Item 1. Business.
Overview
Merisel, Inc., a Delaware corporation and a holding company (together with its subsidiaries, "Merisel" or the "Company"), is a software licensing solution provider. The Company operates its software licensing business through its main operating subsidiary Merisel Americas, Inc. ("Merisel Americas"). Until July 28, 2001, the Company also operated a Canadian distribution business, which distributed computer hardware and software products to a broad range of reseller customers in Canada. In addition, prior to 2001 the Company operated a full-line U.S. computer products distribution business which, excluding software licensing, the Company determined to wind down in December 2000.
Merisel's software licensing business provides U.S. customers with nearly 20,000 licensing products from leading software publishers, including Microsoft, Lotus/IBM, Network Associates, Executive Software, Macromedia, Borland, Computer Associates, Corel, Panda Software and Symantec. The software licensing business involves the sale of multiple end user licenses for software products and requires minimal distribution of boxed product. Merisel began operating its software licensing business as a separate division of its U.S. distribution business in 1997 and, by 1999, it had earned the reputation as a leader in operational efficiency and customer service. Today, Merisel's software licensing business is focused on leveraging its positive reputation in the marketplace and growing revenues in key vertical markets in support of software publisher strategies.
The Company's net sales were approximately $81.6 million in 2002 and $96.0 million in 2003. In 2002, the Company changed its fiscal year from the Saturday closest to December 31 to December 31. The Company had net sales on December 31, 2001 of $929,000 or 1.14% of total net sales, which were included in net sales for fiscal year 2002 due to this change.
As a result of the sale of Merisel Open Computing Alliance ("MOCA"), a distributor of Sun Microsystems products, and the Canadian distribution business and the wind-down of its U.S. distribution business, excluding software licensing, the Company has substantial cash balances that are in excess of what it believes it requires for liquidity for its ongoing business and to meet obligations related to the wind-down. The Company is actively seeking and exploring acquisition and other investment opportunities, primarily outside the computer products distribution industry.
For a discussion of certain business and other factors that may have an adverse effect on the Company, see "Certain Business Factors" and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations."
The Company files annual, quarterly and special reports, proxy statements and other information with the SEC. The Company's SEC filings are available free of charge to the public over the Internet at the SEC's website at http://www.sec.gov. Our SEC filings can also be accessed on Merisel's website at http://www.merisel.com by a link to the SEC's website as soon as they are filed with or furnished to the SEC. You may also read and copy any document Merisel files with the SEC at its public reference rooms in Washington, D.C., New York, NY and Chicago, IL. Please call the SEC at (800) SEC-0330 for further information on the public reference rooms.
Background and Business Strategy
General. The Company was incorporated in 1980 under the name Softsel Computer Products, Inc. and changed its name to Merisel, Inc. in 1990 in connection with the acquisition of Microamerica, Inc. ("Microamerica"). In the years following the Microamerica acquisition, the Company's revenues increased rapidly through both internal growth and acquisition. This increase reflected the substantial growth in both domestic and international sales as the worldwide market for computer products expanded and manufacturers increasingly turned to wholesale distributors for product distribution. From 1996 through the first quarter of 1997, the Company engaged in the process of divesting of its operations outside of the United States and Canada and its non-distribution operations, which resulted in the Company's operations being focused exclusively in the United States and Canada and consisting of three distinct business units: United States distribution, Canadian distribution and MOCA. On October 27, 2000, the Company completed the sale of its MOCA business unit to Arrow Electronics, Inc. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview."
In December 2000, the Company determined that, primarily as a result of a significant contraction in sales and continuing substantial operating losses, the U.S. distribution business would focus solely on software licensing and that the balance of the U.S. distribution business would be wound down. Although the wind-down was substantially completed by the end of the first
quarter of 2001, the Company has substantial remaining obligations related to the U.S. distribution business, primarily with respect to leases and vendors. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." As part of the wind-down, the U.S. distribution business sold all of its non-software licensing inventory and discontinued all of its non-software licensing manufacturer relationships.
On July 28, 2001, the Company sold its Canadian distribution business ("Merisel Canada") to SYNNEX Information Technologies, Inc. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Overview."
Through its subsidiary Optisel, Inc. ("Optisel"), in November 2000, the Company acquired substantially all the e-services assets of Value America, Inc. with the intention of leveraging the Company's distribution and logistics capabilities to operate a logistics and electronic services business. In connection with the sale of the MOCA business to Arrow in October 2000, the Company entered into a transition services agreement with Arrow pursuant to which Optisel provided fee-based distribution and logistics services and information technology services for MOCA through February 1, 2002. In connection with the sale of Merisel Canada to Synnex, Merisel and Synnex entered into a fee-based transition services agreement pursuant to which Optisel provided information technology services to Merisel Canada through September 10, 2001. Optisel did not generate any significant revenue except under these two transition services agreements. As a result of economic conditions and Optisel's lack of success in generating Internet-related business, the Company decided to discontinue operation of the Optisel business during the fourth quarter of 2001.
Software Licensing. During 2000, the Company's software licensing business was adversely affected by the contraction of the U.S. distribution business and the termination of many vendor relationships. Net sales for the U.S. software licensing business were approximately $68 million, $68 million and $56 million for the first, second and third quarters of 2000, respectively, and declined to $3.2 million for the fourth quarter of 2000. Despite the precipitous decline in net sales for the U.S. software licensing business, the Company determined that, with its strong reputation in software licensing and its positive relationships with many key software publishers, the business had the potential to be returned to a successful business model, albeit on a much smaller scale. Since the fourth quarter of 2000, net sales for the software licensing business have increased significantly to approximately $27.5 million in the fourth quarter of 2003.
Today, Merisel's software licensing business strategy is to (i) grow its customer base and increase its customer loyalty by focusing on providing superior customer service and (ii) reduce its vendor concentration by expanding its product breadth through the development of new relationships with key software publishers. Merisel's strategy includes creating and maintaining a knowledgeable outcall-driven sales team that provides greater value to customers than taking orders.
Merisel currently concentrates its marketing and sales efforts on the security, mobile technology and storage markets due to our expertise and product offerings. The growth of antivirus solutions, content filtering and firewall technology spending is expected to increase significantly in the coming years, and Merisel believes the demand for mobile information services, mobile access to enterprise networks and advanced wireless applications and other mobile technologies will continue to accelerate. Merisel also focuses on creating increasingly efficient systems that take advantage of modern technologies to improve the customer experience.
Acquisition Strategy. At December 31, 2003 the Company had $44,948,000 of cash, which it believes exceeds what it requires for liquidity for its ongoing business and to meet obligations related to the wind-down. The Company also has available a U.S. Federal net operating loss carryforward valued at approximately $266,165,000 at December 31, 2003. The Company is actively seeking and exploring acquisition and other investment opportunities, primarily outside the computer products distribution industry, that will allow it to better utilize some or all of its net operating loss carryforward and cash balances.
The Computer Products Distribution Industry
The Company's software licensing business competes in the computer products industry. The primary participants in the computer products industry are software publishers, wholesale distributors, solution providers and resellers. The supply chain was traditionally based on a model through which software publishers would sell directly to wholesalers, resellers and end users; wholesale distributors would sell to resellers; and resellers would sell to other resellers and directly to end users. As the industry continues to mature, the roles of channel players are becoming less clearly defined. Generally, full-line wholesale distributors purchase a wide range of products in bulk directly from manufacturers and software publishers and then ship products in smaller quantities to many different types of resellers. Solution providers like the Company's software licensing business operate similarly to both wholesale distributors and resellers, but with a narrower product offering. The Company
believes that by focusing solely on software licensing, it has the potential to become a leading solution provider in this important category. As the software industry continues to shift from the sale of boxed product to licensing, the Company believes that its opportunities will increase. Types of resellers include corporate resellers, value-added resellers or "VARs," system integrators, direct marketers, independent dealers, mass merchants and computer chain stores, and resellers conducting business via the Internet ("e-tailers"). Resellers are often further defined and distinguished by the types of value-added services they provide and by the end-user markets they serve, such as large corporate accounts, small to medium-sized businesses, and home users.
Resellers rely on wholesale distributors and/or solution providers for product availability, flexible financing alternatives, technical support, prompt and efficient delivery. In addition, some resellers are increasingly relying on distributors for "back-office" support services, such as product procurement, fulfillment, logistics and a broad product offering. Software publishers benefit from using wholesale distributors and solution providers as an alternative to direct sales to customers by not having to maintain large sales forces, warehouse facilities and financing capabilities. Software publishers also rely on distributors and solution providers to provide marketing and support services as well as credit for customers. Resellers and end users rely on solution providers for in depth product knowledge, customized services, and greater customer support.
The computer products industry has historically experienced double-digit growth throughout North America. However, according to an Equity Research report on Technology Distribution published by Raymond James and Associates, Inc., growth rates were substantially lower during 2000 and were negative during 2001, 2002 and 2003, but are expected to improve moving into 2004. Trends in the computer products supply chain include custom configuration of products by distributors, various supply chain management strategies to eliminate time and cost, and an increase in the use of "eBusiness" solutions. Electronic business, or eBusiness, refers to the use of electronic systems and applications to exchange information and transact business. Electronic business can simplify account set-up, ordering, shipping and support, and thereby facilitate sales while decreasing both selling and purchasing costs. Electronic business continues to increase in significance in the computer products distribution industry.
Products and Suppliers
The Company's software licensing business offers its customers nearly 20,000 products from leading software publishers, including Microsoft, Lotus/IBM, Network Associates, Executive Software, Macromedia, Borland, Computer Associates, Corel, Panda Software and Symantec. The software licensing business involves the sale of multiple-end user licenses for software products, generally for installation on multiple systems, and requires minimal distribution of boxed software product. Prior to the contraction of the Company's U.S. distribution business during 2000, Merisel's U.S. software licensing business offered products from 21 software publishers and ranked number one in software licensing sales for key software publishers such as Microsoft and Novell. Although many of these distribution arrangements were terminated during 2000, management of Merisel's software licensing business has maintained positive relationships with many key software publishers beyond the software publishers whose products it currently distributes.
Merisel enters into written agreements with the software publishers of the products it sells. As is customary in the industry, these agreements usually provide non-exclusive rights and often contain territorial restrictions that limit the countries in which Merisel is permitted to sell the products. The Company's suppliers generally warrant the products sold by the Company and allow the Company to return defective products, including those that have been returned to the Company by its customers, as well as products discontinued by the supplier. Because software licensing involves very limited distribution of boxed product, the Company maintains minimal inventory, most of which consists of documents and software media that may be shipped in connection with a software license purchase. Accordingly, unlike the computer products industry generally, there is little, if any, risk of loss due to slow-moving inventory, supplier price reductions, product updates or obsolescence. The Company's agreements with its suppliers, which typically have a term of at least one year, generally contain provisions permitting early termination by either party upon written notice.
