MANAGEMENT AND SUPPORT SERVICES: Pomeroy can support part or all
of a client's IT asset management functions - from performing an initial
baseline inventory via the Web to selecting and implementing tracking and
database tools for both hardware assets and software licenses. Pomeroy's
vendor-neutral heritage and partnerships with virtually every leading
equipment supplier are at the heart of the company's Hardware Support
Services. These offerings include break/fix and install, move, add, and
change (IMAC) services; out-of-warranty hardware support and repair;
technology refresh and integration; equipment disposition strategy planning
and certified destruction of obsolete equipment.
Most computer products are sold pursuant to purchase orders. For larger
procurements, the Company may enter into written contracts with customers. These
contracts typically establish prices for certain equipment and services and
require short delivery dates for equipment and services ordered by the customer.
These contracts do not require the customer to purchase computer products or
services exclusively from Pomeroy and may be terminated without cause upon 30 to
90 days notice. Most contracts are for a term of 12 to 24 months and, in order
to be renewed, may require submission of a new bid in response to the customer's
request for proposal.
2
Pomeroy provides its services to its customers on a time-and-materials basis and
pursuant to written contracts or purchase orders. Either party can generally
terminate these service arrangements with limited or no advance notice.
Pomeroy also provides some of its services under fixed-price contracts rather
than contracts billed on a time-and-materials basis. Fixed-price contracts are
used when Pomeroy believes it can clearly define the scope of services to be
provided and the cost of providing those services.
Pomeroy has also established relationships with industry leaders including the
authorization to perform warranty and non-warranty repair work for several
vendors. From the extensive list of technology brands we offer to our clients,
Pomeroy has selected an exclusive group of best in breed manufacturers with
which to develop comprehensive alliance agreements. These alliances underscore
our commitment to providing our customers with the most sought-after technology
solutions. Pomeroy engages our alliance partners at the highest levels, in order
to meet our customers' needs in accordance with our standards of excellence.
The Pomeroy Alliance Program goals are:
- To build strong on-going business relationships with a select group of
vendors and manufacturers
- To maintain extensive sales of, and technical readiness on, alliance
product and solution sets
- To bring the advantages of strong industry relationships to bear on
individual customer projects for the benefit of the customer
The following are the manufacturers included within our Alliance Program.
American Power Conversion
Belkin Corporation
Brother International Corporation
Cisco Systems
Crucial Technology
Hitachi Data Systems
Hewlett Packard
IBM
Kingston Technology
Lefthand Networks
Lexmark International, Inc.
Logitech
MGE UPS
Microsoft Corporation
NEC Display
Nortel Networks
Okidata
Ricoh Corporation
Samsung
Sony
Startech.com
Sun Microsystems
Viewsonic
Xerox Corporation
Pomeroy believes that its relationships with such vendors enable it to offer a
wide range of products and solutions to meet the diverse requirements of its
customers. Additionally, Pomeroy's ability to bundle products with solutions
enables its customers to obtain the flexibility, expertise, and conveniences of
multiple vendors from a single source provider of IT solutions.
Pomeroy has select dealer agreements with its major vendors/manufacturers. These
agreements are typically subject to periodic renewal and termination on short
notice. Substantially all of Pomeroy's dealer agreements may be terminated by
either party without cause upon 30 to 90 days advance notice, or immediately
upon the occurrence of certain events. A vendor could also terminate an
authorized dealer agreement for reasons unrelated to Pomeroy's performance.
Although Pomeroy has never lost a major vendor/manufacturer, the loss of such a
vendor/product line or the deterioration of Pomeroy's relationship with such a
vendor/manufacturer could have a material adverse effect on Pomeroy.
3
Significant product supply shortages have resulted from time to time due to
manufacturers' inability to produce sufficient quantities of certain products to
meet client demand. As in the past, the Company could experience some
difficulty in obtaining an adequate supply of products from its major vendors.
Historically, this has resulted, and may continue to result, in delays in
completing sales. These delays have not had, and are not anticipated to have, a
material adverse effect on the Company's results of operations. However, the
failure to obtain adequate product supply could have a material adverse effect
on the Company's operations and financial results.
OUR MARKETS
- ------------
Pomeroy's target markets include Fortune 1000 companies ("Enterprise"), small to
medium sized business ("SMB"), governmental agencies and educational
institutions ("Public Sector") and vendor alliance customers. These customers
fall into government and education, financial services, health care and other
sectors. Pomeroy's clients are located throughout the United States, with
largest client population being based in the Midwest, Southeast, & Northeast.
Refer to Item 1A. Risk Factors for Dependence on Major Customers.
COMPETITION
The computer products and services market is highly competitive. Pomeroy
competes for product sales directly with local and national distributors and
resellers. In addition, Pomeroy competes with computer manufacturers that sell
product through their own direct sales forces to end users and to distributors.
Although Pomeroy believes its prices and delivery terms are competitive, certain
competitors offer more aggressive hardware pricing to their customers.
Pomeroy competes, directly and indirectly, for services revenues with a variety
of national and regional service providers, including services organizations of
established computer product manufacturers, value-added resellers, systems
integrators, internal corporate management information systems and consulting
firms. Pomeroy believes that the principal competitive factors for information
technology services include technical expertise, the availability of skilled
technical personnel, breadth of service offerings, reputation, financial
stability and price. To be competitive, Pomeroy must respond promptly and
effectively to the challenges of technological change, evolving standards and
its competitors' innovations by continuing to enhance its service offerings and
expand sales channels. Any pricing pressures, reduced margins or loss of market
share resulting from Pomeroy's failure to compete effectively could have a
material adverse effect on Pomeroy's operations and financial results.
Pomeroy believes it competes successfully by providing a comprehensive solution
portfolio for its customers' information technology asset management and
networking services needs. Pomeroy delivers cost-effective, flexible,
consistent, reliable and comprehensive solutions to meet customers' information
technology infrastructure service requirements. Pomeroy also believes that it
distinguishes itself on the basis of its technical expertise, competitive
pricing and its ability to understand its customers' needs.
Competition, in particular the pressure on pricing, has resulted in industry
consolidation. In the future, Pomeroy may face fewer but larger competitors as a
consequence of such consolidation. These competitors may have access to greater
financial resources than Pomeroy. In response to continuing competitive
pressures, including specific price pressure from the direct telemarketing,
internet and mail order distribution channels, the computer distribution channel
is currently undergoing segmentation into value-added resellers who emphasize
advanced systems together with service and support for business networks, as
compared to computer "superstores," who offer retail purchasers a relatively low
cost, low service alternative and direct-mail suppliers which offer low cost and
limited service. Certain direct response and internet-based fulfillment
organizations have expanded their marketing efforts to target segments of the
Company's customer base, which could have a material adverse impact on Pomeroy's
operations and financial results. While price is an important competitive factor
in Pomeroy's business, Pomeroy believes that its sales are principally dependent
upon its ability to provide comprehensive customer support services. Pomeroy's
principal competitive strengths include: (i) quality assurance; (ii) service and
technical expertise, reputation and experience; (iii) competitive pricing of
products through alternative distribution sources; (iv) prompt delivery of
products to customers; (v) various financing alternatives; and (vi) its ability
to provide prompt responsiveness to customers services needs and to build
performance guarantees into services contracts.
EMPLOYEES
As of January 5, 2007, Pomeroy had 2,212 full-time employees consisting of the
following:
- 1,710 technical personnel;
- 87 service delivery management personnel;
- 130 direct sales representatives and sales support personnel;
4
- 19 management personnel; and
- 266 administrative and distribution personnel.
Pomeroy offers its full-time employees the options to participate in health and
dental insurance, short and long term disability insurance, life insurance,
401(k) plan and an employee stock purchase plan. Also, Pomeroy is now offering a
non-benefit option for those resources who would like to opt for higher
compensation packages in lieu of benefits packages. This employee workforce
consists of 1,171 technical personnel. Pomeroy has no collective bargaining
agreements and believes its relations with its employees are good. Pomeroy is
committed to continuing to build its areas of expertise and offerings through
continual hiring and training of personnel, and strategic acquisitions of
companies that bring new skill sets and experience.
OUR TECHNICAL TEAM
Pomeroy technical resources are trained in the nine functional areas of project
management outlined in the standard known in the industry as the Project
Management Body of Knowledge, an open standard developed by the Project
Management Institute. Additionally, the company has adopted Six Sigma quality
principles and established a robust training program with Yellow Belt
certification requirements for all consultants, technicians, and engineers and
Green Belt requirement for management and leadership roles.
Pomeroy's technical personnel maintain some of the highest credentials.
Maintaining a knowledgeable and resourceful technical staff is an objective that
Pomeroy cultivates through career development programs that promote education
and skills training. These certifications include:
CISCO CCIE, CCNA, CCNP, CCDP, CCDA, CCSP, CCVP, INFOSEC Professional,
and Cisco Specialist certifications (CQS) in IP Communications, Advanced
Wireless LAN, and Advanced Security
NOVELL: CNE, MCNE, CNA, and Certified GroupWise Engineer
MICROSOFT: MCP, MCSA, MCSA Security Specialization, MCSE Messaging Specialization,
MCSE, MCSE+1, MCDST, MOS, MCDBA, CRM Professional and Office
Specialists and Experts
IBM: xSeries Certified System Engineer, eServer Certified Specialist, IBM Technical
Specialist RS 6000 SP, and IBM Advanced Technical Expert RS 6000, Tivoli
Storage Manager Technical Sales
HEWLETT PACKARD: HP Certified Professionals (NT, NetWare, Alpha/Unix, and StorageWorks), HP
Accredited Integration Specialist, HP Certified System Engineers (HP-
UX) and Master Accredited Systems Engineers - SAN Architect
Data Availability Solutions
NORTEL: Nortel Support & Design Specialists, Nortel Support & Design
Experts, Technical Specialist and Experts
COMPTIA: A+ Certified Technicians, Network+, IT Project+, Linux+,
Server+, i-Net+ and Security+
SUN: Storage Engineers, Solaris System and Network Administrator
(ISC)2 Certified Information Systems Security Professional (CISSP)
ORACLE: Oracle Certified Professional (OCP)
EMC: Implementation Engineer -Expert, Technology Architect-Expert,
NAS Associate and Legato EmailXtender and EmailXaminer Administrator
ALTIRIS: Certified Professional (ACP)
CITRIX: Certified Administrator (CCA)
F5 NETWORKS: Product Specialist
HELP DESK INSTITUTE: Support Specialists, Helpdesk Manager, Helpdesk Analyst and
Support Center Manager
LEFTHAND NETWORKS: LeftHand Certified System Engineer
PMI: Project Management Associates and Professionals (PMP)
SYMANTEC/VERITAS: Certified Specialists and Professionals
VMWARE: VMware Certified Professional
BICSI: Installer Level 1 and 2, Technician, and Registered Communications Distribution
Designer (RCDD(R)).
5
3COM: Certified IP Telephony NBX Expert,
PEREGRINE: Asset Center certified
ITIL: IT Service Management Certifications - Foundations, Practitioner and
Managers
WARRANTY CERTIFIED Apple, Brother, Dell, Epson, Gateway, HP, Lenovo, IBM, Kyocera,
TO SERVICE: Lexmark, Okidata, Sony, Toshiba, and Xerox
OUR ISO CERTIFICATION
Purchasing products and/or solutions from Pomeroy assures that highly skilled
professionals adhere to world-class quality standards which are leveraged to
manage the IT initiatives of its customers. Since 1997, Pomeroy's Distribution
Center has been registered to the International Organization of Standardization
("ISO") ISO 9001:2000 Quality Standard. The ISO Quality Standard has been
accepted by the U.S. and over eighty other countries around the world as the
basis for a world class Quality Management System ("QMS"). Pomeroy's QMS
specifies the policies, procedures and processes necessary to satisfy customer
requirements and ensures those processes are appropriately managed, controlled
and continually improved. As a result of Pomeroy's ISO 9001:2000 registration,
Pomeroy's customers can be assured that Pomeroy's QMS meets international
standards. Documented procedures and records that demonstrate its commitment to
the very highest quality standards back up the Company's ISO registration.
The information technology needs of its customers are serviced by Pomeroy's ISO
9001:2000 registered distribution and integration center located in Hebron,
Kentucky. This facility is approximately 161,000 square feet and distributes and
integrates products and technologies sold by the Company as well as products
supplied by its customers. Pomeroy also operates a service depot operation
within this centralized facility.
OUR FACILITIES
The Company believes that its distribution and integration center is adequately
designed to support its customers' business and technology needs for the
foreseeable future. Pomeroy's distribution and integration center utilizes
state-of-the-art warehouse management and enterprise resource planning ("ERP")
systems in order to manage the supply chain needs of our clients, which include
procurement, stage, stock, pick and management of the company's on-hand physical
and perpetual inventories. The radio-frequency based warehouse management system
controls and manages the flow of physical inventory from the earliest point of
demand generation, purchase order creation, to the final step in the supply
chain process, shipping to meet its customers' delivery and integration needs.
The warehouse management system controls re-order points and directs its
fulfillment needs to the product source which can deliver at the lowest possible
capital cost while maintaining the speed to market required by Pomeroy's
customers. The warehouse management system tracks the inventory in a real time
mode, updating Pomeroy's ERP system, which then in turn updates its customers'
specific technology driven supply chain management systems. The intelligence
inherent within the system is flexible, allowing customization to almost any
specific communication standard required by Pomeroy's diverse customer base.
Essentially, Pomeroy has the ability to link its ERP and warehouse management
systems to its customers' supply chain management ("SCM") systems. As a result,
the Company has been able to provide its customers with product shipping
information as well as the ability to efficiently process orders while
safeguarding its inventory.
BACKLOG
Other than future sales and revenues from existing long-term contracts, Pomeroy
does not have a significant backlog of business since it normally delivers and
installs products purchased by its customers within 10 days from the date of
order. Accordingly, backlog is not material to Pomeroy's business or indicative
of future sales. From time to time, Pomeroy experiences difficulty in obtaining
products from its major vendors as a result of general industry conditions.
These delays have not had, and are not anticipated to have, a material adverse
effect on Pomeroy's results of operations.
6
PATENTS AND TRADEMARKS
The Company owns no trademarks or patents. Although Pomeroy's various dealer
agreements do not generally allow the Company to use the trademarks and trade
names of these various manufacturers, the agreements do permit the Company to
refer to itself as an "authorized representative" or an "authorized service
provider" of the products of those manufacturers and to use their trademarks and
trade names for marketing purposes. Pomeroy considers the use of these
trademarks and trade names in its marketing efforts to be important to its
business.
ACQUISITIONS
Acquisitions have contributed significantly to Pomeroy's growth. The Company
believes that acquisitions are one method of increasing its presence in existing
markets, expanding into new geographic markets, adding experienced service
personnel, gaining new product offerings and services, obtaining more
competitive pricing as a result of increased purchasing volumes of particular
products and improving operating efficiencies through economies of scale. In
recent years, there has been consolidation among providers of computer products
and services and Pomeroy believes that this consolidation will continue, which,
in turn, may present additional opportunities for the Company to grow through
acquisitions. The Company continually seeks to identify and evaluate potential
acquisition candidates.
During fiscal 2006 and 2005, the Company did not make any acquisitions. During
fiscal 2004, the Company completed one acquisition. The total consideration paid
consisted of $46.1 million, which was funded from cash on hand and borrowings
from Pomeroy's existing line of credit.
The results of operations of the acquisition are included in the consolidated
statements of operations from the respective date of the acquisition. See Note
12 to the Consolidated Financial Statements for unaudited pro forma results of
operations of the Company for fiscal 2004 as if the acquisition had occurred on
January 6, 2004.
CHANGE IN SEGMENTS
During the fourth quarter of 2005, the Company realigned its management and
reporting responsibilities into functional lines: Sales, Service Operations,
Finance and Administrative. Management and the board of directors now review
operating results on a consolidated basis. As a result the Company now reports
one reportable segment and this information in this report has been revised to
reflect the Company's current segment reporting.
INFORMATION
We make available free of charge on our web site at www.pomeroy.com our Annual
---------------
Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K
and all amendments to those reports as soon as reasonably practicable after such
material is electronically filed with the Securities and Exchange Commission
(the "SEC"). We also make available on our web site other reports filed with the
SEC under the Securities Exchange Act of 1934, including our proxy statements
and reports filed by officers and directors under Section 16(a) of that Act. We
do not intend for information contained in our web site to be part of this Form
10-K or any other report that we file with the SEC.
ITEM 1A. RISK FACTORS
The following factors, among others, are likely to affect Pomeroy's operations
and financial results and should be considered in evaluating Pomeroy's outlook.
Pricing Pressures
- -----------------
Pomeroy believes its prices and delivery terms are competitive; however, certain
competitors may offer more aggressive pricing to their customers. The Company
has experienced and expects continued pricing pressure due to industry
consolidation and the efforts of manufacturers to sell directly to Pomeroy's
customers. In addition, the general weakness in the U.S. economy has impacted
Pomeroy's business. In an attempt to stimulate sales to existing and new
customers, the Company believes that pricing pressures may increase in the
future, which could require the Company to reduce prices, which may have an
adverse impact on its operating results. Decreasing prices of Pomeroy's
products and services offerings will require the Company to sell a greater
number of products and services to achieve the same level of net sales and
operating income.
7
Dependence on Major Customers
- -----------------------------
During fiscal 2006, approximately 38.5% of Pomeroy's total net product and
service revenues were derived from its top 10 customers. Only one customer, IBM
Corporation, accounted for more than 10% of Pomeroy's total net product and
service revenues with approximately $74.5 million in revenues for fiscal 2006.
The revenues generated from IBM Corporation are primarily resulting from
services provided. The loss of one or more significant customers could have a
material adverse impact on the Company's operating results.
Government Contracts
- --------------------
A portion of Pomeroy's revenue is derived from contracts with state and local
governments and government agencies. In the event of a dispute, the Company
would have limited recourse against the government or government agency.
Furthermore, future statutes and/or regulations may reduce the profitability of
such contracts. In addition, certain of the Company's government contracts have
no contractual limitation of liability for damages resulting from the provision
of services.
