ITEM 1. BUSINESS
COMPANY OVERVIEW
Pomeroy IT Solutions, Inc. is a national IT solutions provider with a comprehensive portfolio of consulting, infrastructure and lifecycle services. Our mission is to provide customers with increased efficiencies, decreased costs, and the ability to maximize their existing IT investments. We are committed to our customers, our employees and our shareholders and aim to consistently meet and exceed their expectations.
Pomeroy was founded in 1981 and organized as a Delaware corporation in February 1992. Since then, Pomeroy IT Solutions, Inc., collectively with its subsidiaries, ("Pomeroy" or the "Company") has strategically acquired several companies to strengthen the core services offerings the Company delivers. Some of these acquisitions include Ballantyne Consulting Group in Charlotte, NC; and Micrologic Business Solutions in Kansas City, MO. Most recently, the Company made the largest acquisition in its history, that of Alternative Resources Corporation (ARC) in Barrington, IL. The combined service capabilities of ARC and Pomeroy IT Solutions has strengthened our ability to provide:
- Full Life Cycle Services from technology acquisition to end of life solutions. These solutions embrace both ISO 9001-2000 and Information Technology Infrastructure Library ("ITIL") methodologies. - Consulting expertise covering Enterprise Resource Planning ("ERP"), Customer Relationship Management ("CRM"), Application Development, Security and Data Warehousing solutions. - Network Infrastructure Solutions with specialization in IP Communications, Storage, UNIX, Wireless and Software Solutions. - A robust Service Desk offering that can be co-sourced, off-site or blended to meet customer help desk needs.
Our Employees - -------------- Pomeroy employs over 3,500 people, including approximately 2,000 technical personnel located throughout the country. Pomeroy is committed to continuing to build its areas of expertise and offerings through continual hiring, training, and strategic acquisitions of companies that bring new skill sets and experience. Collectively, the Company holds thousands of certifications and specializations, including some of the highest recognitions in the industry such as CCIE, HP Master SAN, CISSP, VPN Security, Wireless LAN, IP Communications, PhD, ITIL Practitioner, ITIL Master and PMP.
Our Solution-Focused Company - ------------------------------ Pomeroy seeks to understand the strategic goals of customers' organizations as well as the specific challenges faced by IT executives. Through this collaborative approach, the Company's sales and technical teams can combine the right people, partners, technologies and methodologies to deliver solutions that meet those goals and challenges. The Company takes advantage of its low-cost business model and scalability to deliver the most economical, flexible solutions to its customers. Ultimately, this allows our customers to reinvest savings into their organizations.
Our Markets - ------------ Pomeroy's target markets include governmental agencies, educational institutions, Fortune 1000 and small and medium business ("SMB") customers. These customers fall into government and education, financial services, health care and other sectors. Pomeroy's customers are located throughout the United States with an emphasis in the Southeast and Midwest regions.
Our Growth Strategy - --------------------- Pomeroy's growth strategy is to gain share in existing markets, expand its geographical coverage, and increase the breadth and depth of its service offerings while continuing its strategic model. In addition, Pomeroy's growth strategy includes taking advantage of the expansion in scale and scope that the ARC integration provides. The key impacts of the acquisition are expanded service offerings, client base and geographies. Pomeroy will continue to focus on higher margin services, continued operating expense control and maintaining a strong balance sheet. Pomeroy believes by following this growth strategy, it will be able to improve its earnings performance in the future. The Company has experienced and expects continued pricing pressure in its products segment due to industry consolidation and the efforts of manufacturers to sell directly to Pomeroy's customers. In addition, the general weakness in the U.S. economy has impacted Pomeroy's business. Any pricing pressures, reduced margins or loss of market share resulting from the Company's inability to compete effectively could have a material adverse effect on the Company's operations and financial results.
Our Dedicated Delivery Organization - --------------------------------------
In 2004, the Company invested in various initiatives to greatly enhance its service delivery capabilities. These initiatives have enabled improved utilization of our 3000+ technical resource base ensuring that the right technician is identified and available to meet the customer's needs. Pomeroy leverages proven methodologies and industry best practices to ensure consistent and repeatable service delivery regardless of geography.
Our Segments - ------------- The Company operates in three industry segments: products, services and leasing. See Note 21 of Notes to Consolidated Financial Statements for a presentation of segment financial information. Pomeroy's products segment is comprised of the sale of a broad range of IT products that include desktop computing equipment, servers, infrastructure devices and peripherals. Pomeroy's services business entails providing IT services which support such computer products. The services segment can be classified into three components: enterprise consulting, infrastructure solutions and lifecycle services. The Company also offers leasing solutions to its customers via an agency agreement with a financial institution located in Cincinnati.
Our Information - ---------------- We make available free of charge on our web site at www.pomeroy.com our Annual --------------- Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (the "SEC"). We also make available on our web site other reports filed with the SEC under the Securities Exchange Act of 1934, including our proxy statements and reports filed by officers and directors under Section 16(a) of that Act. We do not intend for information contained in our web site to be part of this Form 10-K or any other report that we file with the SEC.
PRODUCTS SEGMENT
The Company's products segment is comprised of the sale of a broad range of IT products that include desktop computing equipment, servers, infrastructure devices and peripherals.
Our Partners - ------------- Out of the extensive list of technology brands we provide, Pomeroy has selected an exclusive group of leading manufacturers with which to develop comprehensive alliance agreements. These alliances underscore our commitment to providing our customers with the most sought-after technologies. Pomeroy engages our alliance partners at the highest levels in order to meet our customer needs in accordance to our standards of excellence. The Pomeroy Marketing Alliance Program goals are:
- To build strong on-going business relationships with a select group of vendors and manufacturers - To maintain extensive sales of, and technical readiness on, alliance product and solution sets - To bring the advantages of strong industry relationships to bear on individual customer projects for the benefit of the customer
The following are manufacturers included within our Marketing Alliance Program.