The Company's software licensing business provides software publishers with access to Merisel's customer base, as well as the means to reduce credit, marketing and overhead costs typically associated with maintaining direct customer relationships. Merisel develops and implements marketing and sales programs for specific software publishers to increase customer purchasing depth and breadth. Programs include bundled offers, growth-goal incentives, telemarketing campaigns, web advertising and customer training events as well as channel communication vehicles such as targeted direct mail, e-mail blasts, webcasts, monthly newsletters and advertising.
The sale of products supplied by two of the Company's vendors, Network Associates and Symantec, accounted for approximately 93.5% and 1.0% in 2003, 79.8% and 13.8% in 2002 and 71.2% and 23.4% in 2001, respectively, of net sales for the Company's U.S. software licensing business. Despite the loss of a direct relationship between the Company and Symantec effective during the third quarter of 2002, the Company experienced overall sales and margin growth during the fourth quarter of 2002. However, the loss of a direct relationship with its remaining primary vendor could have a material adverse impact on the Company's business and financial results. During the first quarter of 2004, the Company was notified of impending changes in the channel which will impact a number of the products it currently distributes. Because of these changes, typical seasonality, and changes in the Company's sales organization, the Company expects to experience a decline in revenue and margin during the first quarter of 2004. See Item 1 - "Certain Business Factors - Dependence on Key Software publishers."
Customers and Customer Services
With the dramatic decline in net sales of the software licensing business as the U.S. distribution business contracted in 2000, the number of active customers declined to a fraction of prior levels. The software licensing business is focused on reestablishing customer relationships and broadening its customer base through proactive marketing to prospective new customers. Merisel's customer base is largely comprised of, and Merisel's recruitment efforts are mainly focused on, value-added customers that service small-to-medium size businesses and enterprise solution providers. In the computer products industry generally, larger customers often establish direct relationships with software publishers for their more popular products but utilize distributors and/or software solution providers for slower-moving products and for fill-in orders of fast-moving products that may not be available on a timely basis from software publishers. Customer service (particularly with respect to the complexities of software publishers' licensing processes), quick response to bid requests, and electronic ordering capabilities are critically important to software licensing customers. Merisel has had a long-standing reputation as a leader in these areas and is currently leveraging this positive reputation in the marketplace to rebuild and grow its software licensing business.
Merisel generally does not have contracts with its customers. Merisel's largest customers include Comp-E-Ware, Expert Networks, Future Com, PC Connection, Softchoice, Software House International and Software Spectrum. Merisel's top 10 customers for its software licensing business accounted for 71.8% of total software licensing net sales in 2003. Merisel had two customers for its software licensing business that individually accounted for more than 10% of total U.S. software licensing net sales in 2003, accounting for 25.2% and 15.7% of net sales. Merisel's top 10 customers for its software licensing business accounted for 64.8% of total software licensing net sales in 2002. Merisel had one customer for its software licensing business that accounted for more than 10% of total U.S. software licensing net sales in 2002, accounting for 19.8% of net sales. Merisel's top 10 customers for its software licensing business accounted for 76.0% of total software licensing net sales in 2001. Merisel had two customers for its software licensing business that accounted for more than 10% of total U.S. software licensing net sales in 2001, accounting for 24.2% and 15.0% of net sales. The loss of one or more of the Company's major customers could have a material adverse effect on the Company. See Item 1 "Certain Business Factors - Dependence on Major Customers."
Single-Source Provider. The software licensing products currently offered by Merisel fall mainly in the categories of anti-virus, desktop applications, graphics, IT management, security, storage and storage management, system utilities, system applications and web-based solutions products. Merisel believes that, while it is no longer a full-line distributor of computer hardware and software products, it can offer significant value by becoming a single-source provider of software licensing products to its customers and focusing on providing superior customer service for software licensing only. Merisel is focused on reestablishing relationships with major software publishers whose products it does not currently distribute and establishing relationships with software publishers in emerging technologies in order to expand its product offering.
Customers and Sales Organizations. Merisel's software licensing business caters specifically to customers who serve the software needs of corporate, institutional and government clients. This business serves its customers through a team of highly trained sales representatives that receive cross-training on all of the products sold through the business. This cross training is unique in the industry and leads to enhanced customer service with every sales representative trained to assist customers with every software product. Merisel's team of licensing professionals is dedicated to servicing and supporting customers through a customer-centric approach that focuses on thoroughly understanding vendor solutions as well as the needs of the reseller and its customers. The sales team's efforts include the introduction of new products and programs to expand the customers' product offerings and enhance their value proposition to their customers.
Financing Programs. Merisel offers various credit terms to qualifying customers and also sells on a pre-pay and credit card basis. Merisel's credit policy for qualified customers allows them to use their Merisel credit line for software licensing purchasing, increasing their credit availability to be used for other products with full-line distributors. With respect to credit sales, the Company attempts to control its bad debt exposure by monitoring customers' creditworthiness and, where practicable, through participation in credit associations that provide customer credit rating information for certain accounts. The Company establishes reserves for estimated credit losses in the normal course of business. If the Company's receivables experience a substantial deterioration in their collectibility, the Company's financial condition and results of operations may be adversely impacted. See Item 1. "Certain Business Factors - Dependence on Major Customers; - Customer Credit Exposure."
Information Services. Merisel provides its customers with state-of-the-art e-business solutions. The Company's Web site provides information on Merisel's programs and services, strategic announcements, publisher products and links, and access to SELline, the Company's advanced on-line configuration, query and procurement tool. SELline offers secure, 24-hour access and real-time interfaces to Merisel's information technology systems so that customers can identify products, place quotations and orders and review order and shipment status at their convenience. Software publishers' up-to-date promotions, product news, programs and trial download information are listed on SELline to help educate customers. The Company also offers various types of electronic interfaces with its partners, including EDI, XML, and flat file. In addition, Merisel is the only self-hosted solution provider for Network Associates. In this capacity, the Company deploys McAfee's anti-virus managed services to the end user on behalf of the reseller.
Operations and Systems
Merisel has made significant investments in advanced ERP, warehouse management, and customer relationship management systems to support sales growth and improve service levels. Merisel's distribution center is co-located with its offices in El Segundo, California and utilizes a computerized warehouse management system to improve shipping, receiving and picking accuracy rates.
The Company utilizes an SAP R/3 enterprise-wide information system that integrates all functional areas of the business, including sales and distribution, inventory management, financial services and marketing, in a real-time environment. The system is designed to support business growth by providing greater functionality, up-to-date technology, increased flexibility and enhanced reporting capabilities. SAP has provided a solid base for application development, allowing Merisel to expedite the development cycle for functionality improvements in the system. The Company's SAP system performs with sub-second, on-line response time. Availability for all of Merisel's core systems has averaged 99.9 percent or above since April 1999. SAP also enforces a high degree of data integrity, which better supports Merisel's reporting needs. The Company is currently on the 4.6D version of SAP.
Competition
Competition in the computer products distribution industry is intense. Key competitive factors in the distribution of software licenses include price, breadth of products, credit availability and financing options, availability of technical support and product information, marketing services and programs, and ability to influence a buyer's decision.
Certain of Merisel's competitors have substantially greater financial resources and broader product offerings than Merisel. Merisel's principal competitors for software licensing business include large United States-based distributors such as Ingram Micro and Tech Data, as well as a number of regional distributors and resellers. Because of the nature of software licensing, Merisel competes with software publishers that sell directly to computer resellers and end users to a more limited extent than in other areas of computer products distribution. See Item 1. "Certain Business Factors - Size of Competitors."
Variability of Quarterly Results and Seasonality
Historically, the industry in which the Company operates has experienced variability in its net sales and operating margins on a quarterly basis and the Company expects these patterns to continue in the future with respect to its software licensing business. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Variability of Quarterly Results and Seasonality."
Employees
As of March 26, 2004, Merisel had approximately 40 employees. Merisel continually seeks to enhance employee morale and strengthen its relations with employees. None of the employees are represented by unions and Merisel considers its employee relations to be good.
Environmental Compliance
The Company believes that it is in substantial compliance with all material environmental laws applicable to it and its operations.
Certain Business Factors
In addition to the other information in this report, readers are cautioned to carefully consider the following business factors that may affect the future operations and performance of the Company.
Size of Software Licensing Business. The Company's software licensing business is not currently profitable and is not generating sufficient revenue to cover selling, general and administrative expenses and other costs required to operate this business. The Company believes that, in order to compete effectively in software licensing, it must maintain high service levels, specialized sales and marketing infrastructure, specific software licensing management expertise, and state-of-the-art information technology capabilities that entail fixed costs that cannot be further reduced significantly. To become profitable, the Company's software licensing business must grow significantly and the Company must add key software publishers. The Company believes that it will only be able to achieve revenue levels that will allow its software licensing business to be profitable if the Company is successful in adding new vendors. There is no assurance that the Company will be successful in doing so.
Dependence on Major Customers. For 2003, 10 customers accounted for approximately 71.8% of the Company's revenues, with the top two customers individually accounting for approximately 25.2% and 15.7%. The Company is focused on increasing its customer base and decreasing the percentage of net sales and receivables attributable to a small number of customers. Until that has been accomplished, however, the loss of one or more of the Company's major customers could have a material adverse effect on the Company.
Dependence on Key Software Publishers. In 2003, 93.5% of Merisel's sales were derived from products supplied by its largest vendor. As is customary in the industry, the Company's agreements with these vendors provide non-exclusive distribution rights and may be terminated by either party on short notice. The termination of the Company's distribution agreement with its key vendor, or a material change in the terms of the distribution agreement, including a decrease in rebates, could have a material adverse effect on the Company.
Customer Credit Exposure. Substantially all of the Company's sales are financed by the Company. As a result, the Company's business could be adversely affected in the event of the deterioration of the financial condition of one or more of its customers, particularly one of the Company's larger customers, resulting in the customer's inability to pay amounts owed to the Company. This risk would be increased in the event of a general economic downturn affecting a large number of the Company's customers. At December 31, 2003, the Company's two largest customers combined represented 43.2%, or $8,941,000, of the Company's total trade receivables. On March 15, 2004, the Company was notified by one customer, with a current outstanding accounts receivable balance of approximately $746,000, that it does not have sufficient liquidity to repay the amount it owes the Company, and has requested an extended repayment plan. There is no assurance that the customer's restructured business plan will be successful or that the amounts owed will be collected. The Company believes, taking into consideration all factors mentioned above, it has established an adequate reserve against the December 31, 2003 accounts receivable balance.
Size of Competitors. The Company's competitors in its software licensing business include distributors with businesses that are substantially larger than the Company's. Because of their size and the fact that many of these larger competitors operate world-wide businesses, these firms can achieve greater economies of scale than the Company, allowing them to offer more favorable pricing and other terms to resellers, and may be able to form stronger relationships with software publishers. The Company believes that it can achieve operating expense levels as a percentage of sales as low as those that can be achieved by its much larger competitors only if it significantly increases its revenues. See "Competition" above.