Dependence on Key Personnel
- ------------------------------
The success of Pomeroy is dependent on the services of Stephen E. Pomeroy,
President and Chief Executive Officer of the Company and other key personnel.
The loss of the services of Stephen E. Pomeroy, or other key personnel could
have a material adverse effect on Pomeroy's business. Pomeroy has entered into
employment agreements with certain of its key personnel, including Stephen E.
Pomeroy. Pomeroy's success and plans for future growth will also depend on its
ability to attract and retain highly skilled personnel in all areas of its
business.
Dependence on Technical Employees
- ------------------------------------
The future success of Pomeroy's services business depends in large part upon the
Company's ability to attract and retain highly skilled technical employees in
competitive labor markets. There can be no assurance that Pomeroy will be able
to attract and retain sufficient numbers of skilled technical employees. The
loss of a significant number of Pomeroy's existing technical personnel or
difficulty in hiring or retaining technical personnel in the future could have a
material adverse effect on the Company's operations and financial results.
Dependence on Vendor Relationships
- ----------------------------------
The Company's current and future success depends, in part, on its relationships
with leading hardware and software vendors and on its status as an authorized
service provider. Pomeroy is currently authorized to service the products of
many industry-leading hardware, software and internetworking product vendors.
Without these relationships, the Company would be unable to provide its current
range of services, principally warranty services.
The Company may not be able to maintain, or attract new relationships with the
computer hardware and software vendors that it believes are necessary for their
business. Since Pomeroy utilizes vendor relationships as a marketing tool, any
negative change in these relationships could adversely affect its financial
condition and results of operations while it seeks to establish alternative
relationships. In general, authorization agreements with vendors include
termination provisions, some of which are immediate. The Company cannot assure
that vendors will continue to authorize it as an approved service provider. In
addition, the Company cannot assure that vendors, which introduce new products,
will authorize it as an approved service provider for such new products.
Significant product supply shortages have resulted from time to time because
manufacturers have been unable to produce sufficient quantities of certain
products to meet demand. The Company expects to experience some difficulty in
obtaining an adequate supply of products from its major vendors, which may
result in delays in completing sales.
The loss of any vendor relationship, product line, or product shortage could
reduce the supply and increase costs of products sold by Pomeroy and adversely
impact the Company's competitive position.
Growth and Future Acquisitions
- ---------------------------------
In the past, Pomeroy has grown both internally and through acquisitions.
Pomeroy continues to focus on customer satisfaction as well as execution of its
market development and penetration strategies. Pomeroy's business strategy is
to grow both internally and through acquisitions. There can be no assurance
that, in the future, Pomeroy will be successful in repeating the growth
experienced in recent years related to service revenues. Pomeroy expects future
growth will result from acquisitions in addition to organic growth. In fiscal
2004, Pomeroy completed one acquisition and continues to evaluate expansion and
acquisition opportunities that would complement its ongoing operations. As part
of Pomeroy's growth strategy, it plans to continue to make investments in
complementary companies, assets and technologies, although there can be no
assurance that Pomeroy will be able to identify, acquire or profitably manage
additional companies or successfully integrate such additional companies into
Pomeroy without substantial costs, delays or other problems. In addition, there
can be no assurance that companies acquired in the future will be profitable at
the time of their acquisition or will achieve levels of profitability that
justify the investment therein.
8
Acquisitions may involve a number of special risks, including, but not limited
to, adverse short-term effects on Pomeroy's reported operating results,
disrupting ongoing business and distracting management and employees, incurring
debt to finance acquisitions or issuing equity securities which could be
dilutive to existing stockholders, dependence on retaining, hiring and training
key personnel, incurring unanticipated problems or legal liabilities and
amortization of acquired intangible assets. Some or all of these special risks,
if they occur could have a material adverse effect on Pomeroy's operations and
financial results.
Material Weaknesses in Internal Control over Financial Reporting
- ----------------------------------------------------------------
Pomeroy faces certain risks in connection with the material weaknesses it has
identified in its internal control over financial reporting (See Item 9A). The
material weaknesses identified for fiscal years 2004 and 2005 contributed to the
delay in Pomeroy's filing of the quarterly report on Form 10-Q for the third
quarter of fiscal 2005 and the restatements of the quarterly results for the
first and second quarters of fiscal 2005. Pomeroy has completed the
identification and implementation of modifications to controls and procedures
needed to remediate the material weaknesses. In the future, if the controls
assessment process required by Section 404 of the Sarbanes-Oxley Act reveals new
material weaknesses or significant deficiencies, the correction of such material
weaknesses or deficiencies could require remedial measures that could be costly
and time-consuming. In addition, the discovery of new material weaknesses could
also require the restatement of prior period operating results. If Pomeroy
continues to experience material weaknesses in its internal control over
financial reporting, Pomeroy could lose investor confidence in the accuracy and
completeness of its financial reports, which would have an adverse effect on its
stock price. If Pomeroy is unable to provide reliable and timely financial
reports, its business and prospects could suffer material adverse effects. For
example, under Pomeroy's current credit facility, financial statements must be
presented in a timely manner. Delay in these filings would result in a default.
An event of default could adversely affected Pomeroy's ability to obtain
financing on acceptable terms.
Business Technology Systems
- ----------------------------
Pomeroy relies upon the accuracy, availability and proper utilization of its
business technology systems to support key operational areas including financial
functions, product procurement and sales, and engagement and technician
management, staffing and recruiting. To manage its growth, Pomeroy is
continually evaluating the adequacy of its existing systems and procedures. Over
the last year, the company has focused its efforts on improving the reliability,
availability and serviceability of the technologies and applications used in
support of its services business and invested in tools to improve financial
reporting. The Company has also signed agreements with industry leading firms in
support of its business recovery and system availability capabilities. Pomeroy
anticipates that it will regularly need to make capital expenditures to upgrade
and modify its business technology systems, including software and hardware, as
Pomeroy grows and the needs of its business change. There can be no assurance
that Pomeroy will anticipate all of the demands which expanding operations may
place on its business technology systems. The occurrence of a significant system
failure or Pomeroy's failure to expand or successfully implement its systems
could have a material adverse effect on Pomeroy's operations and financial
results.
Vendor Receivables
- -------------------
Any change in the level of vendor rebates or manufacturer market development
funds offered by manufacturers that results in the reduction or elimination of
rebates or manufacturer market development funds currently received by Pomeroy
could have a material adverse effect on Pomeroy's operations and financial
results. In particular, a reduction or elimination of rebates related to
government and educational customers could adversely affect Pomeroy's ability to
serve those customers profitably. In addition, there are specific risks,
discussed below, related to the individual components of vendor receivables that
include vendor rebates, manufacturer market development funds and warranty
receivables. The determination of an appropriate allowance is based on the
deterioration in the aging of the vendor receivables, the expected resolution of
the disallowed claims (see primary reasons for vendor rebate claims being
disallowed in "Vendor Rebates" below) and the general posture of the OEMs
regarding resolution.
Vendor Rebates
---------------
The most significant component of vendor receivables is vendor rebates.
Vendor rebate programs are developed by OEMs allowing them to modify
product pricing on a case-by-case basis (generally determined by individual
customers) to maintain their competitive edge on specific transactions.
Pomeroy contacts the OEM to request a rebate for a specific transaction,
and if approved, the OEM provides Pomeroy with a document authorizing a
rebate to be paid to Pomeroy at a later date when a claim is filed. If the
business is won, Pomeroy records the sale and the cost of the sale is
reduced by the amount of the rebate, which is recorded as a vendor
receivable. Rebate programs involve a complex set of rules varying by
manufacturer. As a result of the rules and complexity of applying the rules
to each item sold, claims are often rejected and require multiple
submissions before credit is given resulting in longer aging of vendor
receivables than other types of receivables. In addition, sometimes a claim
is rejected altogether and no credit is
9
given. Primary reasons for claims being disallowed and corresponding
re-files include serial number issues (missing, incomplete, transposed,
data base match-up discrepancies, etc.), pricing issues (dispute in
calculation of rebate amounts) and other missing or incomplete
documentation (bid letters, customer information, etc.) Pomeroy has made
substantial process and system enhancements geared towards minimizing
refiling rebate claims, but there is no assurance that Pomeroy will be able
to successfully claim all of the vendor rebates that were passed along to
the customers in a form of a reduction in sales price. Pomeroy has written
off vendor receivables in the past and may do so in the future.
Manufacturer Market Development Funds
----------------------------------------
Several manufacturers offer market development funds, cooperative
advertising and other promotional programs to distribution channel
partners. Pomeroy utilizes these programs to fund some of its advertising
and promotional programs. While such programs have been available to the
Company in the past, there is no assurance that these programs will be
continued. Total advertising costs associated with these programs are
charged to expense as incurred and are deemed immaterial.
Warranty Receivables
---------------------
The Company performs warranty service work on behalf of the OEM on customer
product. Any labor cost or replacement parts needed to repair the product
is reimbursable to Pomeroy by the OEM. It is the Company's responsibility
to file for and collect these claims. The inability of the Company to
properly track and document these claims could result in the loss of
reimbursements.
Inventory Management
- ---------------------
Rapid product improvement and technological change resulting in relatively short
product life cycles and rapid product obsolescence characterize the information
technology industry. While most of the inventory stocked by Pomeroy is for
specific customer orders, inventory devaluation or obsolescence could have a
material adverse effect on Pomeroy's operations and financial results. Current
industry practice among manufacturers is to provide price protection intended to
reduce the risk of inventory devaluation, although such policies are subject to
change at any time and there can be no assurance that such price protection will
be available to Pomeroy in the future. In prior fiscal years, many manufacturers
reduced the number of days for which they provided price protection. During
fiscal 2006, most of the reductions stabilized, however, current terms and
conditions remain subject to change. In addition to the price protection
mentioned above, subject to certain limitations, Pomeroy currently has the
option of returning inventory to certain manufacturers and distributors. The
amount of inventory that can be returned to manufacturers without a restocking
fee varies under Pomeroy's agreements and such return policies may provide only
limited protection against excess inventory. There can be no assurance that new
product developments will not have a material adverse effect on the value of the
Company's inventory or that the Company will successfully manage its existing
and future inventory. In addition, Pomeroy stocks parts inventory for its
services business. Parts inventory is more likely to experience a decrease in
valuation as a result of technological change and obsolescence. Price
protection practices are not ordinarily offered by manufacturers with respect to
service parts.
Stock Price
- ------------
Pomeroy's stock price is affected by a number of factors, including quarterly
variations in revenue, gross profit and operating income, general economic and
market conditions, and estimates and projections by the investment community.
As a result, Pomeroy's common stock may fluctuate in market price.
10
ITEM 1B. UNRESOLVED STAFF COMMENTS
NONE
ITEM 2. PROPERTIES
Pomeroy's principal executive offices, distribution facility, national training
center, and national service operations center comprised of approximately
36,000, 161,000, 22,000, and 69,000 square feet of space, respectively, are
located in Hebron, Kentucky. These facilities are leased from Pomeroy
Investments, LLC ("Pomeroy Investments"), a Kentucky limited liability company
controlled by David B. Pomeroy, II, Chairman of the Board, under a ten-year
triple-net lease agreement, which expires in July 2015. The lease agreement
provides for 2 five-year renewal options. Pomeroy also has non-cancelable
operating leases for its regional offices, expiring at various dates between
2007 and 2012. Pomeroy believes there will be no difficulty in negotiating the
renewal of its real property leases as they expire or in finding other
satisfactory space. In the opinion of management, the properties are in good
condition and repair and are adequate for the particular operations for which
they are used. Pomeroy does not own any real property.
ITEM 3. LEGAL PROCEEDINGS
Various legal actions arising in the normal course of business have been brought
against Pomeroy. Management believes these matters will not have a material
adverse effect on Pomeroy's consolidated financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information and Holders
The following table sets forth, for the periods indicated, the high and low
sales price for the Common Stock for the fiscal quarters indicated as reported
on the NASDAQ National Market.
Fiscal 2006 Fiscal 2005
------------------ ------------------
High Low High Low
-------- -------- -------- --------
First Quarter $ 10.73 $ 8.20 $ 16.27 $ 14.37
Second Quarter $ 9.49 $ 7.04 $ 15.38 $ 9.57
Third Quarter $ 8.31 $ 7.02 $ 13.49 $ 10.41
Fourth Quarter $ 8.81 $ 7.18 $ 11.59 $ 7.29
As of February 28, 2007, there were approximately 260 holders of record of
Pomeroy's common stock.
Dividends
- ---------
During 2006 and 2005, 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 are restricted under Pomeroy's current credit facility. Under such
credit facility, cash dividends and stock redemptions are limited to $5 million
annually.
11
PERFORMANCE GRAPH
The following Performance Graph compares the percentage of the cumulative total
stockholder return on the Company's Common shares with the cumulative total
return assuming reinvestment of dividends of (i) the S&P 500 Stock Index and
(ii) the NASDAQ Composite Index.
[GRAPHIC OMITTED]
01/05/02 01/05/03 01/05/04 01/05/05 01/05/06 01/05/07
-------- -------- -------- -------- -------- --------
Pomeroy 100 86.50 105.60 104.70 60.90 57.50
- ----------- -------- -------- -------- -------- -------- --------
S&P 500 100 77.49 95.71 100.96 108.61 120.23
- ----------- -------- -------- -------- -------- -------- --------
NASDAQ COMP 100 67.40 99.40 101.60 110.60 117.50
- ----------- -------- -------- -------- -------- -------- --------
12
Unregistered Sales of Equity Securities and Use of Proceeds
- -----------------------------------------------------------
NONE.
PURCHASES OF EQUITY SECURITIES BY THE COMPANY
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, 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 repurchases program out of
working capital. This stock redemption program was approved to remain in place
and in full force/effect for a period of 18 months.
Issuer Purchases of Equity Securities
(c) Total number
of shares
(b) Average purchased as part (d) Maximum number
(a) Total number of price paid per of publicly of shares that may yet
Period shares purchased share announced plan be purchased under the plan
4/6/06 - 5/5/06 - $ - - 500,000
5/6/06 - 6/5/06 - $ - - 500,000
6/6/06 - 7/5/06 20,000 $ 7.17 20,000 480,000
7/6/06-8/5/06 11,980 $ 7.21 11,980 468,020
8/6/06-9/5/06 49,750 $ 7.78 49,750 418,270
9/6/06-10/5/06 90,908 $ 7.97 90,908 327,362
10/6/06-11/5/06 - $ - - 327,362
11/6/06-12/5/06 50,399 $ 7.42 50,399 276,963
12/6/06-1/5/07 97,378 $ 7.63 97,378 179,585
------------------- ----------------------------------------------
Total 320,415 320,415 179,585
=================== ==============================================
13
ITEM 6. SELECTED FINANCIAL DATA
(In thousands, except per share data)
For the Fiscal Years
--------- --------- --------- --------- ---------
2006 2005 2004(1) 2003(2) 2002(3)
--------- --------- --------- --------- ---------
Consolidated Statement of Operations Data:
Net product and service revenues $631,632 $714,749 $742,290 $598,423 $702,800
Cost of revenues 539,596 623,019 647,154 528,030 615,135
--------- --------- --------- --------- ---------
Gross profit 92,036 91,730 95,136 70,393 87,665
--------- --------- --------- --------- ---------
Operating expenses:
Selling, general and administrative (4,5,6,9) 80,973 86,010 72,346 50,279 59,653
Depreciation and amortization 4,894 5,568 4,393 5,319 5,720
Goodwill charge (7) 3,472 16,000 - - -
--------- --------- --------- --------- ---------
Total operating expenses 89,339 107,578 76,739 55,598 65,373
--------- --------- --------- --------- ---------
Income (loss) from operations 2,697 (15,848) 18,397 14,795 22,292
Interest income (582) (193) (310) (133) -
Interest expense 1,149 1,028 561 58 541
--------- --------- --------- --------- ---------
Interest expense (income), net 567 835 251 (75) 541
--------- --------- --------- --------- ---------
Income (loss) before income tax 2,130 (16,683) 18,146 14,870 21,751
Income tax expense (benefit) (8) 987 (6,021) 7,213 5,799 6,742
--------- --------- --------- --------- ---------
Net income (loss) $ 1,143 $(10,662) $ 10,933 $ 9,071 $ 15,009
========= ========= ========= ========= =========
Earnings (loss) per common share (basic) $ 0.09 $ (0.85) $ 0.89 $ 0.74 $ 1.18
Earnings (loss) per common share (diluted) $ 0.09 $ (0.85) $ 0.88 $ 0.73 $ 1.18
Consolidated Balance Sheet Data:
Working capital $ 90,538 $ 84,022 $ 80,959 $116,786 $123,334
Long-term debt, net of current maturities - - 250 913 -
Equity 205,211 204,486 212,722 199,797 203,674
Total assets 305,021 295,145 332,888 269,199 248,496
1) During fiscal 2004, the Company and Pomeroy Acquisition Sub, Inc., a wholly
owned subsidiary of the Company, completed a merger with Alternative
Resources Corporation ("ARC"). See Notes 5 and 12 of Notes to Consolidated
Financial Statements.
2) During fiscal 2003, Pomeroy acquired all the outstanding common stock of
Micrologic Business Systems of K.C., Inc. and acquired certain assets of
eServ Solutions Group, LLC.
3) During fiscal 2002, Pomeroy acquired certain assets of Verity Solutions,
LLC. During fiscal 2002, the Company sold substantially all of the assets
of TIFS.
4) During fiscal 2006, 2005, 2003 and 2002 Pomeroy increased its allowance
against trade and vendor receivables by $1.7 million, $2.0 million, $0.2
million and $0.9 million, respectively.
5) During fiscal 2003, Pomeroy's results include a charge of $150 related to a
litigation settlement. During fiscal 2002, Pomeroy's results include a
charge of $300 related to a litigation settlement.