Gross Margin Pressure. Historically, the computer distribution industry in general and the Company in particular have experienced declines in gross margins. The decline has resulted in part from a reduction in publisher rebates and changes by software publishers in terms and conditions, which have resulted in a shift of costs to distributors, solution providers and resellers; in addition, economies of scale achieved by growing distributors have decreased their costs and allowed them to sell products at lower gross margins. Merisel attempts to address the gross margin issue through pricing and other actions. However, because of the size of Merisel's business relative to its largest competitors and Merisel's need to significantly increase its revenues in order for its software licensing business to become profitable, the Company is particularly vulnerable to competitive pricing actions of its competitors.
Acquisition Strategy. Any failure by us to successfully complete acquisitions that enhance our businesses prospects could harm our business and financial prospects. As part of our business strategy, we frequently engage in discussions with third parties regarding possible acquisitions in order to further our strategic objectives. In order to pursue this strategy successfully, we must identify suitable acquisition candidates, complete these transactions, some of which may be large and complex, and integrate the acquired companies. Integration and other risks of acquisitions can be more pronounced for larger and more complicated transactions, or if multiple acquisitions are pursued simultaneously.
Integration issues are complex, time-consuming and expensive and, without proper planning and implementation, could significantly disrupt our business. The challenges involved in integration include:
o demonstrating to customers and software publishers that the transaction will not result in adverse changes in client service standards or business focus and helping customers conduct business easily;
o consolidating and rationalizing corporate IT infrastructure, including implementing information management and system processes that enable increased customer satisfaction, improved productivity and lower costs;
o consolidating administrative infrastructure, including IT systems, and manufacturing operations and maintaining adequate controls throughout the integration;
o coordinating sales and marketing efforts to communicate our capabilities effectively;
o preserving marketing or other important relationships and resolving potential conflicts that may arise;
o minimizing the diversion of management attention from ongoing business concerns;
o persuading employees that business cultures are compatible, maintaining employee morale and retaining key employees while implementing restructuring programs;
o coordinating and combining operations, subsidiaries and affiliated entities, relationships and facilities, which may be subject to additional constraints imposed by local laws and regulations and also may result in contract terminations or renegotiations and labor and tax law implications; and
o managing integration issues shortly after or pending the completion of other independent reorganizations.
Even if an acquisition is successfully integrated, we may not receive the expected benefits of the transaction. Managing acquisitions requires varying levels of management resources, which may divert our attention from other business operations. These transactions may result in significant costs and expenses and charges to earnings. As a result of the foregoing, any completed, pending or future transactions may contribute to financial results that differ from the investment community's expectations in a given quarter.
Economic Downturn. The economic downturn could adversely affect our revenue, gross margins and expenses. Our revenue and gross margins depend significantly on the overall demand for software products and services. Softening demand for our products and services caused by the ongoing economic downturn may result in decreased revenue, earnings or growth rates and problems with our ability to realize customer receivables. The economy has weakened and market conditions continue to be challenging. As a result, individuals and companies are delaying or reducing expenditures, including those for information technology. In addition, if our customers experience financial difficulties, we could suffer losses associated with the outstanding portion of accounts receivable. During the current downturn, we have experienced gross margin declines,
reflecting the effect of competitive pressures. Our selling, general and administrative expenses have been impacted due in part to an increase in bad debt write-offs and additions to reserves in our receivables portfolio. Further delays or reductions in information technology spending could have a material adverse effect on demand for our products and services and consequently our results of operations, prospects and stock price.
Terrorist Acts. Terrorist acts and acts of war may seriously harm our business and revenue, costs and expenses and financial condition. Terrorist acts or acts of war (wherever located around the world) may cause damage or disruption to the Company, our employees, facilities, partners, suppliers or customers, which could significantly impact our revenue, costs and expenses and financial condition. The terrorist attacks that took place in the United States on September 11, 2001 were unprecedented events that have created many economic and political uncertainties, some of which may materially harm our business and results of operations. The long-term effects on our business of the September 11, 2001 attacks are unknown. The potential for future terrorist attacks, the national and international responses to terrorist attacks or perceived threats to national security, and other acts of war or hostility have created many economic and political uncertainties that could adversely affect our business and results of operations in ways that cannot presently be predicted.
Business Disruptions. Business disruptions could seriously harm our future revenue and financial condition and increase our costs and expenses. Our operations could be subject to natural disasters and other business disruptions, which could seriously harm our revenue and financial condition and increase our costs and expenses. Our corporate headquarters are located in California, near major earthquake faults. The ultimate impact on us, our significant suppliers and our general infrastructure of being located near major earthquake faults is unknown, but our revenue and financial condition and our costs and expenses could be significantly impacted in the event of a major earthquake. In addition, some areas, including California, have experienced, and may continue to experience, ongoing power shortages, which have resulted in "rolling blackouts." These blackouts could cause disruptions to our operations or the operations of our software publishers or customers. We maintain insurance for losses and interruptions caused by certain types of business interruptions; however, there is no assurance that a particular loss may be insured.
Item 2.
Item 2. Properties.
The Company's headquarters and distribution center are located in El Segundo, California, where the Company leases a 50,700 square-foot facility. This lease will expire on November 1, 2004. The Company expects to either extend its current lease or enter into a new lease agreement at another location on or before this date. Based on the current size of the Company, it is estimated that approximately 15,000 square feet will be required and will be leased at substantially the same cost per square foot as the current lease, including $15-$25 per square foot of leasehold improvements. The Company owns 29 acres of undeveloped land in Cary, North Carolina, which the Company is seeking to sell. The Company believes that its facilities provide sufficient space for its present needs. Based on current growth rates, and excluding acquisitions, the Company expects to have capital expenditures of approximately $350,000 for the software licensing business over the next three years, the majority of which will be incurred during the next twelve months.
Item 3.
Item 3. Legal Proceedings.
In February 2004, the Company was served with a summons and complaint in an adversary proceeding captioned Bridge Information Systems, Inc. et al, Debtor, Scott P. Peltz, Chapter 11 Plan Administrator v. Merisel Americas, Inc. and MOCA (the "Complaint"). The Complaint was filed in the United States Bankruptcy Court, Eastern District of Missouri, Eastern Division, Case No. 01-41593-293. The Complaint alleges that Debtor made preferential transfers of money to Merisel Americas, Inc. ("Americas") in the amount of approximately $6.3 million and an additional amount to MOCA, a former subsidiary of Americas, which were avoidable and seeks to recover such transfers. The Company believes that any such transfers alleged in the Complaint are the obligations of MOCA and not that of the Company. The Company has been advised by counsel to Arrow Electronics, Inc. ("Arrow"), the parent company of MOCA, that Arrow has agreed to provide indemnification to the Company with respect to the allegations set forth in the Complaint.
The Company is involved in certain legal proceedings arising in the ordinary course of business, and in connection with discontinued vendors related to the Company's wound down business, none of which is expected to have a material impact on the financial condition or results of operations of Merisel. The Company made estimates of its potential exposures and has established reserves for potential losses related to such proceedings. There can be no assurance that the Company's reserves will fully cover any possible exposure.
In addition, over the last several years the Company has disposed of a number of businesses, including all of its operations outside the United States, many of which had obligations that had been guaranteed by the Company. In connection with those dispositions, the Company sought either to have any guarantees released or to be indemnified against any liabilities under guarantees. The Company may not have identified all guarantees to be released and, in at least one instance, the indemnification provided to the Company is no longer of any value. Due to the nature of these indemnifications, the Company's exposure under the agreements cannot be estimated and no amounts have been recorded for such indemnities.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.
The Company's Common Stock is traded on the National Market tier of the Nasdaq Stock Market under the symbol "MSEL". The following table sets forth the quarterly high and low sale prices for the Common Stock as reported by the National Market. All stock prices are closing prices per The Nasdaq National Market.
High Low Fiscal Year 2002 First quarter.... 2 5/16 1 1/2 Second quarter... 3 3/4 2 Third quarter.... 3 3/4 1 7/16 Fourth quarter... 2 1/4 1 1/4
Fiscal Year 2003 First quarter.... 3 1/2 1 7/8 Second quarter... 4 9/16 2 1/16 Third quarter.... 6 1/16 4 1/4 Fourth quarter... 7 1/4 4 7/8
The last reported sale price of the Company's Common Stock on the Nasdaq National Market on March 26, 2004 was $5.15 per share. As of March 26, 2004, there were 876 record holders of the Company's Common Stock. This number does not include beneficial owners of the Company's Common Stock which is held in nominee or "street" name accounts through brokers.
Merisel has never declared or paid any dividends on its Common Stock and does not anticipate paying dividends on the Common Stock in the foreseeable future.
(1) For the years 1999 through 2001, Merisel's fiscal year was the 52- or 53-week period ending on the Saturday nearest December 31. For clarity of presentation throughout this Annual Report on Form 10-K, Merisel described these fiscal years presented as if the year ended on December 31. All fiscal years presented were 52 weeks in duration. Effective for the year ended December 31, 2002 the Company changed its fiscal year end to a calendar year end of December 31. This change did not have a material effect on the results presented. Additionally, the selected financial data set forth above includes those balances and activities related to the Company's wholly owned subsidiary Merisel Canada through its disposal as of July 28, 2001.
(2) The Company has reclassified its consolidated financial statements to exclude results related to the MOCA and Optisel business units, which are included in discontinued operations.
(3) The Company has reclassified certain items in its 2001 and 2002 consolidated financial statements to conform to the 2003 presentation pursuant to EITF 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor. These reclassifications principally consist of costs associated with consideration received from vendors. The impact to the 2001 consolidated financial statements is to decrease cost of goods sold by $9,000 and to decrease interest income by $9,000. The impact to the fiscal year 2002 consolidated financial
statements is to decrease cost of goods sold by $1,082,000, to increase general and administrative expenses by $43,000 and to decrease interest income by $1,039,000. Amounts in 1999 and 2000 were not determinable and have not been reclassified.
(4) The Company early adopted Statement of Financial Accounting Standard No. 145, "Reporting Gains and Losses from Extinguishment of Debt" in 2002. The adoption resulted in the retroactive reclassification of gain on debt extinguishment from an extraordinary item to a component of operations.
(5) Per share amounts and weighted average common shares outstanding calculations reflect the impact of a one-for-ten reverse stock split that was effective February 14, 2001.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
For an understanding of the significant factors that influenced the Company's performance during the past three years, the following discussion and analysis should be read in conjunction with Item 6.
Item 7A. Quantitative and Qualitative Market Risk Disclosure
Investments
At December 31, 2003, the Company had cash investments of $43,904,000 held in overnight, interest-bearing accounts invested through high-credit quality financial institutions. Additionally, the Company had cash balances of $1,044,000 maintained in various checking accounts at December 31, 2003.
Item 8.
Item 8. Financial Statements and Supplementary Data.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Merisel, Inc.: El Segundo, California
We have audited the accompanying consolidated balance sheets of Merisel, Inc. and subsidiaries as of December 31, 2002 and 2003, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the index at Item 15(a)(2). These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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, such consolidated financial statements present fairly, in all material respects, the financial position of Merisel, Inc. and subsidiaries at December 31, 2002 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 1, during the year ended December 31, 2000 the Company decided to cease activities associated with virtually all of its United States distribution business excluding software licensing. Additionally the Company sold its MOCA business unit effective October 27, 2000. The gain on the sale and results of operations of MOCA prior to the sale are included in discontinued operations in the accompanying consolidated statements of operations. During the year ended December 31, 2001, the Company discontinued its Optisel business. The results of operations of Optisel are included in discontinued operations in the accompanying consolidated statements of operations. Also, effective July 28, 2001 the Company completed the sale of Merisel Canada.
DELOITTE & TOUCHE LLP
Los Angeles, California March 26, 2004
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
MERISEL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (In thousands, except share data)
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2002 and 2003
1. Description of Business and Basis of Presentation
General-- The Company was founded in 1980 as Softsel Computer Products, Inc. and changed its name to Merisel, Inc. in 1990 in connection with the acquisition of Microamerica, Inc. ("Microamerica"). From 1996 through the first quarter of 1997, the Company engaged in the process of divesting of its operations outside of the United States and Canada and its non-distribution operations, which resulted in the Company's operations being focused exclusively in the United States and Canada and consisting of three distinct business units: United States distribution, Canadian distribution and the Merisel Open Computing Alliance ("MOCA"). On October 27, 2000, the Company completed the sale of its MOCA business unit to Arrow Electronics, Inc. ("Arrow"). Additionally, on December 14, 2000, the Company announced that the U.S. distribution business would focus solely on software licensing and that the balance of the U.S. distribution business would be wound down. Effective as of July 28, 2001, the Company completed the sale of its Canadian distribution business ("Merisel Canada") to Synnex Information Technologies, Inc. ("Synnex"). On November 10, 2000, the Company acquired substantially all the e-services assets of Value America, Inc. through the Company's newly formed subsidiary Optisel with the intention of leveraging the Company's distribution and logistics capabilities to operate a logistics and electronic services business. The acquisition was accounted for as a purchase and the purchase price, including assumption of certain liabilities, was $2,375,000. As a result of economic conditions generally and with respect to Internet-related businesses specifically and Optisel's lack of success in generating business, the Company decided to discontinue operation of the Optisel business during the fourth quarter of 2001. As a consequence of the foregoing events, Merisel's only business today is its software licensing business. The Company is, however, actively seeking and exploring acquisition and other investment opportunities, primarily outside the computer products distribution industry.
The consolidated financial statements retroactively reflect the effect of the one-for-ten reverse stock split, which was effective February 14, 2001. Accordingly, all disclosures involving the number of shares of Merisel common stock outstanding, issued or to be issued, and all per share amounts, retroactively reflect the impact of the reverse stock split.
Consolidation Policy - The consolidated financial statements include the accounts of Merisel Americas, Inc., Merisel Properties, Inc. and Merisel Corporate. All material intercompany accounts and transactions have been eliminated in consolidation.
Management's Plans--As stated previously, on December 14, 2000, the Company announced its decision to wind down virtually all of its U.S. distribution business, excluding software licensing. As a result of that decision, the decision to discontinue Optisel and the sales of MOCA and Merisel Canada, the Company's current operations consist of its software licensing distribution business. Primarily as a result of wind-down related gains of $4,481,000 and income from discontinued operations of $275,000 recognized in 2003, the Company had net income available to common stockholders of $1,246,000, after preferred stock dividends of $1,514,000, which decreased its accumulated deficit to $252,799,000 at December 31, 2003.
The Company has developed an operating plan for 2004 that focuses upon growing its software licensing distribution business, maximizing cash in winding down its U.S. distribution business, and seeking acquisition opportunities. At December 31, 2003, the Company had approximately $44,948,000 of cash and cash equivalents on hand. Management believes that, with its cash balances and anticipated cash balances after wind-down related expenditures, which balances are substantial in relation to the Company's working capital needs, as well as expected revenues and cash flow from operations, it has sufficient liquidity for the foreseeable future. If the Company were to use a significant amount of cash to fund one or more acquisitions, the Company could have less liquidity to meet its working capital needs.
2. Summary of Significant Accounting Policies
Risks and Uncertainties--In 2003, 93.5% of the Company's software licensing net sales were derived from products supplied by one vendor. The termination of the Company's distribution agreement with its key vendor, or a material change in the terms of the distribution agreement, including a decrease in rebates, could have a material adverse effect on the Company. For
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2003, 10 customers accounted for approximately 71.8% of the Company's net sales, with the top two customers individually accounting for approximately 25.2% and 15.7% of net sales. The Company is focused on increasing its customer base and decreasing the percentage of revenues and receivables concentrated with a small number of customers. Until that has been accomplished, the loss of one or more of the Company's major customers could have a material adverse effect on the Company. Substantially all of the Company's software licensing net sales are financed by the Company. As a result, the Company's business could be adversely affected in the event of the deterioration of the financial condition of one or more of its customers, particularly one of the Company's larger customers, resulting in the customer's inability to pay amounts owed to the Company. This risk would be increased in the event of a general economic downturn affecting a large number of the Company's customers.
Concentration of Credit Risk-- Financial instruments that subject the Company to credit risk consist primarily of cash equivalents and trade accounts receivable. The Company invests its excess cash with high-quality financial institutions and actively evaluates the creditworthiness of the financial institutions with which it conducts business. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses; however, credit risk with respect to trade accounts receivable is currently a significant risk to the Company. At December 31, 2003, the Company's two largest customers combined represented 42.8%, or $8,941,000, of the Company's total trade receivables. On March 15, 2004, the Company was notified by one customer, with a current outstanding accounts receivable balance of approximately $746,000, that it does not have sufficient liquidity to repay the amount it owes the Company and has requested an extended repayment plan. There is no assurance that the customer's restructured business plan will be successful or that the amounts owed will be collected. The Company believes, based on historical write-offs and identified credit risks, it has established an adequate reserve against the December 31, 2003 accounts receivable balance.
Use of Estimates--The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include the allowance for doubtful accounts and certain amounts related to restructuring and wind-down activities recorded in accounts payable and accrued liabilities.
Fiscal Periods-- Effective December 31, 2002, the Company's fiscal year ends on December 31 and its fiscal quarters end on March 31, June 30, September 30 and December 31. Prior to December 31, 2002, the Company's fiscal year was the 52-week period ending on the Saturday nearest to December 31 and its fiscal quarters were the 13-week periods ending on the Saturday nearest to March 31, June 30, September 30 and December 31. For clarity of presentation of prior years, the Company has described fiscal years presented as if the years ended on December 31 and fiscal quarters presented as if the quarters ended on March 31, June 30, September 30 and December 31.
Cash and Cash Equivalents--The Company considers all highly liquid investments purchased with initial maturities of three months or less to be cash equivalents. The Company invests excess cash in interest-bearing accounts. Interest income earned on cash balances for 2001, 2002 and 2003 was $1,578,000, $829,000 and $752,000, respectively.
Inventories--Inventories are valued at the lower of cost or market. Cost is determined using the average cost method.
Property and Depreciation--Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally three to ten years. Leasehold improvements are amortized over the shorter of the life of the lease or the improvement.
Investments - As of December 31, 2002 and 2003, other assets include approximately $529,000 and $751,000, respectively, of equity securities, classified as available-for-sale. These securities are carried at fair value with any unrealized gain or loss recorded as other comprehensive income (loss).
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Impairment of Long-Lived Assets--The Company reviews the recoverability of long-lived assets to determine if there has been any impairment. This assessment is performed based on the estimated undiscounted future cash flows from operating activities compared with the carrying value of the related asset. If the undiscounted future cash flows are less than the carrying value, an impairment loss is recognized, measured by the difference between the carrying value and the estimated fair value of the assets (see Note 8 - "Impairment Losses").
Vendor Rebates and Promotions - The Company receives income from certain suppliers in the form of rebates, promotions and trade discounts. Agreements are made with each individual supplier and income is earned as buying levels are met and/or marketing costs are incurred. Rebate income, including trade discounts, is recorded as a reduction of cost of sales, and cooperative promotional income is recorded as a reduction of operating expenses. Any amount of cooperative promotional income exceeding related operating expenses is recorded as a reduction of cost of goods sold. Cost of goods sold includes term discounts earned from certain vendors for early payment of accounts payable in the amount of approximately $9,000, $1,039,000 and $1,619,000 for the years ended December 31, 2001, 2002 and 2003, respectively.
Income Taxes--Income taxes are accounted for under an asset and liability approach that requires the recognition of deferred income tax assets and liabilities for the expected future consequences of events that have been recognized in the Company's consolidated financial statements and income tax returns. Management provides a valuation allowance for deferred income tax assets when it is considered more likely than not that all or a portion of such deferred income tax assets will not be realized.
Fair Values of Financial Instruments--Financial instruments include cash and cash equivalents, accounts receivable and investments in securities. The fair values of cash and cash equivalents and accounts receivable approximate their carrying value because of their short-term nature. Investments in securities are recorded at fair market value as determined by quoted market prices.
Foreign Currency Translation--Assets and liabilities of Merisel Canada are translated into United States dollars at the exchange rate in effect at the close of the period. Revenues and expenses are translated at the average exchange rate during the period. The aggregate effect of translating the financial statements at the above rates is included in a separate component of stockholders' equity entitled "Accumulated Other Comprehensive Loss". As previously stated, effective July 28, 2001, the Company completed the sale of Merisel Canada. In the second quarter of 2001, the Company recorded an impairment charge equal to the entire translation adjustment in anticipation of the sale of Merisel Canada.
Foreign Exchange Instruments--At December 31, 2003, the Company had no foreign exchange instruments outstanding. Prior to the sale of Merisel Canada, the Company's use of derivatives was limited to the purchase of spot and forward foreign currency exchange contracts in order to minimize foreign exchange transaction gains and losses. The Company purchased forward Canadian and U.S. dollar contracts to hedge short-term advances to Merisel Canada and to hedge commitments to acquire inventory for sale and did not use the contracts for trading purposes. In 2001 the Company recorded a net foreign currency transaction loss of $229,000. This amount is included in other expense in the accompanying consolidated statements of income.
Revenue Recognition, Returns and Sales Incentives-- The Company derives revenues from software licensing, product updates and customer support services and training and consulting services purchased directly from third party vendors. The Company records revenue from software licensing when there is persuasive evidence of an arrangement, the fee is fixed and determinable, collection is reasonably assured and delivery of the product has occurred (as prescribed by Statement of Position ("SOP") 97-2, "Software Revenue Recognition"). In arrangements that include software licenses and professional services and/or product updates ("multiple elements"), the Company allocates revenue based on vendor specific objective evidence ("VSOE") of fair value of all elements, defers revenue for the undelivered items and recognizes as revenue the fair value of the delivered items based on VSOE of each element determined by the price for which the element is sold separately.