14
6) During fiscal 2006, the Company recorded severance charges totaling $0.1
million. During fiscal 2005, the Company recorded severance charges
totaling $0.9 million resulting primarily from a re-alignment of the
structure of the Company's internal organization. Additionally, during
fiscal 2005, the Company recorded restructuring charges aggregating $1.4
million due to unrecoverable assets related to the Company's former
wholly-owned subsidiary, Technology Integration Financial Services
("TIFS"). Substantially all of the assets of TIFS were sold in fiscal 2002.
During fiscal 2004, Pomeroy's results include an after tax charge of $1.5
million ($0.12 per diluted share) related to the Company recording
restructuring and severance charges totaling $2.4 million. During fiscal
2002, Pomeroy's results include an after tax charge of $2.5 million ($0.20
per diluted share) related to the Company recording an increase in reserves
and a restructuring charge totaling $4.0 million.
7) During fiscal 2006 and 2005, Pomeroy recorded a charge for the write down
of goodwill totaling $3.5 million and $16 million, respectively.
8) During fiscal 2002, Pomeroy's results include an income tax benefit of $1.6
million ($0.13 per diluted share) due to a tax accounting change.
9) During fiscal 2006, Pomeroy's results include $1.6 million related to share
based compensation due to adoption of FAS 123R. This expense was $0 in the
prior years.
QUARTERLY RESULTS OF OPERATIONS - UNAUDITED (in thousands, except per share
data)
The following table sets forth certain unaudited operating results of each of
the eight prior quarters. This information is unaudited, but in the opinion of
management, includes all adjustments, consisting of normal recurring
adjustments, necessary for a fair presentation of the results of operations of
such periods.
Fiscal 2006
--------------------------------------------------------
First Second Third Fourth
Quarter (1) Quarter (3) Quarter (3,4) Quarter (3)
------------ ------------ -------------- ------------
Net product and service revenues $ 150,692 $ 164,118 $ 154,933 $ 161,889
Gross profit $ 21,038 $ 24,783 $ 22,660 $ 23,555
Net income (loss) $ (1,419) $ 2,031 $ (1,012) $ 1,543
Comprehensive income (loss) $ (1,419) $ 2,027 $ (1,013) $ 1,539
Earnings (loss) per common share:
Basic $ (0.11) $ 0.16 $ (0.08) $ 0.12
Diluted $ (0.11) $ 0.16 $ (0.08) $ 0.12
Fiscal 2005
--------------------------------------------------------
First Second Third Fourth
Quarter (1) Quarter Quarter (1,2,3) Quarter (1,4)
------------ -------- ---------------- --------------
Net product and service revenues $ 165,832 $192,025 $ 185,001 $ 171,891
Gross profit $ 22,816 $ 25,147 $ 22,516 $ 21,251
Net income (loss) $ 565 $ 2,365 $ (1,480) $ (12,112)
Comprehensive income (loss) $ 667 $ 2,365 $ (1,480) $ (12,112)
Earnings (loss) per common share:
Basic $ 0.05 $ 0.19 $ (0.12) $ (0.96)
Diluted $ 0.04 $ 0.19 $ (0.12) $ (0.96)
1. During fiscal 2006 and 2005, the Company recorded severance charges
totaling $0.1 million in first quarter fiscal 2006 and $0.9 million in
fiscal 2005 of which $0.1 million, $0.3 million and $0.5 million were in
the first, third and fourth quarters, respectively, resulting primarily
from a re-alignment of the structure of the Company's internal
organization.
15
2. During the third quarter of fiscal 2005, the Company recorded restructuring
charges aggregating $1.4 million due to unrecoverable assets related to the
Company's former wholly-owned subsidiary, Technology Integration Financial
Services ("TIFS"). Substantially all of the assets of TIFS were sold in
fiscal 2002.
3. During fiscal 2006, Pomeroy increased its allowance against trade and
vendor receivables totaling $1.7 million of which $0.2 million, $0.3
million and $1.2 million were in the second, third and fourth quarter,
respectively and $2.0 million in the third quarter of fiscal 2005.
4. During the third quarter of fiscal 2006 and the fourth quarter of fiscal
2005, Pomeroy recorded a goodwill impairment charge of $3.5 million and $16
million, respectively.
16
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the Company's results of operation and
financial position should be read in conjunction with its consolidated financial
statements included elsewhere in this report. In addition, the factors
described under "Risk Factors" should be considered in evaluating the Company's
outlook.
CRITICAL ACCOUNTING POLICIES
In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management makes estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reporting period. Management believes that it consistently applies judgments
and estimates and such consistent application results in financial statements
and accompanying notes that fairly represent all periods presented. However,
any errors in these judgments and estimates may have a material impact on the
Company's statement of operations and financial condition. Critical accounting
policies, as defined by the Securities and Exchange Commission, are those that
are most important to the portrayal of the Company's financial condition and
results of operations and require management's most difficult and subjective
judgments and estimates of matters that are inherently uncertain. The Company
considers its critical accounting policies to be (1) revenue recognition, (2)
vendor and trade receivable allowances, (3) valuation of long-lived assets, (4)
income taxes and (5) contingencies and accruals.
Revenue recognition
In December 2003, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 104, Revenue Recognition, which superseded SAB
101, Revenue Recognition in Financial Statements. SAB 104 updated certain
interpretive guidance included in SAB 101, including the SAB 101 guidance
related to multiple element revenue arrangements, to reflect the issuance by the
Emerging Issues Task Force ("EITF") of EITF 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables.
Generally, the Company, in accordance with SAB 104, recognizes revenue on the
sale of products when the products are shipped, persuasive evidence of an
arrangement exists, delivery has occurred, collection of the relevant receivable
is probable and the sales price is fixed or determinable.
Generally the Company, in accordance with the requirements of SAB 101,
determines if revenue should be reported based on (a) the gross amount billed to
a customer because it has earned revenue from the sale of the goods or services
or (b) the net amount retained (that is, the amount billed to the customer less
the amount paid to a supplier) because it has earned a commission or fee by
determining if the Company performs as an agent or broker without assuming the
risks and rewards of ownership of the goods, in that case sales would be
reported on a net basis.
When the Company provides a combination of products and services to customers,
the arrangement is evaluated under Emerging Issues Task Force Issue No. 00-21,
"Revenue Arrangements with Multiple Deliverables," or EITF 00-21, which
addresses certain aspects of accounting by a vendor for arrangements under which
the vendor will perform multiple revenue generating activities. The application
of the appropriate accounting guidance to our revenue requires judgment and is
dependent upon the specific transaction and whether the sale includes items such
as configuration, training, installation, service, or a combination of these
items. Service revenue is recognized when the applicable services are provided
or for service contracts, ratably over the lives of the contracts.
Vendor and trade receivable allowances
Pomeroy maintains allowances for doubtful accounts on both vendor and trade
receivables for estimated losses resulting from the inability of its customers
or vendors to make required payments. The determination of a proper allowance
for vendor receivables is based on an ongoing analysis as to the recoverability
of the Company's vendor receivable portfolio based primarily on account aging.
The determination of a proper allowance for trade receivables is based on an
ongoing analysis as to the credit quality and recoverability of the Company's
trade receivable portfolio. Factors considered are account aging, historical
bad debt experience, current economic trends and others. The analysis is
performed on both vendor and trade receivable portfolios. A separate allowance
account is maintained based on each analysis.
17
Valuation of long-lived assets
Long-lived assets, including property and equipment, goodwill and other
intangible assets are reviewed for impairment when events or changes in facts
and circumstances indicate that their carrying amount may not be recoverable.
Events or changes in facts and circumstances that Pomeroy considers as
impairment indicators include the following:
- Significant underperformance of the Company's operating results
relative to expected operating results;
- Net book value compared to fair value;
- Significant adverse economic and industry trends;
- Significant decrease in the market value of the asset;
- Significant changes to the asset since the Company acquired it; and
- The extent that the Company may use an asset or changes in the manner
that the Company may use it.
When the Company determines that one or more impairment indicators are present
during the Company's annual testing of its goodwill, excluding long-lived
assets, Pomeroy compares the carrying amount of the asset to the net future
undiscounted cash flows that the asset is expected to generate. If the carrying
amount of the asset is greater than the net future undiscounted cash flows that
the asset is expected to generate, Pomeroy would recognize an impairment loss to
the extent the carrying value of the asset exceeds its fair value. An impairment
loss, if any, would be reported in the Company's results of operations.
When the Company determines that one or more impairment indicators are present
for its goodwill, Pomeroy compares its reporting unit's carrying value to its
fair value. During fiscal 2005, the Company re-aligned the structure of its
internal organization such that management and the board of directors now review
operating results on a consolidated basis. As a result, the Company now has one
reporting unit for goodwill testing. In fiscal 2004 the Company had two
reporting units for goodwill testing which were a products reporting unit and a
services reporting unit. The Company has adopted January 5 as the valuation date
for the annual testing. Write down of goodwill, if any, would be reported in
the Company's results of operations. During the third quarter of fiscal 2006
and the fourth quarter of fiscal 2005, the Company recorded a write down of
goodwill of $3.5 million and $16 million, respectively as further discussed
herein.
Income taxes
Pomeroy is required to estimate income taxes in each of the jurisdictions in
which the Company operates. This process involves estimating the Company's
actual current tax exposure together with assessing temporary differences
resulting from differing treatment of items for tax and accounting purposes.
These differences result in deferred tax assets and liabilities, which are
included within the Company's consolidated balance sheet. The Company must then
assess the likelihood that the deferred tax assets will be recovered from future
taxable income and to the extent that the Company believes recovery is not
likely, the Company must establish a valuation allowance. To the extent the
Company establishes a valuation allowance in a period, the Company must include
an expense within the tax provision in the statement of operations. Pomeroy has
not recorded a valuation allowance to reduce the carrying amount of recorded
deferred tax assets representing future deductions, as the Company believes it
will have sufficient taxable income in the future to realize these deductions.
Pomeroy considers future taxable income and ongoing prudent and feasible tax
planning strategies in assessing the need for a valuation allowance. In the
event Pomeroy were to determine that it would not be able to realize its
deferred tax assets in the future, an adjustment to the deferred tax asset would
decrease income in the period such determination was made.
Contingencies and Accruals
We are subject to the possibility of various loss contingencies and accruals
arising in the ordinary course of business. We accrue an estimated loss
contingency when it is probable that a liability has been incurred and the
amount of loss can be reasonably estimated. We regularly evaluate current
information available to us to determine whether such accruals should be
adjusted and whether new accruals are required.
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 net
product and service revenues:
18
Net Product and Service Revenues
Financial Results For the Fiscal Years
- -------------------------------------- -------------------------------------------------------------------------
% of % of % of
2006 Revenues 2005 Revenues 2004 Revenues
-------------------------------------------------------------------------
Net product and service revenues:
Product $ 373,232 59.1% $ 483,431 67.6% $ 545,115 73.4%
Service 258,400 40.9% 231,318 32.4% 197,175 26.6%
-------------------------------------------------------------------------
Total revenues 631,632 100.0% 714,749 100.0% 742,290 100.0%
-------------------------------------------------------------------------
Gross profit
Product 29,543 4.7% 36,048 5.0% 41,097 5.5%
Service 62,493 9.9% 55,682 7.8% 54,039 7.3%
-------------------------------------------------------------------------
Total gross profit 92,036 14.6% 91,730 12.8% 95,136 12.8%
-------------------------------------------------------------------------
Gross profit %
Product % 7.9% 7.5% 7.5%
Service % 24.2% 24.1% 27.4%
Operating expenses:
Selling, general and administrative 80,973 12.8% 86,010 12.0% 72,346 9.7%
Depreciation and amortization 4,894 0.8% 5,568 0.8% 4,393 0.6%
Goodwill charge 3,472 0.5% 16,000 2.2% - 0.0%
-------------------------------------------------------------------------
Total operating expenses 89,339 14.1% 107,578 15.0% 76,739 10.3%
-------------------------------------------------------------------------
Income (loss) from operations 2,697 0.5% (15,848) -2.2% 18,397 2.5%
Interest income (582) -0.1% (193) 0.0% (310) 0.0%
Interest expense 1,149 0.2% 1,028 0.1% 561 0.0%
-------------------------------------------------------------------------
Interest expense, net 567 0.1% 835 0.1% 251 0.0%
-------------------------------------------------------------------------
Income (loss) before income tax 2,130 0.4% (16,683) -2.3% 18,146 2.5%
Income tax expense (benefit) 987 0.2% (6,021) -0.8% 7,213 1.0%
-------------------------------------------------------------------------
Net income (loss) $ 1,143 0.2% $ (10,662) -1.5% $ 10,933 1.5%
=========================================================================
19
FISCAL YEAR 2006 COMPARED TO FISCAL YEAR 2005
Total Net Product and Service Revenues. Total net product and service revenues
decreased to $631.6 million in fiscal 2006 from $714.7 million in fiscal 2005.
Product sales decreased $110.2 million to $373.2 million in fiscal 2006 from
$483.4 million in fiscal 2005. The decrease in product sales is primarily
attributable to several factors: continuing competitive pressure in the
marketplace; reduction in IT spending by our customers; and delays in IT project
deployments by our customers. Product margins increased to 7.9% in fiscal 2006
compared to 7.5% in fiscal 2005. The year over year product margins increased
due to the mix of product sales.
Service revenues increased $27.1 million to $258.4 million in fiscal 2006 from
$231.3 million in fiscal year 2005. The increase in service revenues relates
primarily to the growth from new service contracts. Service margins increased
to 24.2% in fiscal 2006 compared to 24.1% in fiscal 2005. The Company continues
to take steps to improve utilization and productivity in order to increase
margins.
Gross Profit. Gross profit increased $0.3 million to 92.0 million in fiscal
2006 from $91.7 million in fiscal 2005. Gross profit, as a percentage of
revenue, increased to 14.6% in fiscal 2006 from 12.8% in fiscal 2005. This
increase in gross margin is primarily due to a change in the product/service
mix, with a greater percentage from higher margin service revenue that produced
higher gross margins.
Operating Expenses. Total operating expenses decreased $18.3 million to $89.3
million in fiscal 2006 from $107.6 million in fiscal 2005. The decrease is
primarily the result of decreases in provision for doubtful accounts of $0.3
million, restructuring and severance charges of $2.2 million, a reduction in the
goodwill charge of $12.5 million and employee benefit costs. Expressed as a
percentage of total net product and service revenues, these expenses decreased
to 14.1% in fiscal 2006 from 15.0% for fiscal 2005.
Write Down of Goodwill. Pursuant to the provisions of SFAS 142, the Company
performs its goodwill impairment testing on an annual basis. Historically, the
Company has performed its annual goodwill impairment test based on the year end
valuation date of its fiscal year and reflects the results of that testing
in its annual consolidated financial statements included in its Annual Report
on Form 10-K.
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. For the year ended January 5, 2006, the Company determined
there was an impairment. The primary factor leading to the impairment was the
Company's declining stock price in the fourth quarter of 2005. The second step
of the goodwill impairment test was not completed prior to the issuance of the
fiscal 2005 financial statements. Therefore, the Company recognized a charge of
$16 million as a reasonable estimate of the impairment loss in its fiscal 2005
financial statements.
During the third quarter of fiscal 2006, the Company completed the second step
of the goodwill analysis as required under SFAS 142. The second step of the
goodwill impairment test used to measure the amount of the impairment loss,
compares the implied fair value of reporting unit goodwill with the carrying
amount of that goodwill. The implied fair value of goodwill is determined in the
same manner as the amount of goodwill recognized in a business combination. As a
result, in our step two analysis, the Company allocated the fair value of the
reporting unit determined in step one to all of the assets and liabilities of
the Company (including any unrecognized intangible assets) as if the reporting
unit had been acquired in a business combination and the fair value of the
reporting unit was the price paid to acquire the reporting unit. The excess of
the fair value of the reporting unit over the amounts assigned to its
assets and liabilities is the implied fair value of the goodwill. The implied
value of the goodwill calculated in our step two analysis was approximately
$97.5 million compared to goodwill initially carried on the balance sheet of
approximately $117.0 million as of January 5, 2006, indicating a goodwill
impairment of approximately $19.5 million.
As discussed above, an initial estimated impairment of $16 million was recorded
for the year ended January 5, 2006. As a result of completing our step two
analysis in the third quarter of fiscal 2006, an additional impairment of
approximately $3.5 million was recorded in fiscal 2006.
Income (Loss) from Operations. Income from operations increased $18.5 million,
to $2.7 million in fiscal 2006 from a loss of $15.8 million in fiscal 2005. The
Company's operating margin increased to 0.5% in fiscal 2006 as compared to a
negative 2.2% in fiscal 2005. This increase is a result of the decrease in
operating expenses as described above.
20
Net Interest Expense. Net interest expense was $0.6 million during fiscal 2006
as compared to $0.8 million during fiscal 2005. This decrease in net interest
expense was a result of decreased borrowings under the Company's credit facility
and an increase in interest earned due to cash on hand, offset by an increase
due to the accretion of interest of future rental payments that were accrued for
a leased facility that was part of the ARC acquisition.
Income Taxes. The Company's effective income tax rate was 46.3% in fiscal 2006
compared to a benefit of 36.1% for fiscal 2005. This fluctuation was
principally related to the reduction of book loss and the permanent differences
being a higher percentage of book income. The primary permanent difference was
related to the 50% limitation on business meals. Income tax expense was $1.0
million during fiscal 2006 as compared to a benefit of $6.0 million during
fiscal 2005.
Net Income (Loss). Net income increased $11.8 million, to $1.1 million in
fiscal 2006 from a $10.7 million net loss in fiscal 2005. The increase was a
result of the factors described above.
FISCAL YEAR 2005 COMPARED TO FISCAL YEAR 2004
Total Net Product and Service Revenues. Total net product and service revenues
decreased $27.6 million, or 3.7%, to $714.7 million in fiscal 2005 from $742.3
million in fiscal 2004.
Product sales decreased $61.7 million, or 11.3%, to $483.4 million in fiscal
2005 from $545.1 million in fiscal 2004. This decrease is the result of
customers not renewing product sales agreements and certain customers reducing
expenditures during 2005. The loss of sales renewals is primarily a result of
personnel turnover as the Company began implementing certain changes to the
delivery organization. The Company believes these changes will have a positive
impact on future net sales and revenues.