The Company recognizes revenue related to product updates and customer support services that they provide ratably over the term of the arrangement. Revenue from training and consulting services is recognized when the services are completed.
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company recognizes revenue on a gross basis as (a) the Company has sole discretion in determining the price for which it sells software licenses and services, (b) its suppliers impose no control or limitations on the Company's pricing, (c) the Company assumes all credit risk associated with its customers, (d) the Company often actively assists the customer in the selection of its products and services and (e) the Company has the discretion to purchase the products and services it offers from a variety of different suppliers and distributors.
The Company frequently monitors its customers' financial condition and credit worthiness and only sells products, licenses or services to customers where, at the time of the sale, collection is reasonably assured. The Company, subject to certain limitations including approval of its software publishers, may permit its customers to return products and to exchange products or receive credits against future purchases. The Company offers its customers several sales incentive programs that, among other things, include funds available for cooperative promotion of product sales. Customers earn credit under such programs based upon the volume of purchases. The cost of these programs is partially subsidized by marketing allowances provided by the Company's vendors. A provision for estimated product returns and costs of customer incentive programs is recorded concurrently as a component of net sales with the recognition of revenue.
Accounting for Stock-Based Compensation - Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, requires companies to estimate employee stock compensation expense based on the fair value method of accounting. However, the statement allows the alternative of continued use of the intrinsic value method described in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," if pro forma disclosure of fair value amounts is provided. The Company has elected the alternative of continued use of APB Opinion No. 25.
Had compensation cost for the Company's stock option plans been determined based on their fair value at the grant date for options granted in 2001, 2002 and 2003 consistent with the provisions of SFAS No. 123, the Company's net income and net income per share would have been adjusted to the pro forma amounts indicated below:
Reclassifications--Certain reclassifications were made to prior year statements to conform to the current year presentation.
New Accounting Pronouncements-- In April 2002, the FASB issued SFAS No. 145, which rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. A principal effect will be the prospective characterization of gains and losses from debt extinguishments used as part of an entity's risk management strategy. Under SFAS No. 4, all gains and losses from early extinguishment of debt were required to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. Under SFAS No. 145, gains and losses from extinguishment of debt are not classified as extraordinary items unless they meet much more narrow criteria in APB Opinion No. 30. SFAS No. 145 may be adopted early, but is otherwise effective for fiscal years beginning after May 15, 2002, and must be adopted with retroactive effect. The Company elected to adopt the provisions of SFAS No. 145 early, which resulted in the reclassification of $2,872,000 in 2001 related to early extinguishment of debt previously recorded as an extraordinary item to a component of operating income (loss) in the accompanying consolidated statements of income.
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires that costs associated with an exit or disposal activity be recognized when incurred as opposed to an entity's commitment to an exit plan as previously allowed. The provisions of SFAS No. 146 are effective for exit or disposal activities initiated after December 31, 2002, with early application encouraged. The Company's adoption of FSAS No. 146 on January 1, 2003 had no impact on its consolidated financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." This statement amends SFAS No. 123, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. This statement also amends APB Opinion No. 28, "Interim Financial Reporting" to require disclosure about those effects in interim financial statements. SFAS No. 148 is effective for financial statements for fiscal years ending after December 15, 2002. The Company has elected not to change to the fair value based method of accounting for stock-based compensation at this time and has complied with the disclosure requirements of SFAS No. 148.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" which is effective for financial instruments entered into or modified after May 31, 2003 and to all other instruments that exist as of the beginning of the first interim financial reporting period beginning after June 15, 2003. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The Company's adoption of SFAS No. 150 on July 1, 2003 had no impact on its consolidated financial position or results of operations.
In November 2001, the Emerging Issues Task Force ("EITF") issued EITF Issue No. 01-9, "Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor's Products." This new guidance provides that consideration from a vendor to a reseller is generally presumed to be a reduction of the selling prices of the vendor's products, and, therefore, should be characterized as a reduction of revenue when recognized in the vendor's income statement. The Company recognizes consideration given to a customer in conformity with EITF No. 01-9.
EITF Issue No. 02-16 "Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor" was issued January 2003 regarding the circumstances under which cash consideration received from a vendor by a reseller should be considered (a) an adjustment of the prices of the vendor's products or services and, therefore, characterized as a reduction of cost of sales when recognized in the reseller's income statement, (b) an adjustment to a cost incurred by the reseller and, therefore, characterized as a reduction of that cost when recognized in the reseller's income statement, or (c) a payment for assets or services delivered to the vendor and, therefore, characterized as revenue when recognized in the reseller's income statement. The Company adopted, effective January 1, 2003, the provisions of EITF 02-16 which resulted in certain amounts, including trade discounts and promotional marketing allowances, being reclassified from interest income and selling, general and administrative expenses, respectively, to cost of goods sold for all periods presented. The impact to the 2001 consolidated financial statements is to decrease cost of goods sold by $9,000 and to decrease interest income by $9,000. The impact to the fiscal year 2002 consolidated financial statements is to decrease cost of goods sold by $1,082,000, to increase general and administrative expenses by $43,000 and to decrease interest income by $1,039,000.
3. Sale of Accounts Receivable
Under securitization facilities, the Company and its subsidiaries have sold trade receivables to financial institutions. All of the facilities expired or terminated in 2000 and 2001 and no amounts were outstanding as of December 31, 2003. Under the securitization facilities, the receivables were sold at face value with payment of a portion of the purchase price being deferred. Fees incurred in connection with the sale of accounts receivable under these agreements for the year ended December 31, 2001 were $206,000, and are recorded as a component of other expense in the accompanying consolidated statements of income.
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Property and Equipment
Property and equipment consisted of the following (in thousands):
In May 2002 the Company completed the sale of an office building in Cary, North Carolina. The $3,000,000 purchase price was paid $25,000 in cash and the remainder in a promissory note due May 20, 2004 or earlier in certain circumstances (the "Note"). The Note bears interest at the prime rate plus 2.25% payable monthly and is secured by the property. The prime rate was 4.00% at September 30, 2003. The Company recorded the Note at a discounted amount of $2,714,000 which approximated the carrying value of the property and is included in other assets in the accompanying consolidated balance sheets. The Company recognized no gain or loss on the sale of the property, net of actual disposal costs. In connection with the sale, the Company agreed to lend the purchaser up to an additional $1,000,000, at terms similar to the Note described above, to fund improvements to the property after the purchaser has funded $1,000,000 in initial improvements. As of December 31, 2003 no additional amounts have been loaned. During 2003, the purchaser informed the Company that the purchaser's plans for developing the property securing the Note may not be economically feasible, resulting in an impairment of the Note. See "Note 8 - Impairment Losses" for discussion on current status on repayment of the Note.
5. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following at December 31 (in thousands):
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Income Taxes
The components of income (loss) from operations before income taxes consisted of the following (in thousands):
The provision (benefit) for income taxes consisted of the following (in thousands):
Deferred income tax assets and liabilities were comprised of the following (in thousands):
The major elements contributing to the difference between the federal statutory tax rate and the effective tax rate on income from continuing operations are as follows:
In 1997 the Company experienced an ownership change for Federal income tax purposes, resulting in an annual limitation on the Company's ability to utilize its net operating loss carryforwards to offset future taxable income. The annual limitation was determined by multiplying the value of the Company's equity before the change by the long-term tax exempt rate as defined by the Internal Revenue Service. The Company adjusted its deferred tax asset to reflect the
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
estimated limitation. At December 31, 2003, the Company had available U.S. Federal net operating loss carryforwards of $266,165,000, which expire at various dates beginning December 31, 2012. As of December 31, 2003, $72,810,000 of the net operating loss carryforwards is restricted as a result of the ownership change and the remaining amount of $193,355,000 is not restricted. The restricted net operating loss is subject to an annual limitation of $7,476,000. The Company has certain state net operating losses, which, due to limitations, are not expected to be fully utilized and may expire. The Company has recorded a full valuation allowance against the net deferred income tax assets at December 31, 2002 and 2003 based upon the Company's estimate of the future realization of deferred income tax assets.
7. Restructuring Charges
On December 14, 2000, the Company announced its plan to wind down virtually all of its U.S. distribution business (excluding software licensing). Pursuant to this plan, the Company recorded a restructuring charge of $6,672,000, of which $600,000 related to Optisel and has been reported as discontinued operations. Approximately $921,000 of the charge consists of severance costs and $5,151,000 related to lease termination and facility closures for all but two of the Company's United States locations.
During the third quarter of 2000, the Company announced plans that it would reduce its workforce by approximately 1,000 full-time positions. As a result, the Company recorded a restructuring charge of $10,964,000. Approximately $7,098,000 of the charge consists of termination benefits including severance pay and outplacement services to be provided to those employees that were involuntarily affected by the reduction in workforce. The charge also reflects approximately $3,866,000 of lease termination fees related to the planned closure of certain warehouses and offices.
During 2001 the Company adjusted the restructuring charges previously taken in relation to the wind-down of its U.S. distribution business (excluding software licensing) reducing the charge by $102,000. The adjustment is primarily due to $569,000 of favorable settlements reached with lessors of disposed facilities, net of $467,000 of additional charges related to severance costs associated with six employees.
During 2002 the Company recorded additional restructuring charges in relation to the wind-down of its U.S. distribution business (excluding software licensing) of $465,000. The adjustment is primarily due to $200,000 of additional charges related to facility lease costs and $265,000 of additional charges related to severance costs associated with four employees.
During 2003 the Company recorded additional restructuring charges in relation to the wind-down of its U.S. distribution business (excluding software licensing) of $650,000. The adjustment is due to $208,000 of additional charges related to severance costs associated with approximately ten employees and $442,000, primarily related to facility lease costs.
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As of December 31, 2003, $1,929,000 of total restructuring costs had not been paid and was included in accrued liabilities in the accompanying consolidated balance sheets. Future payments of these liabilities are expected to be approximately $1,364,000 and $565,000 in 2004 and 2005, respectively. The following tables display the activity and balances of the restructuring reserve account from December 31, 2000 to December 31, 2003 (in thousands):
8. Impairment Losses
On July 28, 2001, the Company completed the sale of Merisel Canada to Synnex. The purchase price was CDN$30,000,000, of which CDN$1,000,000 was deposited in an escrow account pending resolution of indemnification claims made during the 12 months after closing. The amount was received in July 2002. As a result of the pending sale of Merisel Canada, the Company reviewed the recoverability of its long-lived assets, including identifiable intangible assets, to determine if there had been any impairment. Based on this review, the Company recorded an impairment charge of $29,416,000 as of June 30, 2001. The impairment charge includes $13,000,000 for the SAP operating system, $8,900,000 for the Company's foreign translation adjustment, $3,600,000 for the unamortized goodwill attributable to Merisel Canada, and $3,916,000 related to various other assets. During the fourth quarter of 2001, the closing balance sheet of Merisel Canada was finalized and agreed to by the Company and Synnex. This resulted in a payment of CDN$2,000,000 to the Company, which is recorded as a $1,305,000 adjustment to the impairment charge previously recorded in the second quarter of 2001.
As a result of the pending sale of an office building located in Cary, North Carolina, the Company reviewed the carrying value on its books to determine if there had been any impairment. Based on this review, the Company recorded an impairment charge of $288,000 in the fourth quarter of 2001 to adjust the carrying value of the building to the estimated selling price, less estimated selling expenses.
In April 2003, the purchaser of the office building located in Cary, North Carolina informed the Company that the purchaser's plans for developing the property securing the Note may not be economically feasible; and therefore the purchaser was likely to default on the Note and stop making any further payments. The Company discontinued recognizing interest income on the loan and considered appropriate actions to maximize the underlying value of this Note, including potentially foreclosing on the property. In the third quarter of 2003, management obtained a real property market valuation of the property securing the
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note and determined that the Note was impaired due to the continuing default of the holder and the underlying value of the collateral securing the Note. The Company recorded an impairment loss of $1,800,000 to reduce the book value of the Note to the estimated fair value of the property. See "Note 4 - Property and Equipment" for details of the sale.
9. Discontinued Operations
On October 27, 2000, the Company completed the sale of its MOCA business unit to Arrow Electronics, Inc. The stock sale agreement pursuant to which the sale was made provided for a purchase price of $110,000,000, subject to adjustments based on changes in working capital reflected on the closing balance sheet of MOCA, plus an additional amount up to $37,500,000 payable by the end of March 2001 based upon MOCA's ability to retain existing and gain additional business (the "Additional Payment"). The actual purchase price (excluding the Additional Payment but including amounts received as deferred purchase price payments) was approximately $179,800,000 of which approximately $57,500,000 was for amounts outstanding under the Merisel asset securitization facility. Based on the purchase price the Company realized a gain, net of costs associated with the sale, of approximately $25,200,000. In March 2001 the Company received an Additional Payment of $37,500,000 which, after deducting certain obligations relating to the payment, netted $36,250,000, which was recorded in the quarter ended March 31, 2001 and resulted in a gain of $36,250,000 in 2001.
Through Optisel, in November 2000 the Company acquired substantially all the e-services assets of Value America, Inc. with the intention of leveraging the Company's distribution and logistics capabilities to operate a logistics and electronic services business. In connection with the sale of the MOCA business to Arrow, the Company entered into a transition services agreement with Arrow pursuant to which Optisel provided fee-based distribution and logistics services and information technology services for MOCA through February 1, 2002. In connection with the sale of Merisel Canada to Synnex, Merisel and Synnex entered into a fee-based transition services agreement pursuant to which Optisel provided information technology services to Merisel Canada through September 10, 2001. Optisel did not generate any significant revenue except under these two transition services agreements. As a result of economic conditions generally and with respect to Internet-related businesses specifically and Optisel's lack of success in generating business, the Company decided to discontinue operation of the Optisel business during the fourth quarter of 2001.
The Company has reclassified its consolidated financial statements to reflect the sale of the MOCA business and the discontinuance of Optisel's operations and to segregate the revenues, direct costs and expenses (excluding any allocated costs), assets and liabilities, and cash flows of the MOCA and Optisel businesses. The net operating results and net cash flows of these businesses have been reported as "Discontinued Operations" in the accompanying consolidated statements of income and cash flows. At December 31, 2003, there are no remaining assets or liabilities of the discontinued operations. At December 31, 2002 there were no assets and $418,000 of liabilities recorded as discontinued operations in the accompanying consolidated balance sheets.
Summarized financial information for the discontinued operations for the year ended December 31, is as follows (in thousands):
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Gain on Debt Extinguishment
In the first quarter of 2001, the Company purchased or redeemed the remaining $23,803,000 principal amount of the 12.5% Senior Notes due 2005 outstanding at an aggregate purchase price of $20,931,000, resulting in a gain on extinguishment of debt of $2,872,000. As a result, none of the 12.5% Notes remain outstanding and the Company's obligations under the indenture relating to the 12.5% Notes have been discharged.
11. Commitments and Contingencies
The Company leases certain of its facilities and equipment under noncancelable operating leases. As of December 31, 2003, there are no noncancelable operating leases that have initial or remaining noncancelable lease terms in excess of one year. Rent payments for 2001, 2002 and 2003 were $3,221,000, $893,000 and $868,000 respectively, including amounts charged to the restructuring reserve. Amounts representing rent expense for 2001, 2002 and 2003 were $2,551,000, $223,000, and $217,000, respectively.
In February 2004, the Company was served with a summons and complaint in an adversary proceeding captioned Bridge Information Systems, Inc. et al, Debtor, Scott P. Peltz, Chapter 11 Plan Administrator v. Merisel Americas, Inc. and MOCA (the "Complaint"). The Complaint alleges that Debtor made preferential transfers of money to Merisel Americas, Inc. ("Americas") in the amount of approximately $6.3 million and an additional amount to MOCA, a former subsidiary of Americas, which were avoidable and seeks to recover such transfers. The Company believes that any such transfers alleged in the Complaint are the obligations of MOCA and not that of the Company. The Company has been advised by counsel to Arrow Electronics, Inc. ("Arrow"), the parent company of MOCA, that Arrow has agreed to provide indemnification to the Company with respect to the allegations set forth in the Complaint.
The Company is involved in certain legal proceedings arising in the ordinary course of business, and in connection with discontinued vendors related to the Company's wound down business, none of which is expected to have a material impact on the financial condition or results of operations of Merisel. The Company made estimates of its potential exposures and has established reserves for potential losses related to such proceedings. There can be no assurance that the Company's reserves will fully cover any possible exposure.
In addition, over the last several years the Company has disposed of a number of businesses, including all of its operations outside the United States, many of which had obligations that had been guaranteed by the Company. In connection with those dispositions, the Company sought either to have any guarantees released or to be indemnified against any liabilities under guarantees. The Company may not have identified all guarantees to be released and, in at least one instance, the indemnification provided to the Company is no longer of any value. Due to the nature of these indemnifications, the Company's exposure under the agreements cannot be estimated and no amounts have been recorded for such indemnities.
12. Stock
In June 2000, an affiliate of Stonington Partners, Inc., which owns approximately 65.6% of the Company's outstanding common stock, purchased 150,000 shares of convertible preferred stock (the "Convertible Preferred") issued by the Company for an aggregate purchase price of $15,000,000. The Convertible Preferred provides for an 8% annual dividend payable in additional shares of Convertible Preferred. Dividends are cumulative and will accrue from the original issue date whether or not declared by the Board of Directors. Cumulative accrued dividends amounted to $1,969,000, $3,368,000 and $4,881,000 as of December 31, 2001, 2002 and 2003, respectively.
At the option of the holder, the Convertible Preferred is convertible into the Company's common stock at a per share conversion price of $17.50. At the option of the Company, the Convertible Preferred can be converted into Common Stock when the average closing price of the Common Stock for any 20 consecutive trading days is at least $37.50. At the Company's option, on or after June 30, 2003, the Company may redeem outstanding shares of the Convertible Preferred initially at $105 per share and declining to $100 on or after June 30, 2008,
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
plus accrued and unpaid dividends. In the event of a defined change of control, holders of the Convertible Preferred have the right to require the redemption of the Convertible Preferred at $101 per share plus accrued and unpaid dividends. As of December 31, 2003, no redemptions have been made and the Company has no plans to exercise its redemption rights in the foreseeable future.
13. Employee Stock Options and Benefit Plans
Employee Stock Options - On December 19, 1997, the Company's stockholders approved the Merisel Inc. 1997 Stock Award and Incentive Plan (the "Stock Award and Incentive Plan"). Under the Stock Award and Incentive Plan, incentive stock options and nonqualified stock options as well as other stock-based awards may be granted to employees, directors, and consultants. The plan authorized the issuance of an aggregate of 800,000 shares of Common Stock less the number of shares of Common Stock that remain subject to outstanding option grants under any of the Company's other stock-based incentive plans for employees after December 19, 1997 and are not either canceled in exchange for options granted under the Stock Award and Incentive Plan or forfeited. At December 31, 2003, 707,099 shares were available for grant under the Stock Award and Incentive Plan. The grantees, terms of the grant (including option prices and vesting provisions), dates of grant and number of shares granted under the plans are determined primarily by the Board of Directors or the committee authorized by the Board of Directors to administer such plans, although incentive stock options are granted at prices which are no less than the fair market value of the Company's Common Stock at the date of grant. On December 22, 1997, the Company granted options under the Stock Award and Incentive Plan in exchange for previously granted employee stock options that were then outstanding and that had an exercise price greater than the then-market price of the Common Stock, subject to the agreement of each optionee to cancel the outstanding options. As of December 31, 2003, 78,425 options remain outstanding under the Stock Award and Incentive plan.
As of December 31, 2003, 2,520 options, including 600 options issued to non-employee Directors, remain outstanding under the Company's other employee stock option plans, however, no new options may be issued under these plans. In addition to the shares issuable under the Stock Award and Incentive Plan, 4,000 shares are reserved for issuance under the Company's 1992 Stock Option Plan for Non-Employee Directors.
During 1999, the Company issued 51,500 restricted stock units to certain employees under the Stock Award and Incentive Plan. Each restricted stock unit represented the right to receive one share of common stock of the Company at no cost to the employee. The restricted stock units cliff vest after three years with provisions for accelerated vesting in the event certain operating performance targets are met. As of December 31, 2002 all restricted stock units had either been exercised or cancelled, therefore there were no restricted stock units outstanding at December 31, 2002 and 2003. Compensation expense, measured by the fair value at the grant date of the Company's common stock issuable in respect of the units, totaled $135,000 and was amortized over the related three-year vesting period. During 2000 and 2001 the Company recorded approximately $22,000 and $13,000 of compensation expense related to the restricted stock units outstanding. During 2002, $133,000 of previously recorded compensation expense related to the restricted stock units was reversed due to
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the cancellation of the awards. The following summarizes the aggregate activity in all of the Company's plans for the three years ended December 31, 2003:
The following table summarizes information about stock options outstanding at December 31, 2003:
The fair value of each option granted during 2001 was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions. There were no stock options granted in 2002 or 2003:
Expected life 5.0 Expected volatility 95.77% Risk-free interest rate 3.47% Dividend Yield 0.00%
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Benefit Plan - The Company offers a 401(k) savings plan under which all employees who are 21 years of age with at least 30 days of service are eligible to participate. The plan permits eligible employees to make contributions up to certain limitations, with the Company matching certain of those contributions. The Company's contributions vest 25% per year. The Company contributed $234,000, $109,000 and $78,000 to the plan during the years ended December 31, 2001, 2002 and 2003, respectively. The contributions to the 401(k) plan were in the form of cash, which prior to the second quarter of 2001 was used to purchase shares of the Company's common stock on the open market.