Service revenues increased $34.1 million, or 17.3%, to $231.3 million in fiscal
2005 from $197.2 million in fiscal year 2004. This increase relates to increases
in revenue associated with the acquisition of Alternative Resources Corporation
("ARC") on July 23, 2004.
Gross Profit. Gross profit margin was 12.8% of net product and service revenues
in fiscal 2005 and 2004, respectively. This gross profit was driven by
increasing margin contribution from service revenue offset by declining margin
contribution from product sales. On a forward looking basis, the Company
expects to continue its aggressive product pricing in order to maintain market
share. Reduced utilization rates from new engagements and service parts write
offs has also resulted in downward pressure on service margins. Additionally,
the Company expects to continue increasing the breadth and depth of its service
offerings, which will have a continued impact on service gross margin. Factors
that may have an impact on gross margin in the future include technical employee
utilization rates, the mix of the type of products sold and services provided,
the percentage of equipment or service sales with lower-margin customers, and
the Company's decision to aggressively price certain products and services.
Operating Expenses. Total operating expenses increased $30.9 million, or 40.3%,
to $107.6 million in fiscal 2005 from $76.7 million in fiscal 2004. The
increases are primarily the result of increase in expenses due to the
acquisition of ARC in July 2004, a $2.0 million increase in provision for
doubtful accounts, $0.5 million increase in non-trade accounts receivable
reserves and an increase of $0.9 million in outside consultants fees associated
with third quarter late filing and $16.0 million recorded for write down of
goodwill (discussed below). Expressed as a percentage of total net product and
service revenues, these expenses increased to 15.0% in fiscal 2005 from 10.3%
for fiscal 2004. On a forward-looking basis, the Company expects to continue
monitoring its selling, general and administrative expenses for strict cost
controls.
Restructuring and Severance Charges. Restructuring and severance charges
reported were $2.3 million for fiscal 2005 and $2.4 million for fiscal 2004.
During fiscal 2005, the Company recorded severance charges totaling $0.9 million
resulting primarily from a re-alignment of the organizational structure of the
Company. Additionally, during fiscal 2005, the Company recorded restructuring
charges aggregating $1.4 million due to unrecoverable assets related to the
Company's former wholly-owned subsidiary, Technology Integration Financial
Services ("TIFS"). Substantially all of the assets of TIFS were sold in fiscal
2002. During fiscal 2004, in connection with certain strategic initiatives, the
Company recorded restructuring and severance charges of $1.0 million. The
restructuring charge is associated with costs of facilities and processes of
Pomeroy that have or will become duplicative or redundant as ARC operations are
integrated into the Company. The Company also recorded a non-recurring,
one-time charge for severance in the amount of $1.4 million related to the
resignation of David B. Pomeroy II as CEO of the Company. David B. Pomeroy II
continues to serve as Chairman of the Board of the Company.
21
Write Down of Goodwill. 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 worked with a
valuation firm to assess goodwill impairment and determined there was
impairment. The primary factor leading to the impairment was the Company's
declining stock price in the fourth quarter of 2005. The second step of the
goodwill impairment test was not complete. Therefore, 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, differed from this estimate. An adjustment to this estimated
impairment loss based on the completion of the measurement of the impairment
loss was recognized in fiscal 2006 as a change in estimate.
Income (Loss) from Operations. Income (loss) from operations decreased $34.2
million, to a loss of $15.8 million in fiscal 2005 from income of $18.4 million
in fiscal 2004. The Company's operating margin decreased to a negative 2.2% in
fiscal 2005 as compared to a positive 2.5% in fiscal 2004. This decrease is a
result of the decrease in sales and in gross profit and the increase in
operating expenses as described above.
Net Interest Expense. Net interest expense was $0.8 million during fiscal 2005
as compared to $0.3 million during fiscal 2004. This increase in net interest
expense was primarily the result of increased average borrowings under our
credit facility relating to the ARC acquisition.
Income Taxes. Income tax benefit was $6.0 million during fiscal 2005 as
compared to expense of $7.2 million during fiscal 2004. This decrease was
principally related to the loss recognized in fiscal 2005.
Net Income (Loss). Net income decreased $21.6 million, to a $10.7 million net
loss in fiscal 2005 from $10.9 million net income in fiscal 2004. The decrease
was a result of the factors described above.
22
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $30.1 million in fiscal 2006. Cash
used in investing activities was $0.7 million, which included $2.6 million
related to certificate of deposits offset by $2.3 million for capital
expenditures and $0.7 million for earn out provisions related to acquisitions
completed in prior years and $0.3 million for covenants not-to-compete as
required per agreements. Cash used in financing activities was $17.3 million
which included $15.3 million of payments on short-term borrowings, $2.5 million
for the purchase of treasury stock, and was offset by $0.2 million from the
exercise of stock options and related excess tax benefit, and $0.3 million
proceeds from the 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 fiscal 2006 were $30.1 million as
compared to cash flows used in operating activities of $4.4 million for fiscal
2005. The increase in cash flows from operating activities in fiscal 2006
compared to fiscal 2005 resulted primarily from timing of payments on accounts
payable, offset by a reduction in accounts receivable and inventories.
Accounts payable and floor plan financing increased $27.7 million, primarily due
to increased use of subcontractors on new outsourcing contracts. Trade, vendor
and other receivables increased $8.2 million primarily due to timing of payments
from customers and vendors. Inventories increased $2.6 million due to customer
owned inventory not being shipped by the end of the year.
Cash flows used in operating activities in fiscal 2005 were $4.4 million as
compared to cash flows provided by operating activities of $5.8 million for
fiscal 2004. The decrease in cash flows from operating activities in fiscal
2005 compared to fiscal 2004 resulted from accounts payable and floor plan
financing decrease of $25.4 million which is primarily due to a decision to
aggressively pursue cash discounts and to the decline in business and by a
reduction in trade, vendor and other accounts receivable of $9.2 million due to
timing of payments and to the decline in business
A significant part of Pomeroy's inventories are financed by floor plan
arrangements with third parties. At January 5, 2007, these lines of credit
totaled $78.5 million, including $75.0 million with GE Commercial Distribution
Finance ("GECDF") and $3.5 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. Overall, the average
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 million Syndicated Credit Facility Agreement with GECDF.
The credit facility has a three-year term and its components include a maximum
of $75 million for inventory financing and a revolving line of credit,
collateralized primarily by accounts receivable, of up to $110 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 million. Under
the agreement, the credit facility provides a letter of credit facility of $5
million. Under the credit facility, the interest rate is based on the London
InterBank Offering Rate ("LIBOR") and a pricing grid. As of January 5, 2007 the
adjusted LIBOR rate was 7.57%. This credit facility expires June 28, 2007.
At January 5, 2007 the Company did not have a balance outstanding under the
credit facility and the amount available was $56.5 million. At January 5,
2006, the Company had a balance outstanding under the credit facility of $15.3
million. The credit facility is collateralized by substantially all of the
assets of Pomeroy, except those assets that
23
collateralize certain other financing arrangements. Under the terms of the
credit facility, the Company is subject to various financial covenants. As of
January 5, 2007. Pomeroy was in compliance with those financial covenants.
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. The Company's credit facility expires
June 28, 2007. The Company intends to negotiate a new credit facility with terms
sufficient for its financing needs and does not anticipate any problems securing
a new credit facility before June 28, 2007. However if the company is unable to
negotiate a new credit facility, it could adversely effect the Company's ability
to operate.
On March 31, 2006, the Board of Directors of the Company authorized a program to
repurchase up to 500,000 shares, at an aggregate price of no more than $5.0
million. The Company intends to effect such repurchases, 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. This stock redemption program was approved to
remain in place and in full force/effect for a period of 18 months. During
fiscal 2006, the Company purchased 320.4 thousand shares at an average price per
share of $7.67 at a total cost of $2.5 million.
Off-Balance Sheet Arrangements and Contractual Obligations
Aggregated information about the Company's contractual obligations as of January
5, 2007 is presented in the following table:
Payments due by period
-------------------------------------------------------
LESS THAN MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
- -------------------------------------------------------------------------------------------
Operating leases $17,873 $ 4,052 $ 5,114 $ 3,243 $ 5,464
Restructuring payments 3,599 1,286 2,313 - -
Floor plan arrangements 17,226 17,226 - - -
-------------------------------------------------------
Total contractual cash obligations $38,698 $ 22,564 $ 7,427 $ 3,243 $ 5,464
=======================================================
The operating leases, shown above, are not recorded on the consolidated balance
sheet. Operating leases are utilized in the normal course of business. The
expected timing or payment of obligations discussed above is estimated based on
current information. Timing of payments and actual amounts paid may be
different depending on changes to agreed-upon amounts for some obligations.
Impact of Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an
interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48 clarifies the
accounting for income taxes by prescribing the minimum recognition threshold a
tax position is required to meet before being recognized in the financial
statements. FIN 48 also provides guidance on derecognition, measurement,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. FIN 48 applies to all tax positions related to income
taxes subject to FASB Statement No. 109, "Accounting for Income Taxes" ("FASB
No. 109"). FIN 48 is effective for fiscal years beginning after December 15,
2006. Differences between the amounts recognized in the statements of financial
position prior to the adoption of FIN 48 and the amounts reported after adoption
should be accounted for as a cumulative-effect adjustment recorded to the
beginning balance of retained earnings. The Company is currently in the process
of determining the impact, if any, that the adoption of FIN 48 will have on the
consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB No. 108"), to address
diversity in practice in quantifying financial statement misstatements. SAB No.
108 requires the Company to quantify misstatements based on their impact on each
of its financial statements and related disclosures. SAB No. 108 is effective as
of the end of the Company's 2006 fiscal year, allowing a one-time transitional
cumulative effect
24
adjustment to retained earnings as of January 6, 2006 for errors that were not
previously deemed material, but are material under the guidance in SAB No. 108.
The Company determined there was no impact on its financial statements by
adopting SAB No. 108.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements,"
which defines fair value, establishes a framework for measuring fair value, and
expands disclosures about fair value measurements. The provisions of SFAS No.
157 are effective as of the beginning of the Company's 2008 fiscal year. The
Company is currently evaluating the impact of adopting SFAS No. 157 on its
financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate risk primarily through its credit
facility with GECDF.
Currently, the Company does not have any significant financial instruments for
trading or other speculative purposes or to manage interest rate exposure.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Registrant hereby incorporates the financial statements required by this item by
reference to Item 15 hereof.
25
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
During fiscal 2006, the Company changed its independent accounting firm as a
result of the resignation of Crowe Chizek and Company LLC ("Crowe Chizek"),
which became effective May 16, 2006. As reported in the Company's Form 8-K
filed on April 26, 2006 and amended May 19, 2006, (1) there was no disagreement
between the Company and Crowe Chizek on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure, which
disagreement, if not resolved to the satisfaction of Crowe Chizek, would have
caused it to make a reference to the subject matter of the disagreement(s) in
connection with its report, and (2) the Company did not have any reportable
events as described under Item 304 (a)(1)(iv) of Regulation S-K except for the
existence of material weaknesses in the Company's internal control over
financial reporting as disclosed by the Company at January 5, 2005 and January
5, 2006 and concurred with by Crowe Chizek. On July 24, 2006, the Company
engaged BDO Seidman, LLP, as its independent registered public accounting firm
for the fiscal year ended January 5, 2007, as reported in the Company's Form 8-K
filed on July 28, 2006.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Management of Pomeroy IT Solutions, Inc (the "Company") evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rules 13(a)-15(e) and 15(d)-15(e) of the Securities
Exchange Act of 1934 (the "Exchange Act"), as of the end of the period covered
by this report. Our management, including the Chief Executive Officer and Chief
Financial Officer, supervised and participated in the evaluation. Based on the
evaluation, management concluded that, as of the end of the period covered by
this report, our disclosure controls and procedures were effective in providing
reasonable assurance that information required to be disclosed by us in the
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.
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting. The Company's internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with accounting
principles generally accepted in the United States of America. Internal control
over financial reporting includes policies and procedures that: (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the Company, (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with U.S. generally
accepted accounting principles, and that receipts and expenditures of the
Company are being made only in accordance with authorizations of management and
directors of the Company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use or disposition
of the Company's assets that could have a material effect on the financial
statements. The Company's management assessed the effectiveness of the
Company's internal control over financial reporting as of January 5, 2007. In
making this assessment, the Company's management used the criteria set forth by
the Committee of Sponsoring Organizations of the Treadway Commission in Internal
Control-Integrated Framework. Based on such assessment, management has
concluded that the Company's internal control over financial reporting was
effective as of January 5, 2007.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management report on internal control over financial reporting for the year
ended January 5, 2006 described four material weaknesses in our internal
control over financial reporting with respect to; service billing calculations
and revenue recognition related to service activity, financial reporting and
close function to appropriately apply generally accepted accounting principles
ensuring the adequacy of amounts and completeness of disclosures in the
consolidated financial statements, computer applications used for financial
reporting and payroll process. These material weaknesses continued to exist as
of the end of the first three quarters of 2006. In the fourth quarter of 2006,
we completed the implementation and testing of the remedial measures put in
place to address these material weaknesses. The remediation plans included the
following:
Actions Relating to Maintaining Effective Control Over The Accrual of Service
Billing Calculations and Service Revenue Recognition.
26
Our remediation work focused on service parts, service contracts, service
invoicing and subcontracting processes to improve their internal controls over
financial reporting. The service revenue and expense recognition processes and
procedures were assessed and remediation plans were implemented during the 3rd
quarter of 2006. Contract and engagement approval procedures were put in place
in order to verify that terms are established and agreed upon prior to work
being performed. Procedures were put in place to give adequate ownership,
accountability, and timely processing of transactions related to service parts
inventory. Reporting mechanisms and procedures were put in place to ensure that
time is submitted, approved, and billed in a timely manner and recorded in the
correct period for both Pomeroy employees and subcontractors. The Company
completed the remediation and testing during the fourth quarter.
Actions Relating to Maintaining Effective Control Over Financial Close and
Reporting Process.
During the third quarter we developed and implemented several new accounting
policies and procedures. During the fourth quarter of 2006 we developed and
implemented more accounting policies. 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 was implemented during the second quarter of 2006.
During the third quarter, the Company fully documented its Financial Close and
Reporting Process. All financial close and reporting controls were fully
remediated and tested in the fourth quarter.
Actions Related to Maintaining Effective Control Over Computer Applications Used
in Financial Reporting.
The Company has developed and implemented controls over system changes and
upgrades. In addition, the Company has addressed the necessary changes to
resolve the application issues associated with improper system access rights by
developing and implementing an IT Security Access Policy. A Segregation of
Duties Framework was implemented in the fourth quarter to ensure conflicts
within key applications had been remediated or mitigated. These controls were
fully remediated and tested in the fourth quarter.
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 implemented additional procedures, including
automated monitoring controls, that will hold one-up managers accountable and
responsible for timely notifications of terminated employees. These controls
were fully remediated and tested in the fourth quarter.
In connection with this testing, and in connection with the evaluation described
in the above paragraph ("Evaluation of Disclosure Controls and Procedures"),
management has concluded that all of the material weaknesses have been
remediated as of January 5, 2007. Management considers the remediation of these
material weaknesses during our quarter ended January 5, 2007 to represent a
change that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
The Company's independent registered public accounting firm, BDO Seidman, LLP,
has issued an audit report on management's assessment of the effectiveness of
the Company's internal control over financial reporting as of January 5, 2007,
which follows.
27
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Pomeroy IT Solutions, Inc.
Hebron, Kentucky
We have audited management's assessment, included in the accompanying Item 9A,
Controls and Procedures, that Pomeroy IT Solutions, Inc. maintained effective
internal control over financial reporting as of January 5, 2007, based on
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (the COSO
criteria)". Pomeroy IT Solutions, Inc. management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
made only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that Pomeroy IT Solutions, Inc.
maintained effective internal control over financial reporting as of January 5,
2007, is fairly stated, in all material respects, based on the COSO criteria.
Also in our opinion, Pomeroy IT Solutions, Inc. maintained, in all material
respects, effective internal control over financial reporting as of January 5,
2007, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
Pomeroy IT Solutions, Inc. as of January 5, 2007, and the related consolidated
statement of income, equity, and cash flows for the year ended January 5, 2007
and our report dated March 16, 2007 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
Chicago, Illinois
March 16, 2007
28
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Item 201(d) disclosure will be incorporated by reference in the
definitive Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information required by Part III is omitted from this report because we intend
to file a definitive Proxy Statement pursuant to Regulation 14A (the "Proxy
Statement") no later than 120 days after the end of the fiscal year covered by
this report, and certain information to be included therein is incorporated
herein by reference.