Stock repurchase program - The Company has a stock repurchase program, where it expects to repurchase up to $1,000,000 of its outstanding common stock. The Company repurchased $328,000, $516,000 and $6,000 under the program in 2001, 2002 and 2003, respectively.
14. Segment Information
The Company implemented SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information" ("SFAS 131"), which requires disclosure of certain information about operating segments, geographic areas in which the Company operates, major customers, and products and services. In accordance with SFAS 131, the Company had determined it had two operating segments: the United States distribution (which included software licensing) and the Canadian distribution segment. For the years ended December 31, 2002 and 2003, the Company operated a single segment, the United States distribution Business.
In accordance with SFAS 131, the Company has prepared the following table which present information related to each operating segment included in internal management reports (in thousands).
----------------------------------------- US Canada Total ------------- ------------ -------------- Net sales to external customers $40,371 $295,682 $336,053 Depreciation and amortization 2,793 2,255 5,048 Operating income (loss) 10,476 (27,225) (16,749) Non current assets 3,509 3,509 Total segment assets 68,955 68,955 Capital expenditures 114 114
15. Earnings Per Share
The Company calculates earnings per share ("EPS") in accordance with SFAS No. 128, "Earnings Per Share". Basic earnings per share is calculated using the average number of common shares outstanding. Diluted earnings per share is computed on the basis of the average number of common shares outstanding plus the effect of dilutive outstanding stock options using the "treasury stock" method. There were no significant dilutive common stock equivalents for the years ended December 31, 2001, 2002 or 2003.
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following tables reconcile the weighted average shares used in the computation of basic and diluted EPS and income available to common stockholders for the income statement periods presented herein (in thousands except share data):
16. Quarterly Financial Data (Unaudited)
Selected financial information for the quarterly periods for the years ended 2002 and 2003 is presented below (in thousands, except per share amounts):
MERISEL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During 2002 the Company recorded reductions of cost of sales in the amounts of $492,000, $810,000, $1,982,000 and $1,532,000 in the first, second, third and fourth quarters, respectively. These amounts related primarily to settlements reached with product vendors. The Company also recorded restructuring charges of $279,000 and $220,000 during the first and fourth quarters of 2002, respectively, and a reversal of previously recorded charges of $34,000 in the second quarter of 2002. Additionally, in the fourth quarter of 2002, the Company settled and/or reviewed certain matters related to its U.S. distribution business (excluding software licensing), resulting in an aggregate adjustment of $2,519,000 to previously established reserves. Of this amount, $1,840,000 related to favorable settlements experienced with information technology vendors of the Company's U.S. distribution business and is reflected as a reduction of selling, general and administrative expenses.
During 2003 the Company recorded reductions of cost of sales in the amounts of $486,000, $89,000, $182,000 and $344,000 in the first, second, third and fourth quarters, respectively. These amounts related primarily to settlements reached with product vendors. The Company also recorded restructuring charges of $256,000, $214,000 and $228,000 during the first, third and fourth quarters of 2003, respectively, and a reversal of previously recorded charges of $48,000 in the second quarter of 2003. Additionally the Company settled and/or reviewed certain matters related to its U.S. distribution business (excluding software licensing) during 2003, which resulted in reductions of selling, general and administrative expenses in the amounts of $1,070,000, $210,000, $280,000 and $276,000 in the first, second, third and fourth quarters, respectively.
******
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
The Company completed an evaluation, under the supervision and with the participation of the Company's chief executive officer and chief financial officer of the effectiveness of the Company's disclosure controls and procedures pursuant to Rule 13a-14 of the Exchange Act. Based on this evaluation, the Company's chief executive officer and chief financial officer concluded that, as of the period covered by this report, the Company's disclosure controls and procedures were effective with respect to timely communicating to them all material information required to be disclosed in this report as it related to the Company and its subsidiaries.
There have been no significant changes in the Company's internal controls or in other factors that occurred during the period covered by this report that could significantly affect the internal controls subsequent to the date the Company completed this evaluation.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
The following individuals are the executive officers and directors of the Company as of March 15, 2004:
(1) Member of Audit Committee (2) Member of Nominating Committee (3) Member of Compensation Committee
Albert J. Fitzgibbons III has been a member of the Board of Directors since December 1997 as a Class I director, and his term extends through the Company's 2004 annual meeting of stockholders. Mr. Fitzgibbons is a Partner and a Director of Stonington Partners, Inc. ("Stonington"), and a Partner and a Director of Stonington Partners, Inc., II ("Stonington II"), positions that he has held since 1993. He served as a Director of Merrill Lynch Capital Partners, Inc. ("MLCP"), a private investment firm associated with Merrill Lynch & Co. ("ML&C"), from 1988 to May 2001 and a Consultant to MLCP from 1994 to December 2000. He was a Partner of MLCP from 1993 to 1994 and Executive Vice President of MLCP from 1988 to 1993. Mr. Fitzgibbons was also a Managing Director of the Investment Banking Division of ML&C from 1978 to July 1994.
Bradley J. Hoecker has been a member of the Board of Directors since December 1997 as a Class II director, and his term extends through the Company's 2005 annual meeting of stockholders. Mr. Hoecker is a Partner and Director of Stonington and a Partner and Director of Stonington II since 1997. Prior to being named partner in 1997, Mr. Hoecker was a Principal of Stonington since 1993. He was a Consultant to MLCP from 1994 to December 2000 and was an Associate in the Investment Banking Division of MLCP from 1989 to 1993.
Timothy N. Jenson joined the Company in 1993 as Vice President and Treasurer and was elected Senior Vice President - Finance in 1998. Mr. Jenson became Chief Financial Officer in August 1998 and was elected Executive Vice President in January 2000. Mr. Jenson was appointed Chief Executive Officer and President in April 2001. Also in April 2001, Mr. Jenson was elected to the Board of Directors as a Class III director, with a term extending through the Company's 2006 annual meeting of stockholders. From 1989 to 1993, Mr. Jenson served as Vice President at Citicorp North America, Inc. where he provided financial services, banking products and advisory services to multinational companies, including the Company. Previously, Mr. Jenson served as Vice President of Corporate Banking at Bank of America for five years.
Dr. Arnold Miller was elected to the Board of Directors in August 1989 as a Class II director, and his term extends through the Company's 2005 annual meeting of stockholders. Since its formation in 1987, he has been President of Technology Strategy Group, a consulting firm organized to assist businesses and government in the fields of corporate strategy development, international technology transfer and joint ventures, as well as business operations support. Prior to forming Technology Strategy Group, Dr. Miller was employed at Xerox Corporation, a computer products and information services company, for 14 years, where his most recent position was Corporate Vice President with responsibility for worldwide electronics operations.
Lawrence J. Schoenberg was elected to the Board of Directors following the acquisition by the Company of Microamerica, Inc. ("Microamerica") in April 1990. He is a Class I director, with a term of office extending through the Company's 2004 annual meeting of stockholders. Mr. Schoenberg had previously served as a director of Microamerica from 1983 to April 1990. From 1967 through 1990, Mr. Schoenberg served as Chairman of the Board and Chief Executive Officer
of AGS Computers, Inc. ("AGS"), a computer software company. From January to December 1991, Mr. Schoenberg served as Chairman and as a member of the executive committee of the Board of Directors of AGS. Mr. Schoenberg retired from AGS in 1992. Mr. Schoenberg is also a director of Government Technology Services, Inc., a reseller and integrator for the federal government, and a director of Cellular Technology Services, Inc., a software company.
Traci Barnett joined the Company in April 2001 as its Vice President, Sales and Marketing. From 2000 to March 2001, Ms. Barnett was employed by WhatZnew.com, an internet computer products reseller, as its Senior Vice President of Sales. From 1992 to March 2000, Ms. Barnett was employed by Ingram Micro where she held various positions including Director, Sales and Director, Product Management.
Allyson Vanderford joined the Company in April 1998 as Manager of Financial Planning and Analysis. In December 1999 she was promoted to the position of Director of Financial Planning and Analysis and in April 2001, she was appointed Vice President, Finance and Treasurer. From 1995 to 1998, Ms. Vanderford was employed by the auditing firm of Deloitte & Touche, LLP where she held the positions of staff accountant and senior accountant. From 1992 to 1995, Ms. Vanderford was employed by the Company. During such time Ms. Vanderford held various positions, including Senior Staff Accountant and General Accounting Supervisor.
There are no family relationships among the Company's directors or executive officers. There are no material proceedings to which any of our directors or executive officer or any of their associates, is a party adverse to the Company or any of its subsidiaries, or has a material interest adverse to the Company or any of its subsidiaries.
To the Company's knowledge none of the Company's directors or executive officers has been convicted in a criminal proceeding during the last five years (excluding traffic violations or similar misdemeanors), and none of the Company's directors or executive officers was a party to any judicial or administrative proceeding during the last five years (except for any matters that were dismissed without sanction or settlement) that resulted in a judgment, decree or final order enjoining the person from future violations of, or prohibiting activities subject to, federal or state securities laws, or a finding of any violation of federal or state securities laws.
The Board of Directors maintains an Audit Committee which is currently comprised of Dr. Miller and Messrs. Hoecker and Schoenberg.
The Board of Directors designated Lawrence Schoenberg, an independent director, as its audit committee financial expert. Mr. Schoenberg has an MBA in accounting from the Wharton School, was the Chief Financial Officer of AGS, the chairman of the audit committee of several public companies and has sat on several committees of the American Institute of Certified Public Accountants.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires the Company's executive officers and directors to file reports of ownership and changes in ownership with the Securities and Exchange Commission and to furnish the Company with copies of all such reports they file. Based on its review of the copies of such reports received by it and on written representations from such persons, the Company believes that, during 2003, all filing requirements applicable to its directors and executive officers were complied with.
Code of Business Conduct
In 2002, the Board of Directors adopted and approved the Company Code of Business Conduct (the "Code") (filed with the Company's Annual Report on Form 10-K for the year ended December 31, 2002). All of the Company's employees are subject to the standards and requirements set forth in the Code and are required to sign a certificate of compliance. The Code can be found on the Company's website www.merisel.com under Investor Relations.
Item 11.
Item 11. Executive Compensation.
Summary Compensation Table
The following table sets forth the cash and non-cash compensation for each of the last three fiscal years awarded to or earned by the Chief Executive Officer, and the Company's two other executive officers (the "named executive officers").
(1) Includes amounts contributed by the Company to the Company's 401(k) plan as follows: Mr. Jenson - $6,000 in 2003, $5,500 in 2002, and $5,100 in 2001; Ms. Barnett - $6,000 in 2003, $5,500 in 2002 and $2,369 in 2001; and Ms. Vanderford - $5,679 in 2003, $5,221 in 2002, and $4,176 in 2001. For Mr. Jenson, the amount for 2001 also includes the forgiveness of a loan used to purchase shares of the Company's common stock.