29
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as a part of this report:
- -----------------------------------------------------------------------------------------------------------
2006 Form
10-K Page
-----------
1. Financial Statements:
Reports of Independent Registered Public Accounting Firm F-1 to F-2
Consolidated Balance Sheets,
January 5, 2007 and January 5, 2006 F-3 to F-4
For each of the three fiscal years in
the period ended January 5, 2007:
Consolidated Statements of Operations F-5
Consolidated Statements of Equity F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-8 to F-26
2 Financial Statement Schedule
None
Filed Herewith
7(page #) or
Incorporated
3. Exhibits by Reference to:
----------- ----------------
3(i)(a)1 Certificate of Incorporation of Pomeroy Computer Exhibit 3(i)(a)(1) of
Resources, dated February, 1992 Company's Form 10-Q
filed Aug. 11, 2000
Certificate of Amendment to Certificate of Incorporation, Exhibit 3(i)(a)(2) of
3(i)(a)2 dated July 1997 Company's Form 10-Q
filed Aug. 11, 2000
3(i)(a)3 Certificate of Designations of Series A Junior Exhibit 3(i)(a)(3) of
Participating Preferred Stock of Pomeroy Computer Company's Form 10-Q
Resources, Inc. February 1998 filed Aug. 11, 2000
3(i)(a)4 Certificate of Amendment to Certificate of Incorporation, Exhibit 3(i)(a)(4) of
dated August 2000 Company's Form 10-Q
filed Aug. 11, 2000
- -----------------------------------------------------------------------------------------------------------
30
- -----------------------------------------------------------------------------------------------------------
3(i)(a)5 Certificate of Amendment to Certificate of Incorporation Exhibit 3(I)(a)5 of
for Pomeroy Computer Resources, Inc., dated June 19, 2003 Company's Form 10-Q
filed August 19, 2003
(3)(i)(a)6 Certificate of Amendment to Certificate of Incorporation Exhibit 3(I)(a)6 of
for Pomeroy Computer Resources Sales Company, Inc., Company's Form 10-Q
dated June 19, 2003 filed August 19, 2003
3(ii) Bylaws of the Company Exhibit 3(a) of
Company's Form S-1 filed
Feb. 14, 1992
4 Rights Agreement between the Company and The Fifth Exhibit 4 of
Third Bank, as Rights Agent dated as of February 23,1998 Company's Form 8-K
filed February 23, 1998
10(i) Material Agreements
(b)(1) Agreement for Wholesale Financing (Security Exhibit 10(i)(b)(1) of
Agreement) between IBM Credit Corporation and Company's Form 10-K
the Company dated April 2, 1992 filed April 7, 1994
(b)(2) Addendum to Agreement for Wholesale Financing Exhibit 10(i)(b)(2) of
between IBM Credit Corporation and the Company Company's Form 10-K
dated July 7, 1993 filed April 7, 1994
(e)(1) IBM Agreement for authorized Dealers and Industry Company's Form S-1
Remarketers with the Company, dated September 3, 1991 filed Feb. 14. 1992
(e)(2) Schedule of Substantially Exhibit 10(i)(e)(2) of
Identical IBM Agreements for Authorized Dealers Company's Form S-1
And Industry Remarketers filed Feb. 14, 1992
- -----------------------------------------------------------------------------------------------------------
31
- -----------------------------------------------------------------------------------------------------------
(mm)(10) Asset purchase agreement by, between and among Exhibit 10(I)(mm)(10)
Pomeroy Select Integration Solutions, Inc. and Verity of Company's Form
Solutions, LLC and John R. Blackburn, dated August 30, 2002 10-Q filed May 20, 2002
(mm)(11) Covenant not to compete agreement between John R. Blackburn Exhibit 10(I)(mm)(11) of
and Pomeroy Select Integration Solutions, Inc. the Company's Form
10-Q filed May 20, 2002
(mm)(15) The Credit Facilities Agreement dated June 28, 2004 by, Exhibit 10(i)(mm)(i) of
between, and among Pomeroy IT Solutions, Inc. (formerly the Company's Form
known as, Pomeroy Computer Resources, Inc.), 10-Q filed August 16, 2004
Pomeroy Select Integration Solutions, Inc., Pomeroy
Select Advisory Services, LLC (formerly, prior to
conversion, Pomeroy Select Advisory Services, Inc.),
Pomeroy IT Solutions Sales Company, Inc. (formerly
known as, Pomeroy Computer Resources Sales
Company, Inc.), Pomeroy Computer Resources Holding
Company, Inc., Pomeroy Computer Resources
Operations, LLP, PCR Holdings, Inc. (formerly known
as, Technology Integration Financial Services, Inc.),
PCR Properties, LLC (formerly, prior to conversion,
PCR Properties, Inc., and prior to such conversion,
formerly known as, T.I.F.S. Advisory Services, Inc.),
TheLinc, LLC, Val Tech Computer Systems, Inc.,
Micrologic Business Systems of K.C., LLC, Pomeroy
Acquisition Sub, Inc. (collectively, and separately
referred to as, "Borrower"), and GE Commercial
Distribution Finance Corporation ("GECDF"), as
Administrative Agent, and GECDF and the other
lenders listed on Exhibit 3 of the Agreement and the
signature pages hereto (and their respective
successors and permitted assigns), as "Lenders".
- -----------------------------------------------------------------------------------------------------------
32
- -----------------------------------------------------------------------------------------------------------
(nn)(1) Stock purchase agreement by, between and among Exhibit (nn)(1) of the
James Hollander, trustee, Raymond Hays, trustee, Company's Form 10-Q
David Yoka, trustee and Matthew Cussigh and filed May 20, 2003
Pomeroy Computer Resources, Inc.
(nn)(2) Asset purchase agreement by, between and among Exhibit (nn)(2) of the
Pomeroy IT Solutions, Inc., Pomeroy Select Integration Company's Form 10-K
Solutions, Inc., eServe Solutions Group, LLC, Tim filed March 19, 2004
Baldwin and Pat Sherman.
(nn)(3) Agreement and plan of merger by and between
Pomeroy Acquisition Sub, Inc., a wholly owned Exhibit 10 (I) of the Company's
subsidiary of Pomeroy, and Alternative Resources Form 10-Q filed May 17, 2004
Corporation, dated May 11, 2004
(nn)(4) Lockup and Purchase Agreement by and between Exhibit 10 (ii) of the
Pomeroy IT Solutions, Inc., a Delaware corporation Company's Form 10-Q
("Parent"), and Wynnchurch Capital Partners, L.P. filed May 17, 2004
("Wynnchurch US"), a Delaware limited partnership,
Wynnchurch Capital Partners Canada, L.P.
("Wynnchurch Canada"), an Alberta, Canada limited
partnership and Wynnchurch Capital, Ltd., a Delaware
corporation (Wynnchurch US, Wynnchurch Canada and
Wynnchurch Capital, Ltd. are collectively
"Wynnchurch"), dated May 11, 2004.
10(ii) Material ordinary course of business contracts that
require filing
(D)(1) Lease Agreement by and between Pomeroy Exhibit 10(ii)(D)(1) of
Investments, LLC and Pomeroy Select Integration Form 10K Filed
Solutions, Inc. , dated September 12, 2005 April 14, 2006
(D)(2) Aircraft Lease Agreement by and between Suntrust Exhibit 10(ii)(D)(2) of
Leasing Corporation and Pomeroy IT Solutions Sales Form 10K Filed
Company, Inc and Pomeroy Select Integration April 14, 2006
Solutions, Inc., dated December 28, 2005
(D)(3) Third Amendment to Lease Agreement by and between Exhibit 10(ii)(D)(3) of
Pomeroy Investment, LLC and Pomeroy IT Solutions, Inc. Form 10K Filed April 14, 2006
(o)(1) Consulting Agreement by and between Pomeroy IT Exhibit 10 (ii) (A) of
Solutions, Inc. and David B. Pomeroy, effective the Company's Form
January 5, 2005 8-K filed February 3, 2005
10 (iii) Material Employee Benefit and Other Agreements
(d) The Company Savings 401(k) Plan, Exhibit 10(iii)(d) of
effective July 1, 1991 Company's Form S-1
filed Feb. 14, 1992
(f) The Company's 2002 Amended and Restated Stock Exhibit B to the
Incentive Plan Company's Definitive Proxy
Statement filed May 4, 2004
- -----------------------------------------------------------------------------------------------------------
33
- -----------------------------------------------------------------------------------------------------------
(g) The Company's 2002 Amended and Restated Outside Exhibit A to the
Directors Stock Option Plan Company's Definitive
Proxy Statement filed
May 5, 2005
(j)(2) Incentive Deferred Compensation Agreement between Exhibit 10.4 of
the Company and Stephen E. Pomeroy dated Company's Form S-3
November 13, 1996 filed January 3, 1997
(j)(8) Amended and restated employment agreement by and Exhibit 10(iii)(j)(7)
between Pomeroy IT Solutions, Inc. fka Pomeroy of the Company's
Computer Resources, Inc. and Stephen E. Pomeroy, Form 10-Q filed
dated November 3, 2003 November 19, 2003
- -----------------------------------------------------------------------------------------------------------
34
- -----------------------------------------------------------------------------------------------------------
(j)(9) First Amendment to Amended and restated Exhibit 10(iii)(J)(9)
employment agreement by and between Pomeroy IT of the Company's
Solutions, Inc. and Stephen E. Pomeroy, dated January 6, 2004. Form 10-Q filed
May 17, 2004
(j)(10) Second Amendment to Amended and Restated Exhibit 10(iii)(A) of
Employment Agreement dated October, 13, 2005 by the Company's
and between the Company and Stephen E. Pomeroy. Form 8-K filed
October 13, 2005
(j)(11) Third Amendment to Amended and Restated Exhibit 10(iii)(A) of
Employment Agreement, effective as of October 1, the Company's
2006 between Pomeroy IT Solutions, Inc and Stephen Form 8-K filed
E. Pomeroy, executed on October 13, 2006. October 19, 2006
(k) The Company's 1998 Employee Stock Purchase Exhibit 4.3 of
Plan, Effective April 1, 1999 Company's Form
S-8 filed March 23,
1999
(n)(2) 2002 Amended and Restated Stock Incentive Plan of Exhibit B of the
Pomeroy IT Solutions, Inc. Company's Definitive
Proxy, Schedule 14A,
filed May 4, 2004
(o)(1) Employment Agreement of Kevin G. Gregory Exhibit 10(iii)(o)(1) of
Company's Form 10K
filed April 14, 2006
(p)(1) Employment Agreement of Keith Blachowiak Exhibit 10(iii)(A) of the
Company's Form 8-K
filed February 13, 2006
11 Computation of Per Share Earnings See Note 2 of Notes to
Consolidated Financial
Statements
14 Code of Ethics
21 Subsidiaries of the Company
23.1 Consent of BDO Seidman, LLP
Consent of Crowe Chizek and Company LLC
31.1 Section 302 CEO Certification
31.2 Section 302 CFO Certification
32.1 Section 906 CEO Certification
32.2 Section 906 CFO Certification
35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/ Kevin G. Gregory
-----------------------------------------
Kevin G. Gregory
Senior Vice President and
Chief Financial Officer
Dated: March 21, 2007
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the date indicated.
Signature and Title Date
------------------- ----
By: /s/ David B. Pomeroy March 21, 2007
- -------------------------------------
David B. Pomeroy, II Director
By: /s/ Stephen E. Pomeroy March 21, 2007
- -------------------------------------
Stephen E. Pomeroy, Director
By: /s/ Kevin G. Gregory March 21, 2007
- -------------------------------------
Kevin G. Gregory, Director
By: /s/ James H. Smith III March 21, 2007
- -------------------------------------
James H. Smith III, Director
By: /s/ Ronald E. Krieg March 21, 2007
- -------------------------------------
Ronald E. Krieg, Director
By: /s/ Debra E. Tibey March 21, 2007
- -------------------------------------
Debra E. Tibey, Director
By: /s/ William H. Lomicka March 21, 2007
- -------------------------------------
William H. Lomicka, Director
By: /s/ Kenneth R. Waters March 21, 2007
- -------------------------------------
Kenneth R. Waters, Director
By: /s/ Vincent D. Rinaldi March 21, 2007
- -------------------------------------
Vincent D. Rinaldi, Director
By: /s/ David G. Boucher March 21, 2007
- -------------------------------------
David G. Boucher, Director
36
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pomeroy IT Solutions, Inc.
Hebron, Kentucky
We have audited the accompanying consolidated balance sheet of Pomeroy IT
Solutions, Inc. as of January 5, 2007 and the related consolidated statements of
income, stockholders' equity, and cash flows for the year ended January 5, 2007.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pomeroy IT
Solutions, Inc. at January 5, 2007 and the results of its operations and its
cash flows for the year ended January 5, 2007, in conformity with accounting
principles generally accepted in the United States of America.
As disclosed in Note 2 to the consolidated financial statements, effective
January 1, 2006, the Company adopted the fair value method of accounting
provisions of Statement of Financial Accounting Standard No. 123 (revised 2004),
"Share Based Payment."
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Pomeroy IT
Solutions, Inc. internal control over financial reporting as of January 5, 2007,
based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
and our report dated March 16, 2007 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
Chicago, Illinois
March 16, 2007
F. 1
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Pomeroy IT Solutions, Inc.
We have audited the accompanying consolidated balance sheet of Pomeroy IT
Solutions, Inc. and subsidiaries as of January 5, 2006, and the related
consolidated statements of operations, equity and cash flows for each of the two
years in the period ended January 5, 2006. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Pomeroy
IT Solutions, Inc. and subsidiaries as of January 5, 2006, and the results of
their operations and their cash flows for each of the two years in the period
ended January 5, 2006, in conformity with U.S. generally accepted accounting
principles.
Crowe Chizek and Company LLC
/s/ Crowe Chizek and Company LLC
Louisville, Kentucky
April 14, 2006
F. 2
POMEROY IT SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands) January 5, January 5,
2007 2006
----------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $ 13,562 $ 1,486
Certificates of deposit 1,076 3,629
Accounts receivable:
Trade, less allowance of $4,390 and $4,355 at January 5,
2007 and 2006, respectively 136,055 130,814
Vendor receivables, less allowance of $155 and $100
at January 5, 2007 and 2006, respectively 8,095 4,952
Net investment in leases 1,587 1,912
Other 1,016 2,894
----------- -----------
Total receivables 146,753 140,572
----------- -----------
Inventories 16,274 13,665
Other 10,370 11,730
----------- -----------
Total current assets 188,035 171,082
----------- -----------
Equipment and leasehold improvements:
Furniture, fixtures and equipment 22,540 32,770
Leasehold Improvements 8,459 6,796
----------- -----------
Total 30,999 39,566
Less accumulated depreciation 18,406 24,685
----------- -----------
Net equipment and leasehold improvements 12,659 14,881
----------- -----------
Net investment in leases, net of current portion 42 995
Goodwill 98,314 101,048
Intangible assets, net 2,634 3,007
Other assets 3,403 4,132
----------- -----------
Total assets $ 305,021 $ 295,145
=========== ===========
F. 3
POMEROY IT SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data) January 5, January 5,
2007 2006
----------- ------------
LIABILITIES AND EQUITY
Current Liabilities:
Short-term borrowings $ - $ 15,304
Accounts payable:
Floor plan financing 17,226 15,451
Trade 57,149 31,187
----------- ------------
Total accounts payable 74,375 46,638
----------- ------------
Deferred revenue 2,604 3,444
Employee compensation and benefits 8,642 8,454
Accrued restructuring and severance charges 1,286 2,192
Other current liabilities 10,590 11,028
----------- ------------
Total current liabilities 97,497 87,060
----------- ------------
Accrued restructuring and severance charges. 2,313 3,599
Equity:
Preferred stock, $.01 par value; authorized 2,000 shares,
(no shares issued or outstanding). - -
Common stock, $.01 par value; authorized 20,000 shares,
( 13,476 and 13,400 shares issued at January 5, 2007 and
2006, respectively) 137 135
Paid in capital. 89,992 89,126
Unearned compensation - (1,198)
Accumulated other comprehensive income 15 24
Retained earnings 126,664 125,521
----------- ------------
216,808 213,608
Less treasury stock, at cost ( 1,130 and 810 shares
at January 5, 2007 and 2006, respectively) 11,597 9,122
----------- ------------
Total equity 205,211 204,486
----------- ------------
Total liabilities and equity $ 305,021 $ 295,145
=========== ============
F. 4
POMEROY IT SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands,except per share data) Fiscal Years Ended
----------------------------------------
January 5, January 5, January 5,
2007 2006 2005
------------ ------------ ------------
Net product and service revenues:
Product $ 373,232 $ 483,431 $ 545,115
Service 258,400 231,318 197,175
------------ ------------ ------------
Total revenues 631,632 714,749 742,290
------------ ------------ ------------
Cost of product and service revenues:
Product 343,689 447,383 504,018
Service 195,907 175,636 143,136
------------ ------------ ------------
Total cost of revenues 539,596 623,019 647,154
------------ ------------ ------------
Gross profit 92,036 91,730 95,136
------------ ------------ ------------
Operating expenses:
Selling, general and administrative 80,973 86,010 72,346
Depreciation and amortization 4,894 5,568 4,393
Goodwill charge 3,472 16,000 -
------------ ------------ ------------
Total operating expenses 89,339 107,578 76,739
------------ ------------ ------------
Income (loss) from operations 2,697 (15,848) 18,397
------------ ------------ ------------
Interest income (582) (193) (310)
Interest expense 1,149 1,028 561
------------ ------------ ------------
Interest, net 567 835 251
------------ ------------ ------------
Income (loss) before income tax 2,130 (16,683) 18,146
Income tax expense (benefit) 987 (6,021) 7,213
------------ ------------ ------------
Net income (loss) $ 1,143 $ (10,662) $ 10,933
============ ============ ============
Weighted average shares outstanding:
Basic 12,570 12,554 12,253
============ ============ ============
Diluted (1) 12,659 12,554 12,442
============ ============ ============
Earnings (loss) per common share:
Basic $ 0.09 $ (0.85) $ 0.89
============ ============ ============
Diluted (1) $ 0.09 $ (0.85) $ 0.88
============ ============ ============
(1) Dilutive loss per common share for the year ended January 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 and
unearned restricted shares.
See accompanying notes to consolidated financial statements.
F. 5
POMEROY IT SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF EQUITY
Accum-
(Dollars in thousands) ulated
Other
Compre- Compre-
hensive hensive
Common Paid-in Unearned Retained Treasury Income Income Total
Stock Capital Compensation Earnings Stock (Loss) (Loss) Equity
------- --------- -------------- ---------- ---------- --------- --------- ---------
Balances at January 6, 2004 $ 130 $ 82,696 $ - $ 125,250 $ (8,279) $ - $ - $199,797
Net income 10,933 10,933 10,933
Cumulative translation
adjustment (78) (78) (78)
Treasury stock
purchased (467) (467)
Stock options exercised
and related tax benefit 2 2,139 2,141
40,018 common shares
issued for employee
stock purchase plan 396 396
---------
Comprehensive income $ 10,855
------- --------- -------------- ---------- ---------- --------- ========= ---------
Balances at January 5, 2005 132 85,231 - 136,183 (8,746) (78) 212,722
Net loss (10,662) (10,662) (10,662)
Cumulative translation
adjustment 102 102 102
Treasury stock purchased (376) (376)
Restricted stock issued 1 1,265 (1,266) -
Restricted stock earned 68 68
Stock options exercised
and related tax benefit 2 2,461 2,463
19,688 common shares
issued for employee
stock purchase plan 169 169
---------
Comprehensive loss $(10,560)
------- --------- -------------- ---------- ---------- --------- ========= ---------
Balances at January 5, 2006 135 89,126 (1,198) 125,521 (9,122) 24 204,486
Net income 1,143 1,143 1,143
Cumulative translation
adjustment (9) (9) (9)
Treasury stock purchased (2,475) (2,475)
Reclassification of
unearned compensation (1,198) 1,198 -
Restricted stock issued 1 (1) -
Stock options exercised
and related tax benefit 1 190 191
46,100 common shares
issued for employee
stock purchase plan 304 304
Equity compensation
expense 1,571 1,571
---------
Comprehensive income $ 1,134
------- --------- -------------- ---------- ---------- --------- ========= ---------
Balances at January 5, 2007 $ 137 $ 89,992 $ - $ 126,664 $ (11,597) $ 15 $205,211
======= ========= ============== ========== ========== ========= =========
See accompanying notes to consolidated financial statements.