(2) Consists of bonus compensation payable pursuant to a retention agreement entered into as of April 1, 2001 between Mr. Jenson and the Company. See "Employment and Change of Control Arrangements" below. Portions of such bonus payments have been deferred by Mr. Jenson pursuant to the Deferred Compensation Agreement between Mr. Jenson and the Company dated December 18, 2001.
(3) Ms. Barnett's employment by the Company commenced April 30, 2001.
Options in 2003
The following table summarizes stock option exercises during 2003 to or by the named executive officers and the value of the options held by such persons as of December 31, 2003. The amounts listed in such tables reflect a one-for-ten reverse stock split that was effective on April 14, 2001.
Compensation Committee Interlocks and Insider Participation
The members of the Compensation Committee of the Board of Directors, who are appointed by the Board of Directors, are Messrs. Fitzgibbons and Schoenberg and Dr. Miller.
Director Compensation
Each nonemployee director is entitled to receive an annual retainer fee of $24,000, $1,000 for each Board of Directors meeting attended ($500 for meetings held telephonically), $1,000 quarterly for acting as the chairman of a committee of the Board of Directors, and $500 for each committee meeting attended plus reimbursement for travel expenses incurred in attending Board of Directors and committee meetings. In prior years, Messrs. Fitzgibbons and Hoecker have waived their rights to receive any compensation for services as directors other than reimbursement of travel expenses however, beginning January 1, 2004, Messrs. Fitzgibbons and Hoecker have requested to receive such compensation.
The Company's 1992 Stock Option Plan for Nonemployee Directors (the "Nonemployee Director Plan") provides for annual grants of nonqualified stock options to purchase 1,000 shares of Common Stock to each member of the Company's Board of Directors who is not otherwise an employee or officer of the Company or any subsidiary of the Company. No stock options were granted under the Nonemployee Director Plan during 1997 or 1998 and in March 1998, the Board of Directors voted to suspend the Plan. Beginning in 1998, nonemployee directors were able to elect on an annual basis to take up to 25 percent of their annual retainer fee in shares of Common Stock in lieu of cash, based on the market price of the Common Stock on the first day of the quarter following each annual meeting of stockholders.
Employment and Change of Control Arrangements
The Company has entered into a retention agreement with Mr. Jenson, effective as of April 1, 2001. Pursuant to this retention agreement, Mr. Jenson serves as the Chief Executive Officer and President of the Company with an annual base salary of $400,000. In addition, the retention agreement provides that Mr. Jenson will be entitled to certain bonus payments based upon the achievement of specified objectives that relate to the generation of cash. The Company has no obligation to retain or continue Mr. Jenson as an employee and his employment status as an "at-will" employee of the Company is not affected by the retention agreement. If Mr. Jenson's employment with the Company is terminated for any reason other than as a result of (i) termination for Cause (as defined in the agreement), (ii) death or permanent disability, or (iii) Mr. Jenson's resignation without Good Reason (as defined in the agreement), the Company will pay Mr. Jenson a lump sum payment equal to his annual base salary and an amount equal to any unpaid bonuses and the Company will reimburse Mr. Jenson for the cost of his COBRA payments for one year following the termination of his employment. Mr. Jenson has received bonus payments of $661,590 in 2002 and $421,094 in 2003 under the retention agreement.
In August 2000, the Company entered into a bonus agreement that provided for the payment of the following bonuses to Mr. Jenson, provided that Mr. Jenson was an employee of the Company at the time such amounts were payable or in the event Mr. Jenson's employment terminated except under the circumstances described in the preceding paragraph: $100,000 upon completion of the sale or accounts receivable refinancing of the Company's Merisel Open Computing Alliance business; $100,000 upon completion of the sale, restructuring and/or winding down in all material respects of the Company's U.S. distribution business; and $50,000 upon achievement of quarterly profitability for the Company's Canadian distribution business or upon completion of the sale and/or winding down in all material respects of that business. Mr. Jenson has received aggregate payments of $200,000 under the bonus agreement, which has been superseded by the retention agreement described above before payment of a bonus related to the Company's Canadian distribution business.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The following table sets forth as of March 15, 2004 certain information regarding beneficial ownership of the Company's Common Stock by each stockholder known by the Company to be the beneficial owner of 5% or more of the outstanding Common Stock as of such date, each director and named executive officer of the Company and all directors and executive officers as a group. Unless otherwise indicated, the stockholders have sole voting and investment power with respect to shares beneficially owned by them, subject to community property laws, where applicable. The address for those individuals for which ad address is not otherwise indicated is: c/o Merisel, Inc., 200 Continental Boulevard, El Segundo, California 90245.
*Less than 1% (1) Includes 7,500 shares issuable with respect to stock options exercisable within 60 days after March 15, 2004. (2) Each of Messrs. Fitzgibbons and Hoecker is a director or partner of certain affiliates of Phoenix Acquisition Company II, L.L.C. ("Phoenix") and, therefore, may be deemed to beneficially own the 6,170,409 shares of Common Stock beneficially owned by Phoenix. Each of Messrs. Fitzgibbons and Hoecker disclaims such beneficial ownership. The address of each of Messrs. Fitzgibbons and Hoecker is the same as that given for Phoenix. (3) Includes shares held in the Company's 401(k) plan for the accounts of the following individuals: Mr. Jenson-7,623; Ms. Vanderford-2,352. The administrative committee of the Company's 401(k) plan directs the voting of shares held in the plan. (4) Includes 25,000 shares issuable with respect to stock options exercisable within 60 days after March 15, 2004 and 101,260 shares for which Mr. Jenson shares voting and investment power with his spouse. (5) Includes 300 shares issuable with respect to stock options exercisable within 60 days after March 15, 2004. (6) Includes 1,170,409 shares of Common Stock into which the Convertible Preferred Stock beneficially owned by Phoenix is convertible within 60 days after March 15, 2004. (7) All information regarding share ownership (except for (6) above) is taken from and furnished in reliance upon the Schedule 13D filed by Phoenix pursuant to Section 13(d) of the Securities Exchange Act of 1934. Stonington Capital Appreciation 1994 Fund, L.P. (the "Fund") is the sole member of Phoenix. Stonington Partners, L.P. ("Stonington LP") is the general partner of the Fund, and Stonington Partners, Inc. II ("Stonington II") is the general partner of Stonington LP. The Fund is managed by Stonington. The following individuals are the directors and/or officers of Stonington and Stonington II and have shared voting and dispositive powers with respect to the Common Stock held by Phoenix: Alexis P. Michas; James J. Burke, Jr.; Robert F. End; Albert J. Fitzgibbons III; and Bradley J. Hoecker. Stonington LP, Stonington II, Stonington and each of the directors and officers of Stonington II and Stonington disclaim beneficial ownership of these shares. (8) Includes 33,100 shares issuable with respect to stock options exercisable within 60 days after March 15, 2004.
Equity Compensation Plan Information
The following table provides information regarding (i) the aggregate number of securities (consisting of Merisel Common Stock) to be issued under all of Merisel's stock option plans upon exercise of outstanding options, warrants and other rights and their weighted-average exercise price as of December 31, 2003 and (ii) the number of securities remaining available for issuance under such plans. All of the Company's equity compensation plans have been approved by the Company's stockholders.
Item 13.
Item 13. Certain Relationships and Related Transactions.
Merisel has entered into Indemnity Agreements with some of its directors and executive officers, which agreements require Merisel, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers, employees or agents of Merisel (other than liabilities arising from conduct in bad faith or which is knowingly fraudulent or deliberately dishonest), and, under certain circumstances, to advance their expenses incurred as a result of proceedings brought against them.
In 1999, the Company made an interest-free loan to Mr. Jenson in the amount of $65,000 for the sole purpose of purchasing shares of the Company's common stock. The terms of the loan provided for the entire principal amount to be forgiven on the earlier of (i) the date the Company released its earnings for fiscal year 1999, provided that the Company's pre-tax net income equaled at least a specified amount, and (ii) March 2, 2001. The terms of the loan also provided for the entire principal amount to be forgiven upon termination of Mr. Jenson's employment by the Company other than as a result of termination for cause or resignation by Mr. Jenson without good reason (each as defined in the severance agreement between the Company and Mr. Jenson). The loan was forgiven on March 2, 2001 in accordance with its terms.
Item 14.
Item 14. Principal Accountant Fees and Services.
Audit and Non-Audit Fees
The following table presents fees for professional audit services rendered by the Company's principal accounting firm, Deloitte & Touche LLP ("D&T") for the audit of the Company's annual financial statements and review of the quarterly financial statements for 2002 and 2003, and fees billed for other services rendered by D&T in accordance with new SEC definitions and rules.
2002 2003 ---- ---- Audit fees $142,350 $106,525
Audit-related fees (1) $163,054 $108,628
Tax fees (2) $42,136 $61,294
All other fees -0- -0-
Total $347,540 $276,447
(1) Audit-related fees were primarily for acquisition related due diligence and accounting consultation in 2002 and 2003.
(2) Tax fees were primarily for tax compliance and consulting.
In accordance with existing Audit Committee policy and the more recent requirements of the Sarbanes-Oxley Act, all services to be provided by D&T are subject to pre-approval by the Audit Committee. This includes audit services, audit-related services, tax services and other services. In some cases, pre-approval is provided by the full Audit Committee for up to a year, and relates to a particular category or group of services and is subject to a specific budget. In other cases, Dr. Miller, as the Designated Member, has the delegated authority from the Audit Committee to pre-approve additional services, and such pre-approvals are then communicated to the full Audit Committee. All of the fees listed above have been approved by the Audit Committee.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) List of documents filed as part of this Report:
(1) Financial Statements included in Item 8:
Independent Auditors' Report.
Consolidated Balance Sheets at December 31, 2002 and 2003.
Consolidated Statements of Operations for each of the three years in the period ended December 31, 2003.
Consolidated Statements of Changes in Stockholders' Equity for each of the three years in the period ended December 31, 2003.
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2003.
Notes to Consolidated Financial Statements.
(2) Financial Statement Schedules included in Item 8:
Schedule II - Valuation and Qualifying Accounts.
Schedules other than that referred to above have been omitted because they are not applicable or are not required under the instructions contained in Regulation S-X or because the information is included elsewhere in the Consolidated Financial Statements or the Notes thereto.
(3) Exhibits:
The exhibits listed on the accompanying Index of Exhibits are filed as part of this Annual Report.
(b) The Following Report on Form 8-K was furnished during the quarter ended December 31, 2003:
Report on Form 8-K filed on October 30, 2003 announcing third quarter results.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 29, 2004 MERISEL, INC.
By:/s/Timothy N. Jenson ---------------------------------------- Timothy N. Jenson Chief Executive Officer, President and Chief Financial Officer (Principal Executive and Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.