F. 6
POMEROY IT SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) Fiscal Years Ended January 5,
-------------------------------------------
Cash Flows from Operating Activities: 2007 2006 2005
------------- ------------- -------------
Net income (loss) $ 1,143 $ (10,662) $ 10,933
Adjustments to reconcile net income (loss) to
net cash flows from (used in) operating activities:
Depreciation and amortization 4,926 5,597 4,393
Stock option, restricted stock compensation and Employee
Purchase Plan expense 1,571 68 -
Restructuring and severance charges 133 2,305 2,423
Goodwill charge 3,472 16,000 -
Provision for doubtful accounts 1,690 2,000 -
Amortization of earned income (66) (161) (148)
Deferred income taxes 153 (4,038) 2,763
Loss on disposal of fixed assets 287 15 222
Changes in working capital accounts, net of effects of acquisitions:
Accounts receivable (8,215) 9,186 (13,896)
Inventories (2,609) 1,882 (5,697)
Other current assets 1,818 (2,585) (2,216)
Net investment in leases 1,417 2,949 1,657
Floor plan financing 1,775 (3,943) 2,821
Trade payables 25,962 (21,479) 7,533
Deferred revenue (840) (46) (498)
Income tax payable (148) 95 156
Other, net (2,368) (1,611) (4,665)
------------- ------------- -------------
Net operating activities 30,101 (4,428) 5,781
------------- ------------- -------------
Cash Flows from Investing Activities:
Capital expenditures (2,261) (3,454) (2,350)
Proceeds from sale of fixed assets - 6 20
Proceeds from redemption of certificate of deposits 2,682 - -
Purchases of certificate of deposits (129) (81) (530)
Payment for covenant not-to-compete (285) - -
Acquisitions of businesses (738) (1,256) (16,441)
------------- ------------- -------------
Net investing activities (731) (4,785) (19,301)
------------- ------------- -------------
Cash Flows from Financing Activities:
Payments of acquisition notes payable - (662) (31,385)
Net payments of short-term borrowings (15,304) (4,849) 20,153
Proceeds from exercise of stock options 174 2,194 1,840
Excess tax benefit related to exercise of stock options 16 - -
Purchase of treasury stock (2,475) (376) (467)
Proceeds from issuance of common shares for
employee stock purchase plan 304 169 396
------------- ------------- -------------
Net financing activities (17,285) (3,524) (9,463)
------------- ------------- -------------
Effect of exchange rate changes on cash and cash equivalents (9) 102 (78)
------------- ------------- -------------
Increase (decrease) in cash and cash equivalents 12,076 (12,635) (23,061)
Cash and cash equivalents:
Beginning of year 1,486 14,121 37,182
------------- ------------- -------------
End of year $ 13,562 $ 1,486 $ 14,121
============= ============= =============
See accompanying notes to consolidated financial statements.
F. 7
POMEROY IT SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FISCAL YEARS ENDED JANUARY 5, 2007, JANUARY 5, 2006 AND JANUARY 5, 2005
1. Company Description
Pomeroy IT Solutions, Inc. is a Delaware corporation organized in February
1992. Pomeroy IT Solutions, Inc., collectively with its subsidiaries,
("Pomeroy" or the "Company") is a provider of enterprise-wide information
technology ("IT") solutions that leverage its portfolio of professional
services to create long-term relationships.
The Company's target markets include Fortune 1000, small and medium
business ("SMB") and public sector customers. These customers fall into
government and education, financial services, health care and other
sectors. The Company's customers are located throughout the United States
with an emphasis in the Southeast and Midwest regions.
2. Summary of Significant Accounting Policies
Principles of Consolidation - The accompanying consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation.
Fiscal Year - The Company's fiscal year is a 12 month period ending January
5. References to fiscal 2006, 2005 and 2004 are for the fiscal years ended
January 5, 2007, January 5, 2006 and January 5, 2005, respectively.
Cash and Cash Equivalents - Cash and cash equivalents include highly
liquid, temporary cash investments having original maturity dates of three
months or less.
Goodwill - Goodwill is reviewed for impairment annually or more frequently
if certain conditions exist. Events or changes in facts and circumstances
that Pomeroy considers as impairment indicators include consistent
underperformance of operating results, net book value compared to market
capitalization, and significant adverse economic and industry trends. When
the Company determines that one or more impairment indicators are present,
Pomeroy compares its reporting unit's carrying value to its fair value.
During fiscal 2005, the Company re-aligned the structure of its internal
organization such that management and the board of directors now review
operating results on a consolidated basis. As a result, the Company now has
one reporting unit for goodwill testing. In fiscal 2004, the Company had
two reporting units for goodwill testing which were a products reporting
unit and a services reporting unit. The Company has adopted January 5 as
the valuation date for the annual testing. An impairment loss, if required,
would be reported in the Company's results of operations at the date it is
determined. The Company has completed its annual goodwill impairment test
for the year ended January 5, 2007. The goodwill impairment analysis
indicated there was no goodwill impairment for the year ended January 5,
2007 as the fair value of the reporting unit exceeded the carrying value of
the reporting unit by approximately 5%. The Company considered various
factors in determining the fair value of the reporting unit including
discounted cash flows from projected earnings, values for comparable
companies and the market price of the Company's common stock. The Company
will continue to monitor closely for any impairment indicators such as
underperformance of projected earnings, net book value compared to market
capitalization, declining stock price and significant adverse economic and
industry trends. In the event the Company does not achieve projected
results the Company could incur a goodwill impairment charge in the future.
Other Intangible Assets - The Company's other intangible assets consist
only of intangibles with definitive lives that are being amortized using
straight-line and accelerated methods over periods up to fifteen years.
Other intangible assets are reviewed for impairment in accordance with
Statement of Financial Accounting Standards (SFAS) 144, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of". Impairment indicators include those listed above for goodwill, as well
as significant changes to the asset since acquisition, including the extent
that the Company may use the asset. When the Company determines that one or
more impairment indicators are present, Pomeroy compares the carrying
amount of the asset to the net future undiscounted cash flows that the
asset is expected to generate. If the carrying amount of the asset is
greater than the net future undiscounted cash flows that the asset is
expected to generate, Pomeroy would recognize an impairment loss to the
extent the carrying value of the asset exceeds its fair value. An
impairment loss, if required, would be reported in the Company's results of
operations.
Equipment and Leasehold Improvements - Equipment and leasehold improvements
are stated at cost. Depreciation on equipment is computed using the
straight-line method over estimated useful lives ranging from three to
seven years. Depreciation on leasehold improvements is computed using the
straight-line method over estimated useful lives or the term of the lease,
whichever is less, ranging from two to ten years. Depreciation expense
associated with equipment and leasehold improvements is classified under
operating expenses. Depreciation expense associated with operating leases
is classified under cost of revenues. Expenditures for repairs and
maintenance are charged to expense as incurred and additions and
improvements that significantly
F. 8
extend the lives of assets are capitalized. Expenditures related to the
acquisition or development of computer software to be utilized by the
Company are capitalized or expensed in accordance with Statement of
Position (SOP) 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." The Company reviews equipment and
leasehold improvements for potential impairment in accordance with SFAS
144. Upon sale or retirement of depreciable property, the cost and
accumulated depreciation are removed from the related accounts and any gain
or loss is reflected in the results of operations. The Company leases
various property, plant and equipment. Leased property is accounted for
under Statement of Financial Accounting Standards (SFAS) 13, ''Accounting
for Leases''. Operating leases and the related payments are expensed
ratably over the rental period. Leases that include escalating lease
payments are straight-lined over the non-cancelable base lease period in
accordance with SFAS 13.
Income Taxes - Deferred tax assets and liabilities are recognized for the
estimated future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates in effect for the year in which those
temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Vendor Rebates - The most significant component of vendor receivables is
vendor rebates. Vendor rebate programs are developed by original equipment
manufacturers ("OEM') allowing them to modify product pricing on a case by
case basis (generally determined by individual customers) to maintain their
competitive edge on specific transactions. The Company will contact the OEM
to request a rebate, for a specific transaction, and if approved, the OEM
will provide the Company with a document authorizing a rebate to be paid to
the Company at a later date when a claim is filed. At the time the Company
records product sales, cost of sales is reduced by the amount of the
rebate. Rebate programs involve complex sets of rules varying by
manufacturer. As a result of the rules and complexity of applying the rules
to each item sold, claims are often rejected and require multiple
submissions before credit is given. Pomeroy maintains an allowance for
doubtful accounts on vendor receivables for estimated losses resulting from
the inability of its vendors to make required payments. The determination
of a proper allowance for vendor receivables is based on an ongoing
analysis as to the recoverability of the Company's vendor receivable
portfolio based primarily on account aging. Primary reasons for claims
being disallowed and corresponding re-files include serial number issues
(missing, incomplete, transposed, data base match-up discrepancies, etc.),
pricing issues (dispute in calculation of rebate amounts) and other missing
or incomplete documentation (bid letters, customer information, etc.).
Manufacturer Market Development Funds - Several OEM's offer market
development funds, cooperative advertising and other promotional programs
to distribution channel partners. The Company utilizes these programs to
fund some of its advertising and promotional programs. The Company
recognizes these anticipated funds as vendor receivables when it has
completed its obligation to perform under the specific arrangement. The
anticipated funds to be received from manufacturers are offset directly
against the expense, thereby reducing selling, general and administrative
expenses.
Warranty Receivables - The Company performs warranty service work on behalf
of the OEM on customer product. Any labor cost or replacement parts needed
to repair the product is reimbursable to the Company by the OEM. It is the
Company's responsibility to file and collect these claims. The Company
records the vendor receivables when it has completed its obligation to
perform under the specific arrangement. Any OEM reimbursement for warranty
labor cost incurred is recognized as revenue when the service is provided.
Inventories - Inventories are stated at the lower of cost or market and
consists primarily of purchased equipment and service parts. Cost is
determined by the average cost method. Certain overhead costs are
capitalized as a component of inventory. The inventory reserve is
determined by management based on the Company's aged inventory and specific
identification. Periodically, management reviews inventory and adjusts the
reserve based on current circumstances. The following table summarizes the
activity in the inventory reserve account for fiscal years 2006, 2005 and
2004:
F. 9
(in thousands) Inventory Reserve
-------------------
Balance January 6, 2004 $ 234
Activity 120
-------------------
Balance January 5, 2005 354
-------------------
Activity (33)
-------------------
Balance January 5, 2006 321
Activity 81
-------------------
Balance January 5, 2007 $ 402
===================
Translation of Foreign Currencies - Assets and liabilities of the Company's
Canadian operations are translated at the rate of exchange in effect on the
balance sheet date; income and expenses are translated at the weighted
average rates of exchange prevailing during the period. The related foreign
currency translation adjustments are reflected as accumulated other
comprehensive income (loss) in stockholders' equity
Revenue Recognition - In December 2003, the Securities and Exchange
Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 104,
"Revenue Recognition", which superseded SAB 101, "Revenue Recognition in
Financial Statements". SAB 104 updated certain interpretive guidance
included in SAB 101, including the SAB 101 guidance related to multiple
element revenue arrangements, to reflect the issuance by the Emerging
Issues Task Force ("EITF") of EITF 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables".
Generally, the Company, in accordance with SAB 104, recognizes revenue on
the sale of products when the products are shipped, persuasive evidence of
an arrangement exists, delivery has occurred, collection of the relevant
receivable is probable and the sales price is fixed or determinable.
Generally the Company, in accordance with the requirements of SAB 104,
determines if revenue should be reported based on (a) the gross amount
billed to a customer because it has earned revenue from the sale of the
goods or services or (b) the net amount retained (that is, the amount
billed to the customer less the amount paid to a supplier) because it has
earned a commission or fee by determining if the Company performs as an
agent or broker without assuming the risks and rewards of ownership of the
goods, in that case sales would be reported on a net basis.
When the Company provides a combination of products and services to
customers, the arrangement is evaluated under Emerging Issues Task Force
Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables," or EITF
00-21, which addresses certain aspects of accounting by a vendor for
arrangements under which the vendor will perform multiple revenue
generating activities. The application of the appropriate accounting
guidance to our revenue requires judgment and is dependent upon the
specific transaction and whether the sale includes items such as
configuration, training, installation, service, or a combination of these
items. Service revenue is recognized when the applicable services are
provided or for service contracts, ratably over the lives of the contracts.
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. Under the modified
prospective method, SFAS 123(R) applies to new awards and to awards that
were outstanding as of January 5, 2006 that are subsequently vested,
modified, repurchased or cancelled. Compensation expense recognized during
2006 includes the portion vesting during the period for (1) all share-based
payments granted prior to, but not yet vested as of January 5, 2006, based
on the grant date fair value estimated in accordance with the original
provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123") and (2) all
share-based payments granted subsequent to January 5, 2006, based on the
grant-date fair value estimated using the Black-Scholes option-pricing
model. As a result of adopting SFAS 123(R), the Company recognized
approximately $1.5 million of additional compensation expense for the year
ended January 5, 2007, which resulted in a corresponding decrease in net
income and a corresponding decrease of $0.12 per share to both basic and
diluted earnings per share. In addition, cash flows related to
F. 10
excess tax benefits from the exercise of options totaling $16 thousand
are classified as a financing activity whereas under APB 25 such excess tax
benefits would have been classified as cash flows from operations in the
Company's consolidated statement of cash flows.
The table below illustrates the effect of stock compensation expense on the
periods presented as if the Company had always applied the fair value
method:
(in thousands, except per
share amounts) Fiscal 2005 Fiscal 2004
------------- -------------
Net income (loss) before stock compensation expense $ (10,662) $ 10,933
Stock compensation expense 2,789 2,475
------------- -------------
Pro forma net income (loss) $ (13,451) $ 8,458
============= =============
Basic earnings per common share:
Net income (loss) before stock compensation expense $ (0.85) $ 0.89
Stock compensation expense (0.22) (0.20)
------------- -------------
Pro forma net income (loss) $ (1.07) $ 0.69
============= =============
Diluted earnings per common share:
Net income (loss) before stock compensation expense $ (0.85) $ 0.88
Stock compensation expense (0.22) (0.20)
------------- -------------
Pro forma net income (loss) $ (1.07) $ 0.68
============= =============
No stock-based compensation was capitalized into inventory or fixed assets.
The approximate unamortized stock option compensation as of January 5,
2007, which will be recorded as expense in future periods, is $665
thousand. The weighted average time over which this expense will be
recorded is approximately 22.9 months.
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 risk free interest rate is based on the yield curve
for U.S. Treasury constant maturities with an equivalent remaining term
approximately 3 years. The dividend yield is based on the Company's current
dividend yield as the best estimate of projected dividend yield for periods
within the expected life of the options. The expected volatility in 2006 is
based on the historical volatility of the Company's stock price for the
expected life of the option. The fair value of options at the date of grant
was estimated using the Black-Scholes model with the following weighted
average assumptions:
Fiscal 2006 Fiscal 2005 Fiscal 2004
------------ ------------ ------------
Expected life (years) 3.7 3.3 3.3
Risk free interest rate 4.7% 4.3% 3.3%
Volatility 52% 49% 24%
Dividend yield 0% 0% 0%
Information related to all stock options for fiscal 2006 is shown in the
table below:
Weighted- Weighted-Average
Average Exercise Remaining Contractual
Shares Price Term
Outstanding at
January 6, 2006 2,926,503 $ 13.31
Granted 321,250 $ 9.00
Forfeitures (994,072) $ 13.51
Exercised (29,167) $ 5.98
----------
Outstanding at
January 5, 2007 2,224,514 $ 12.70 2.64 years
==========
Exercisable at
January 5, 2007 1,943,319 $ 12.89 2.49 years
==========
F. 11
Information related to unvested stock options for fiscal 2006 is shown in
the table below:
Weighted-Average Weighted-Average
Grant-Date Fair Remaining Contractual
Shares Value Term
Outstanding unvested
stock options at
January 6, 2006 416,794 $ 4.63
Granted 321,250 $ 3.26
Vested (353,316) $ 3.68
Forfeitures (103,533) $ 4.54
---------
Outstanding unvested
stock options at
January 5, 2007 281,195 $ 4.32 3.68 years
=========
Earnings (Loss) per Common Share - The computation of basic earnings (loss)
per common share is based upon the weighted average number of common shares
outstanding during the period. Diluted earnings per common share is based
upon the weighted average number of common shares outstanding during the
period plus, in periods in which they have a dilutive effect, the effect of
common shares contingently issuable, primarily from stock options and
unearned restricted stock.
The following is a reconciliation of the number of common shares used in
the basic and diluted EPS computations:
(in thousands, except per Fiscal Years
---------------------------------------------------------------------
share data) 2006 2005 2004
--------------------- ---------------------- ----------------------
Per Share Per Share Per Share
Shares Amount Shares Amount Shares Amount
--------- ---------- --------- ----------- --------- -----------
Basic EPS 12,570 $ 0.09 12,554 $ (0.85) 12,253 $ 0.89
--------- ---------- --------- ----------- --------- -----------
Effect of dilutive stock
options and unvested
restricted shares 89 - 114 - 189 (0.01)
--------- ---------- --------- ----------- --------- -----------
Diluted EPS 12,659 $ 0.09 12,668 $ (0.85) 12,442 $ 0.88
========= ========== ========= =========== ========= ===========
*For fiscal 2005, no contingently issuable shares have been included as the
effect of these shares are anti-dilutive.
Use of Estimates in Financial Statements - In preparing financial
statements in conformity with accounting principles generally accepted in
the United States of America, management makes estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures
of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during
the reporting period. Accounting estimates in these financial statements
include allowances for trade accounts receivable and vendor accounts
receivable. Pomeroy maintains allowances for doubtful accounts on both
vendor and trade receivables for estimated losses resulting from the
inability of its customers or vendors to make required payments. The
determination of a proper allowance for vendor receivables is based on an
ongoing analysis as to the recoverability of the Company's vendor
receivable portfolio based primarily on account aging. The determination of
a proper allowance for trade receivables is based on an ongoing analysis as
to the credit quality and recoverability of the Company's trade receivable
portfolio. Factors considered are
F. 12
account aging, historical bad debt experience, current economic trends and
others. The analysis is performed on both vendor and trade receivable
portfolios. A separate allowance account is maintained based on each
analysis. Actual results could differ from those estimates.
Contingencies and Accruals - We are subject to the possibility of various
loss contingencies and accruals arising in the ordinary course of business.
We accrue an estimated loss contingency when it is probable that a
liability has been incurred and the amount of loss can be reasonably
estimated. We regularly evaluate current information available to us to
determine whether such accruals should be adjusted and whether new accruals
are required.
Reclassifications - Certain reclassifications of prior years' amounts have
been made to conform to the current year presentation.
Fair Value Disclosures - The Company has financial instruments consisting
primarily of cash and cash equivalents and short-term borrowings. The fair
value of these financial instruments approximates carrying value because of
their short-term maturity and/or variable, market-driven interest rates.
The Company has no financial instruments with off-balance sheet risk.
Comprehensive Income (Loss) - For fiscal 2006, 2005 and 2004, the only
component of comprehensive income (loss) other than net income (loss) is
foreign currency translation adjustments.
Derivative Instruments and Hedging Activities - The Company does not
currently have any derivative instruments or hedging activities.
Recent Accounting Pronouncements - In July 2006, the Financial Accounting
Standards Board ("FASB") issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109
("FIN 48"). FIN 48 clarifies the accounting for income taxes by prescribing
the minimum recognition threshold a tax position is required to meet before
being recognized in the financial statements. FIN 48 also provides guidance
on derecognition, measurement, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 applies to
all tax positions related to income taxes subject to FASB Statement No.
109, "Accounting for Income Taxes" ("FASB No. 109"). FIN 48 is effective
for fiscal years beginning after December 15, 2006. Differences between the
amounts recognized in the statements of financial position prior to the
adoption of FIN 48 and the amounts reported after adoption should be
accounted for as a cumulative-effect adjustment recorded to the beginning
balance of retained earnings. The Company is currently in the process of
determining the impact, if any, that the adoption of FIN 48 will have on
the consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB No. 108"), to
address diversity in practice in quantifying financial statement
misstatements. SAB No. 108 requires the Company to quantify misstatements
based on their impact on each of its financial statements and related
disclosures. SAB No. 108 is effective as of the end of the Company's 2006
fiscal year, allowing a one-time transitional cumulative effect adjustment
to retained earnings as of January 6, 2006 for errors that were not
previously deemed material, but are material under the guidance in SAB No.
108. The Company determined there was no impact on its financial statements
by adopting SAB No. 108.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements,"
which defines fair value, establishes a framework for measuring fair value,
and expands disclosures about fair value measurements. The provisions of
SFAS No. 157 are effective as of the beginning of the Company's 2008 fiscal
year. The Company is currently evaluating the impact of adopting SFAS No.
157 on its financial statements.
3. Accounts Receivable
Trade accounts receivable represent amounts billed or billable to
customers. Past due receivables are determined based on contractual terms.
The Company generally does not charge interest on its trade receivables.
The allowance for doubtful receivables is determined by management based on
the Company's historical losses, specific customer circumstances and
general economic conditions. Periodically, management reviews accounts
receivable and adjusts the allowance based on current circumstances and
charges off uncollectible receivables against the allowance when all
attempts to collect the receivable have failed. The following table
summarizes the activity in the allowance for doubtful accounts for fiscal
years 2006, 2005 and 2004:
F. 13
Vendor and
(in thousands) Trade Other
-------- -----------
Balance January 6, 2004 $ 2,556 $ 100
Accounts written-off (1,826) -
Recoveries 732 -
-------- -----------
Balance January 5, 2005 1,462 100
Provision 2,000 -
Other 833 -
Accounts written-off (160)
Recoveries 220 -
-------- -----------
Balance January 5, 2006 4,355 100
Provision 1,635 55
Accounts written-off (1,640)
Recoveries 40 -
-------- -----------
Balance January 5, 2007 $ 4,390 $ 155
======== ===========
During fiscal 2005, the Company recorded an increase in trade receivables
allowance of $2.0 million. Also, in fiscal 2005, other adjustments of $0.8
million include ARC purchase price adjustments and reclassification of
balance sheet accounts and therefore did not impact 2005 results of
operations.
4. Net Investment in Leases
The Company's net investment in leases principally includes sales-type and
operating leases. Leases consist principally of notebook and desktop
personal computers, communication products and high-powered servers with
terms generally from one to three years. Unearned income is amortized under
the effective interest method. The following table summarizes the
components of the net investment in sales-type leases as of end of fiscal
years 2006 and 2005:
(in thousands) 2006 2005
------- -------
Minimum lease payments receivable $1,169 $2,438
------- -------
Estimated residual value 489 564
Unearned income (29) (95)
------- -------
Total $1,629 $2,907
======= =======
The future minimum lease payments for the net investment in leases are as
follows:
(in thousands)
Fiscal Year
- -----------------------------
2007 1,130
2008 39
--------
Total minimum lease payments $ 1,169
========
F. 14
5. Goodwill and Other Intangible 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 January 5, 2007 and January 5,
2006:
Intangible assets consist of the following:
(in thousands) Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Amount Amortization Amount Amount Amortization Amount
1/5/2007 1/5/2007 1/5/2007 1/5/2006 1/5/2006 1/5/2006
--------- ------------- --------- --------- ------------- ---------
Amortized intangible assets:
Covenants not-to-compete $ 2,309 $ 1,971 $ 338 $ 2,024 $ 1,859 $ 165
Customer lists 2,877 1,418 $ 1,459 2,877 1,061 1,816
Other intangibles 1,268 431 $ 837 1,268 242 1,026
--------- ------------- --------- --------- ------------- ---------
Total amortized intangibles $ 6,454 $ 3,820 $ 2,634 $ 6,169 $ 3,162 $ 3,007
========= ============= ========= ========= ============= =========
Amortized intangible assets are being amortized straight-line over periods
ranging from 1 to 15 years for covenants not-to-compete and 7 years for
other intangibles. Customer lists are primarily being amortized utilizing
the sum-up-the-year digits method. Customer lists are being amortized from
7 to 15 years. For the year ended January 5, 2007, amortization expense
related to intangible assets was $658 thousand. For the year ended January
5, 2006, amortization expense related to intangible assets was $763
thousand. For the year ended January 5, 2005, amortization expense related
to intangible assets was $364 thousand.
Projected future amortization expense related to intangible assets with
definite lives are as follows:
(in thousands)
Fiscal years:
2007 617
2008 554
2009 450
2010 381
2011 270
2012+ 362
--------
Total $ 2,634
========
The changes in the net carrying amount of goodwill for the years ended
January 5, 2007 and 2006 are as follows:
(in thousands) Consolidated
--------------
Net carrying amount as of 1/6/05 $ 109,913
--------------
Goodwill recorded during fiscal 2005 7,135
Goodwill charge (16,000)
--------------
Net carrying amount as of 1/5/06 101,048
Goodwill recorded during fiscal 2006 738
Goodwill charge (3,472)
--------------
Net carrying amount as of 1/5/07 $ 98,314
==============
Pursuant to the provisions of SFAS 142, the Company performs its goodwill
impairment testing on an annual basis. During fiscal 2005, the Company
realigned its reporting structure and for fiscal 2005 and 2006, is testing
its goodwill based on one reporting unit. In prior years, the Company's
goodwill impairment testing was based on two reporting units.
F. 15
Historically, the Company had performed its annual goodwill impairment test
based on the year end valuation date of its fiscal year and reflects the
results of that testing in its annual consolidated financial statements
included in its Annual Report on Form 10-K.
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. For the year ended January 5, 2006,
the Company determined there was an impairment. The primary factor leading
to the impairment is the Company's declining stock price in the fourth
quarter of 2005. The second step of the goodwill impairment test was not
completed prior to the issuance of the fiscal 2005 financial statements.
Therefore, the Company recognized a charge of $16 million as a reasonable
estimate of the impairment loss in its fiscal 2005 financial statements.
During the third quarter of fiscal 2006, the Company completed the second
step of the goodwill analysis as required under SFAS 142. The second step
of the goodwill impairment test used to measure the amount of the
impairment loss, compares the implied fair value of reporting unit goodwill
with the carrying amount of that goodwill. The implied fair value of
goodwill is determined in the same manner as the amount of goodwill
recognized in a business combination. As a result, in the step two
analysis, the Company allocated the fair value of the reporting unit
determined in step one to all of the assets and liabilities of the Company
(including any unrecognized intangible assets) as if the reporting unit had
been acquired in a business combination and the fair value of the reporting
unit was the price paid to acquire the reporting unit. The excess of the
fair value of the reporting unit over the amounts assigned to its assets
and liabilities is the implied fair value of the goodwill. The implied
value of the goodwill calculated in the step two analysis was approximately
$97.5 million compared to goodwill initially carried on the balance sheet
of approximately $117.0 million as of January 5, 2006, indicating a
goodwill impairment of approximately $19.5 million.
As discussed above, an initial estimated impairment of $16 million was
recorded for the year ended January 5, 2006. As a result of completing the
step two analysis in the third quarter of fiscal 2006, an additional
impairment of approximately $3.5 million was recorded for the three and
nine months ended October 5, 2006. Upon completion of the step two
analysis, the amount attributable to unrecognized intangible assets such as
customer lists and trade name was determined to be greater than the initial
estimates, resulting in a lower implied fair value of goodwill which
resulted in an adjustment of the estimated goodwill impairment charge
during the third quarter of fiscal 2006. In fiscal 2006, the Company
recognized a charge of $3.5 million, as an adjustment to the estimated
impairment loss based on the completion of the measurement of the
impairment loss.
The Company has completed its annual goodwill impairment test for the
year ended January 5, 2007. The goodwill impairment analysis indicated
there was no goodwill impairment for the year ended January 5, 2007 as the
fair value of the reporting unit exceeded the carrying value of the
reporting unit by approximately 5%. The Company considered various factors
in determining the fair value of the reporting unit including discounted
cash flows from projected earnings, values for comparable companies and the
market price of the Company's common stock. The Company will continue to
monitor closely for any impairment indicators such as underperformance of
projected earnings, net book value compared to market capitalization,
declining stock price and significant adverse economic and industry trends.
In the event the Company does not achieve projected results, the Company
could incur a goodwill impairment charge in the future.
During fiscal 2006, the Company recorded $0.7 million of goodwill
associated primarily with earn-out payments made in conjunction with prior
acquisitions.
During fiscal 2005, the Company recorded $7.1 million of goodwill of which
$6.7 million was associated with purchase price adjustments related to the
acquired assets and liabilities of Alternative Resources Corporation
("ARC") and the remaining amount was related to earn-out payments made in
conjunction with prior acquisitions. The earn-out payments are based on
predetermined financial performance benchmarks and are for terms of one to
two additional years.
6. Borrowing Arrangements
A significant part of Pomeroy's inventories are financed by floor plan
arrangements with third parties. At January 5, 2007, these lines of credit
totaled $78.5 million, including $75.0 million with GE Commercial
Distribution Finance ("GECDF") and $3.5 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. Overall, the average rate on these arrangements is less than 1.0%.
The Company classifies amounts outstanding under the floor plan
arrangements as accounts payable.
F. 16
The Company has a $165 million Syndicated Credit Facility Agreement with
GECDF. The credit facility has a three-year term and its components include
a maximum of $75 million for inventory financing and a revolving line of
credit, collateralized primarily by accounts receivable, of up to $110
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 million. Under the agreement, the credit facility provides a
letter of credit facility of $5 million. Under the credit facility, the
interest rate is based on the London InterBank Offering Rate ("LIBOR") and
a pricing grid. As of January 5, 2007 the adjusted LIBOR rate was 7.57%.
This credit facility expires June 28, 2007.
At January 5, 2007 the Company did not have a balance outstanding under the
credit facility and the amount available was $56.5 million. At January 5,
2006, the Company had a balance outstanding under the credit facility of
$15.3 million. The weighted average interest rate on the bank revolving
credit agreements was 5.46% and 7.31% in fiscal 2005 and 2006,
respectively. 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, the Company
is subject to various financial covenants. As of January 5, 2007 Pomeroy
was in compliance with those financial covenants.
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. The Company's credit facility
expires June 28, 2007. The Company intends to negotiate a new credit
facility with terms sufficient for its financing needs and does not
anticipate any problems securing a new credit facility before June 28,
2007. However if the Company is unable to negotiate a new credit facility,
it could adversely effect the Company's ability to operate.
At January 5, 2007 and 2006 the Company had several outstanding letters of
credit issued to worker's compensation insurance providers totaling $1.4
million and $1.1 million, respectively, that have various expiration dates
through December 2007. The outstanding letters of credit reduce the amount
available under the credit facility.
During 2006 and 2005, 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 are restricted under Pomeroy's current credit
facility. Under such credit facility, cash dividends and stock redemptions
are limited to $5 million annually.
7. Restructuring and Severance Charges
During fiscal 2006 and fiscal 2005, the Company recorded severance charges
totaling $0.1 million and $0.9 million, respectively, resulting primarily
from a re-alignment of the structure of the Company's organization.
Severance payments will continue to be made through January 2007.
Additionally, during fiscal 2005, the Company recorded restructuring
charges aggregating $1.4 million due to unrecoverable assets related to the
Company's former wholly-owned subsidiary, Technology Integration Financial
Services, Inc. ("TIFS"). Substantially all of the assets of TIFS were sold
in fiscal 2002.
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 are associated with legacy
Pomeroy costs of facilities and processes that have or will become
duplicative or redundant as ARC operations are integrated into the Company.
These costs consist of facility closing and involuntary employee
termination costs of $576 thousand and $400 thousand, respectively. These
costs are 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 charge for severance in the
amount of $1.4 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. Mr. Pomeroy will continue to receive severance
payments thru January 2009.
The Company records restructuring and severance charges in selling, general
and administrative expense line item on the Consolidated Statement of
Operations.
As of January 5, 2007, the restructuring and severance charge accrual,
consisted of the following:
F. 17
(in thousands) Facility Lease
Severance Consolidations Investments Total
------------------------------------------------------
Accrual balance at January 6, 2004 $ - $ - $ - $ -
Charges accrued 1,847 576 - 2,423
Cash payments and write-offs (440) (200) - (640)
------------------------------------------------------
Accrual balance at January 5, 2005 1,407 376 - 1,783
Charges accrued 880 - 1,425 2,305
Cash payments and write-offs (1,411) (251) (1,425) (3,087)
------------------------------------------------------
Accrual balance at January 5, 2006 876 125 - 1,001
Charges accrued 133 - 133
Cash payments and write offs (849) (125) (974)
------------------------------------------------------
Accrual balance at January 5, 2007 $ 160 $ - $ - $ 160
======================================================
Also, the Company 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) Severance consolidations Total
Total initial liability $ 2,682 $ 3,715 $ 6,397
Cash payments (760) (260) (1,020)
---------------------------------------
Liability balance at January 5, 2005 1,922 3,455 5,377
Cash payments (1,922) (899) (2,821)
Adjustments of initial liability - 2,165 2,165
---------------------------------------
Liability balance at January 5, 2006 - 4,721 4,721
Cash payments (1,296) (1,296)
---------------------------------------
Liability balance at January 5, 2007 $ - $ 3,425 $ 3,425
=======================================
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 and 2003. The total obligations
assumed in connection with this restructuring plan was approximately $2.1
million at July 23, 2004.
As of January 5, 2007 and 2006, the balance of the ARC fiscal 2002 and 2003
accrued restructuring costs recorded consisted of the following:
F. 18
Facility Other
(in thousands) Severance consolidations charges Total
Total liability as of July 23, 2004 $ 647 $ 756 $ 696 $ 2,099
Cash payments (594) (424) (656) (1,674)
--------------------------------------------------
Balance at January 5, 2005 53 332 40 425
Adjustment of initial liability - 100 - 100
Cash payments (53) (388) (15) (456)
--------------------------------------------------
Balance at January 5, 2006 - 44 25 69
Cash payments - (44) (11) (55)
--------------------------------------------------
Balance at January 5, 2007 $ - $ - $ 14 $ 14
==================================================
8. Income Taxes
The provision (benefit) for income taxes consists of the following:
(in thousands) Fiscal Years
-----------------------
2006 2005 2004
----- -------- ------
Current:
Federal $ 709 $ (865) $3,072
State 125 (15) 1,378
----- -------- ------
Total current 834 (880) 4,450
----- -------- ------
Deferred:
Federal 130 (4,458) 2,440
State 23 (683) 323
----- -------- ------
Total deferred 153 (5,141) 2,763
----- -------- ------
Total income tax provision $ 987 $(6,021) $7,213
===== ======== ======
The approximate tax effect of the temporary differences giving rise to the
Company's deferred income tax assets (liabilities) are:
F. 19
(in thousands) Fiscal Years
------------------------
2006 2005
----------- -----------
Deferred Tax Assets:
Receivables allowances $ 1,750 $ 1,727
Deferred compensation 97 151
Non-compete agreements 483 508
Restructuring charges 1,385 1,845
State net operating losses 591 543
Federal net operating losses 4,802 4,802
Other 1,514 1,439
----------- -----------
Total deferred tax assets 10,622 11,015
----------- -----------
Deferred Tax Liabilities:
Depreciation (3,321) (2,692)
Intangibles (1,127) (1,467)
Leases (812) (975)
Other (553) (919)
----------- -----------
Total deferred tax liabilities (5,813) (6,053)
----------- -----------
Net deferred tax assets ( liabilities) $ 4,809 $ 4,962
=========== ===========
As of January 5, 2007, the Company's net current deferred tax assets of
$2,878 are included in other current assets and the net noncurrent deferred
tax assets of $1,931 are included in other assets on the balance sheet. As
of January 5, 2006, the Company's net current deferred tax assets of $2,420
are included in other current assets and the net noncurrent deferred tax
assets of $2,542 are included in other assets on the balance sheet.
The Company recorded $9,357 of net deferred tax assets, primarily related
to the tax effect of federal and state net operating loss carryforwards and
restructuring charges, in connection with the acquisition of ARC in July
2004. The Company's ability to use the federal and state net operating loss
carryforwards of ARC to reduce its future taxable income is subject to
limitations under Section 382 of the Internal Revenue Code associated with
acquired federal and state net operating loss carryforwards. The federal
net operating loss carryforwards of ARC aggregate $13,721 as of January 5,
2007 of which $1,702 will expire in 2020, $8,010 in 2023 and $4,009 in
2024. The Company currently believes it will fully utilize ARC's acquired
net operating loss carryforwards and, accordingly, no valuation allowance
has been provided as of January 5, 2007. In addition, the recorded amounts
of acquired deferred tax assets and liabilities were adjusted during fiscal
2005 upon completion of ARC's final income tax returns for the period prior
to its acquisition by the Company.
The Company's effective income tax rate differs from the federal statutory
rate as follows:
Fiscal Years
----------------------------
2006 2005 2004
-------- -------- --------
Tax (benefit) at federal statutory rate 34.0 % (35.0)% 35.0 %
-------- -------- --------
State taxes, net of federal effect 4.9% (2.7)% 6.1 %
Permanent tax differences and other (primarily meals
& entertainment) 7.4 % 1.6 % (1.4)%
-------- -------- --------
Effective tax rate 46.3 % (36.1)% 39.7 %
======== ======== ========
9. Operating Leases and Commitments
Operating Leases- The Company leases office and warehouse space, vehicles,
and certain office equipment from various lessors including a related
party. See Note 13 of Notes to Consolidated Financial Statements for
information regarding related parties. Lease terms vary in duration and
include various option periods. The leases include certain provisions for
rent escalation, renewals and purchase options, and the Company is
generally responsible for taxes, insurance, repairs and maintenance. In
December 2005, the Company's lease for an airplane expired and a new lease
agreement was signed for a replacement airplane. This lease is treated as
an operating lease for financial reporting purposes. The lease provides for
monthly rental payments of $125 thousand over the three-year term of the
initial lease
F. 20
with four one-year renewal periods thereafter. The Company also provides a
residual value guarantee. We have determined that we are not required to
consolidate the lessor, the leased aircraft or the related debt in
accordance with FASB Interpretation No. 46 (revised), "Consolidation of
Variable Interest Entities."
Future minimum lease payments under noncancelable operating leases with
initial or remaining terms in excess of one year as of January 5, 2007,
including the lease with the related party, are as follows:
(in thousands)
Fiscal Year
- -----------------------------
2007 $ 4,052
2008 3,465
2009 1,649
2010 1,661
2011 1,582
Thereafter 5,464
-------
Total minimum lease payments $17,873
=======
Rental expense was $3.6 million, $3.4 million and $3.4 million for 2006,
2005 and 2004, respectively.
Employment Agreements-The Company is party to employment agreements with
certain executives, which provide for compensation and certain other
benefits. The agreements also provide for severance payments under certain
circumstances.
10. Employee Benefit Plans
The Company has a savings plan intended to qualify under sections 401(a)
and 401(k) of the Internal Revenue Code. The plan covers substantially all
employees of the Company. The Company makes contributions to the plan based
on a participant's annual pay. Contributions made by the Company for fiscal
2006, 2005 and 2004 were approximately $188 thousand, $276 thousand and
$236 thousand, respectively.
The Company has a stock purchase plan (the "1998 plan") under Section 423
of the Internal Revenue Code of 1986, as amended. The 1998 plan, as
amended, provides substantially all employees of the Company with an
opportunity to purchase through payroll deductions up to 2,000 shares of
common stock of the Company with a maximum market value of $25,000 per
year. The purchase price per share is determined by whichever of two prices
is lower: 85% of the closing market price of the Company's common stock in
the first trading date of an offering period (grant date), or 85% of the
closing market price of the Company's common stock in the last trading date
of an offering period (exercise date). 600,000 shares of common stock of
the Company are reserved for issuance under the 1998 plan. The Board of
Directors of the Company may at any time terminate or amend the 1998 plan.
The 1998 plan will terminate twenty years from the effective date unless
sooner terminated.
During fiscal 2006, the Company recognized approximately $70 thousand in
expense related to the stock purchase plan due to it being compensatory
under FAS 123R.
11. Concentrations
During fiscal 2006, 2005, and 2004 approximately 38.5%, 27.7%, and 23.4%,
respectively, of the Company's total net product and service revenues were
derived from its top ten customers.
During fiscal 2006, one customer, IBM Corporation, accounted for more than
10% of the Company's total net product and service revenues with
approximately $74.5 million in revenues. The revenues generated from IBM
Corporation are primarily resulting from services provided. However in
fiscal 2005 and 2004 no customer accounted for more than 10% of the
Company's total net product and service revenues. The loss of one or more
significant customers could have a material adverse impact on the Company's
operating results.
We maintain cash balances which at times exceed FDIC limits.
F. 21
12. Acquisitions
During fiscal 2006 and fiscal 2005, the Company did not make any
acquisitions. During fiscal 2004, the Company completed one acquisition.
The Company and Pomeroy Acquisition Sub, Inc. ("PAS"), a wholly owned
subsidiary of the Company, completed a merger with Alternative Resources
Corporation ("ARC"). On May 11, 2004, the parties entered into a definitive
merger agreement for PAS to acquire all of the issued and outstanding
shares of capital stock of ARC. The merger was approved by ARC shareholders
at a meeting held on July 22, 2004. As a result of the merger, ARC is now a
wholly-owned subsidiary of the Company. The cash consideration paid at
closing, including the cost of all stock, stock options and warrants
purchased and the amount of ARC net debt retired, was approximately $46.1
million, which was funded from cash on hand and borrowings from the
Company's existing line of credit.
The following summarizes the assets purchased and liabilities assumed:
(in thousands)
Cash $ 2,349
Accounts receivable 19,303
Other current assets 4,871
Property and equipment, net 193
Intangible assets 3,530
Goodwill 41,864
Other assets 7,051
-------
Assets acquired 79,161
-------
Current portion of notes payable 15,487
Accounts payable and accrued expenses 29,961
Notes payable, net of current portion 15,236
-------
Liabilities assumed 60,684
-------
Net assets acquired $18,477
=======
Additionally, during fiscal 2005, the Company recorded an additional
purchase price adjustment of $6.7 million, related to additional
pre-acquisition liabilities.
The results of operations of ARC are included in the Company's fiscal 2004
consolidated financial statements from the date of acquisition. If the
fiscal 2004 acquisition of ARC described below had occurred on January 6,
2004, the unaudited pro forma results of operations of the Company would
have been as follows:
(in thousands, except per share data) For the year ended
January 5, 2005
------------------------------
Actual Pro forma
------------------------------
Net product and service revenues $ 742,290 $ 807,345
Income from operations 18,397 16,233
Net income 10,933 9,501
Earnings per common share, diluted 0.88 0.76
13. Related Party Transactions
Leases- Pomeroy's principal executive offices, distribution facility,
national training center, and national service operations center comprised
of approximately 36,000, 161,000, 22,000, and 69,000 square feet of space,
respectively, are located in Hebron, Kentucky. These facilities are leased
from Pomeroy Investments, LLC ("Pomeroy Investments"), a Kentucky limited
liability company controlled by David B. Pomeroy, II, Chairman of the
Board, under a ten-year triple-net lease agreement, which expires in July
2015. The lease agreement provides for 2 five-year renewal options. Base
rental for fiscal 2006, 2005 and 2004 was approximately $1.4 million, $1.2
million and $1.2 million, respectively. The annual rental for these
properties was determined on the basis of a fair market value rental
opinion provided by an independent real estate company, which was updated
in 2005. In addition, the Company pays for the business use of other real
estate that is owned by the former Chief Executive Officer of the Company.
During fiscal year 2006 and 2005, the Company paid $25 thousand and during
fiscal years 2004, the Company paid $95 thousand in connection with this
real estate. The lessor of the headquarters, distribution facility and
national training center does not meet the conditions to be considered a
variable interest entity in accordance with FIN 46.
F. 22
Investment in Lease Residuals - During fiscal 2006, 2005, and 2004, the
Company sold equipment and related support services to National City
Commercial Capital Corporation (formerly ILC), for lease to National City's
customers, in amounts of $17.7 million, $22.3 million and $22.5 million,
respectively. Also, during fiscal 2002, the Company signed an exclusive
seven-year vendor agreement whereby the Company is appointed as an agent
for remarketing and reselling of the leased equipment sold. 33The Company
will be paid a commission on future lease transactions referred to and
accepted by National City and will act as the remarketing and reselling
agent for such future leased equipment. A director of the Company is CEO of
National City Commercial Capital Corporation (formerly ILC).
Employee Receivables - As of January 5, 2007 and 2006, employee receivables
included in other accounts receivable amounted to net of $210 thousand and
$766 thousand, respectively.
14. Supplemental Cash Flow Disclosures
Supplemental disclosures with respect to cash flow information and non-cash
investing and financing activities are as follows:
(in thousands) Fiscal Years
-------------------------------
2006 2005 2004
--------- --------- ---------
Interest paid $ 1,149 $ 1,042 $ 558
========= ========= =========
Income taxes paid $ 33 $ 1,340 $ 5,116
========= ========= =========
Adjustment to purchase price
of acquired assets and goodwill $ - $ 5,879 $ 171
========= ========= =========
15. Treasury Stock
On March 31, 2006, the Board of Directors of the Company authorized a
program to repurchase up to 500,000 shares, at an aggregate price of no
more than $5.0 million. The Company intends to effect such repurchases, 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. This
stock redemption program was approved to remain in place and in full
force/effect for a period of 18 months. During fiscal 2006, the Company
purchased 320,415 shares at an average price per share of $7.67 at a total
cost of $2.5 million.
During fiscal 2005, the Company repurchased 31,300 shares of common stock
at a cost of $0.4 million under the repurchase program that expired October
11, 2005.
During fiscal 2004, the Company repurchased 40,000 shares of common stock
at a cost of $0.5 million under the repurchase program that expired June 1,
2004.
16. Stockholders' Equity and Stock Option Plans
On March 27, 2002, the Company adopted the 2002 Non-Qualified and Incentive
Stock Option Plan and it was approved by the shareholders on June 13, 2002.
The plan was amended and renamed the 2002 Amended and Restated Stock
Incentive Plan on March 11, 2004 and approved by the Company's shareholders
on June 10, 2004. The Company's 2002 Amended and Restated Stock Incentive
Plan provides certain employees of the Company with options to purchase
common stock of the Company through options at an exercise price equal to
the market value on the date of grant. The plan, as amended, also provides
for the granting of awards of restricted stock and stock appreciation
rights. The maximum aggregate number of shares which may be optioned and
sold under the plan is 4,410,905, of which up to 600,000 shares may be
issued in the form of restricted stock. The plan will terminate on June 13,
2012. Stock options granted under the plan are exercisable in accordance
with various terms as authorized by the Compensation Committee. To the
extent not exercised, options will expire not more than ten years after the
date of grant.
During fiscal 2006, the Company awarded 60,258 shares of restricted common
stock, which vest over a 4-year period. Restricted stock awards are valued
at the closing market value of the Company's common stock on the date of
the grant, and the total value of the award is recognized as expense
ratably over the vesting period of the employees receiving the grants Total
compensation expense recognized in fiscal 2006 for vested shares was $276
thousand. During fiscal 2005, the Company awarded 123,261 shares of
restricted common stock, which vest over a 4-year period. Total
compensation expense recognized in fiscal 2005 for vested shares was
F. 23
$68 thousand. As of January 5, 2007, the total amount of unrecognized
compensation expense related to nonvested restricted stock awards was
approximately $1.4 million, which is expected to be recognized over a
weighted-average period of approximately 3.0 years. In fiscal 2005, the
unvested portion of this restricted stock award is presented as unearned
compensation in the consolidated financial statements.
Weighted Average
Shares Exercise price
------- -----------------
Restricted common stock outstanding January 6, 2005 - -
Granted 123,261 $ 10.27
Exercised - -
Forfeitures - -
-------
Restricted common stock outstanding January 5, 2006 123,261 10.27
Granted 60,258 7.81
Exercised - -
Forfeitures - -
-------
Restricted common stock outstanding January 5, 2007 183,519 $ 9.46
=======
On March 27, 2002, the Company adopted the 2002 Outside Directors' Stock
Option Plan and it was approved by the shareholders on June 13, 2002. The
plan was amended on March 11, 2004 and approved by the Company's
shareholders on June 10, 2004. The Company's 2002 Outside Directors' Stock
Option Plan, as amended, provides outside directors of the Company with
options to purchase common stock of the Company at an exercise price equal
to the market value of the shares at the date of grant. The maximum
aggregate number of shares which may be optioned and sold under the plan is
281,356. The plan will terminate on March 26, 2012. Pursuant to the plan,
an option to purchase 10,000 shares of common stock will automatically be
granted on the first day of the initial term of a director. An additional
10,000 shares of common stock will automatically be granted to an eligible
director upon the first day of each consecutive year of service on the
board. Options are fully vested as of the date of grant and must be
exercised within two years of the date of grant, subject to earlier
termination in the event of termination of the director's service on the
Board. The plan was amended again on April 11, 2006, the Board of Directors
approved certain amendments to the Directors' Plan, subject to stockholder
approval. The primary purposes of the amendments was to (1) add restricted
stock as a type of award that may be granted under the Directors' Plan and
provide that the restriction period for restricted stock awards shall be
not less than 4 years, (2) provide that the annual award of common stock to
a Director will be a restricted stock grant (unless the Board determines
otherwise) but that the number of shares subject to the annual award is
decreased from 10,000 shares to 3,300 shares, and (3) decrease the total
number of shares reserved under the Directors Plan by 28,856 shares which
was approved by the shareholders on June 20, 2006. During fiscal 2006, the
Company awarded 19,800 shares under this plan.
The following summarizes the stock option transactions under the plans for
the three fiscal years ended January 5, 2007:
Weighted Average
Shares Exercise price
---------- -----------------
Options outstanding January 6, 2004 2,067,518 13.41
Granted 1,173,250 13.32
Exercised (185,765) 9.91
Forfeitures (321,084) 15.62
----------
Options outstanding January 5, 2005 2,733,919 13.34
Granted 1,012,500 13.04
Exercised (192,763) 11.38
Forfeitures (627,153) 13.73
----------
Options outstanding January 5, 2006 2,926,503 13.31
Granted 321,250 9.00
Exercised (29,167) 5.98
Forfeitures (994,072) 13.51
----------
Options outstanding January 5, 2007 2,224,514 $ 12.70
==========
F. 24
The following summarizes options outstanding and exercisable at January 5,
2007:
Options Outstanding Options Exercisable
---------------------------------------------- ----------------------------
Number Weighted Avg. Number
Range of Outstanding Remaining Weighted Avg. Exercisable Weighted Avg.
Exercise Prices at 1/5/07 Contractual Life Exercise Price at 1/5/07 Exercise Price
- ---------------- ----------- ---------------- --------------- ----------- ---------------
5.66 to $8.48 222,023 3.46 $ 7.91 173,091 $ 7.98
8.49 to $11.30 459,379 2.95 $ 9.88 355,316 $ 9.94
11.31 to $14.13 639,569 2.14 $ 13.05 587,819 $ 13.07
14.14 to $16.95 816,943 2.87 $ 14.79 740,593 $ 14.75
16.96 to $19.78 86,600 0.48 $ 17.64 86,500 $ 17.64
----------- -----------
2,224,514 1,943,319
=========== ===========
The aggregate intrinsic value is defined as the difference between the
market value of the Company's stock as of the end of the period and the
exercise price of the stock options. This value for stock options
outstanding and exercisable as of January 5, 2007 was $10.3 million and
$9.4 million, respectively. The total intrinsic value of stock options
exercised during the year ended 2006 was $60.4 thousand. As a result of the
stock options exercised, the Company recorded common stock and additional
paid-in-capital of $190 thousand, which includes $16 thousand of tax
benefits recognized. During years ended January 5, 2007, 2006 and 2005,
cash received from stock options exercised was $0.2 million, $2.2 million
and $1.8 million, respectively.
During fiscal 2006, the Company recorded compensation expense, net of an
estimated forfeiture rate of 18.5%, related to stock options (vested
portion) of $1.25 million.
The weighted average fair value at date of grant for options granted during
fiscal 2006, 2005 and 2004 was $3.26, $5.17 and $3.48, respectively.
The unissued preferred stock carries certain voting rights and has
preferences with respect to dividends and liquidation proceeds.
17. Contingencies
The Company is party to various negotiations, customer bankruptcies and
legal proceedings in the normal course of business. Management believes
these matters will not have a material adverse effect on the Company's
financial position or results of operations.
18. 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.
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 and
annual external financial statement reporting purposes.
During fiscal 2005, the Company realigned its management and reporting
responsibilities into functional lines: Sales, Service Operations, Finance
and Administrative. Management and the board of directors now review
operating results on a consolidated basis. As a result the Company
determined it had one operating segment and the Company now reports one
reportable segment.
F. 25