3Com Altiris APC (American Power Conversion) Brother Cables to Go Cisco Systems Commvault Computer Associates EMC Epson Hewlett Packard - Compaq Hitachi IBM Kingston Technology Lexmark Macromedia Microsoft Nec/Mitsubishi Nortel Okidata Qlogic Sony Storagetek Sun Surfontrol Symantec Viewsonic
Pomeroy believes that its relationship with such vendors enables it to offer a wide range of products to meet the diverse requirements of its customers as opposed to original equipment manufacturers ("OEMs"), which offer a limited range of products. Additionally, Pomeroy's ability to bundle products with services enables its customers to obtain the flexibility, expertise, and conveniences of multiple vendors from a single source provider of IT solutions.
The information technology needs of its customers are serviced by Pomeroy's ISO 9001:2000 registered distribution and integration center located in Hebron, Kentucky. This facility is approximately 161,000 square feet and distributes and integrates products and technologies sold by the Company as well as products supplied by its customers. Pomeroy also operates a service depot operation within this centralized facility.
Purchasing products and/or services from Pomeroy assures that highly skilled professionals who adhere to world-class quality standards manage the IT initiatives of its customers. Since 1997, Pomeroy's Distribution Center has been registered to the International Organization of Standardization ("ISO") ISO 9001:2000 Quality Standard. The ISO Quality Standard has been accepted by the U.S. and over eighty other countries around the world as the basis for a world class Quality Management System ("QMS"). Pomeroy's QMS specifies the policies, procedures and processes necessary to satisfy customer requirements and ensures those processes are appropriately managed, controlled and continually improved. As a result of Pomeroy's ISO 9001:2000 registration, Pomeroy's customers can be assured that Pomeroy's QMS meets international standards. Documented procedures and records that demonstrate its commitment to the very highest quality standards back up the Company's ISO registration.
Pomeroy is committed to becoming the supplier of choice for all its customers' IT solution needs by continuous process improvements designed to optimize its operational effectiveness without adding undue costs to the model.
Part of its improvement process is an extensive corrective action and internal audit program that not only identifies and solves quality issues but also prevents their recurrence.
The Company believes that its distribution and integration center is adequately designed to support its customers' business and technology needs for the foreseeable future. Pomeroy's distribution and integration center utilizes state-of-the-art warehouse management and enterprise resource planning ("ERP") systems in order to stock, pick and update the status and location of physical and perpetual inventory. The radio-frequency based warehouse management system controls and manages the flow of physical inventory from the earliest point of demand generation, purchase order creation, to the final step in the supply chain process, shipping to meet its customers' delivery and integration needs.
The warehouse management system controls re-order points and directs its fulfillment needs to the product source who can deliver at the lowest possible capital cost while maintaining the speed to market required by Pomeroy's customers. The warehouse management system tracks the inventory in a real time mode, updating Pomeroy's ERP system, which then in turn updates its customers' specific technology driven supply chain management systems. The intelligence inherent with the system is flexible, allowing customization to almost any specific communication standard required by Pomeroy's diverse customer base. Essentially, Pomeroy has the ability to link its ERP and warehouse management systems to its customers' supply chain management ("SCM") systems. As a result, the Company has been able to provide its customers with product shipping information as well as the ability to efficiently process orders while safeguarding its inventory.
Significant product supply shortages have resulted from time to time because manufacturers have been unable to produce sufficient quantities of certain products to meet demand. As in the past, the Company expects to experience some difficulty in obtaining an adequate supply of products from its major vendors. Historically, this has resulted, and may continue to result, in delays in completing sales. These delays have not had, and are not anticipated to have, a material adverse effect on the Company's results of operations. However, the failure to obtain adequate product supply could have a material adverse effect on the Company's operations and financial results.
For fiscal years 2004, 2003 and 2002, sales of computer hardware, software, and related products were approximately $545.0 million, $470.3 million and $568.2 million, respectively, and accounted for approximately 73.4%, 78.6%, and 80.9%, respectively, of the consolidated net sales and revenues of Pomeroy in such years.
SERVICES SEGMENT As a national service solution provider, Pomeroy offers three groups of services: enterprise consulting, infrastructure solutions, and lifecycle services.
Enterprise Consulting - ---------------------- By combining the right people, strategy and technologies, Pomeroy helps companies increase efficiencies and decrease costs.
The enterprise consulting group offerings consist of:
Application Development - Pomeroy has developers who assist in creating ------------------------ custom applications to meet customers' unique business needs.
Business Process Re-engineering - Dedicated to helping customers improve --------------------------------- the bottom line, Pomeroy has consultants who help with process improvement and collaborative logistics.
ERP Solutions - Experienced in Enterprise Resource Planning Solutions, -------------- Pomeroy is a natural choice if customers are considering Oracle or SAP applications.
CRM Solutions - Understanding a customer's experience across all touch -------------- points of its organization is key to customer satisfaction. Pomeroy is experienced in helping companies define and implement the right CRM solution for their business.
E-Business - Pomeroy can help customers create a web site or extend its ---------- business processes to the web.
Business Intelligence - Pomeroy provides customers with the ability to ---------------------- access and analyze mission-critical information on demand and in real-time. This is becoming increasingly more important with market competition and required reporting procedures for certain industries.
Outsourcing - Pomeroy has IT personnel available to supplement its ----------- customers' staffs, freeing up a customers' financial resources and time to concentrate on its core business.
Infrastructure Solutions - ------------------------- Pomeroy has experienced certified engineers to assist the customer with their infrastructure needs from architecture to implementation.
The infrastructure solutions group offerings consist of:
High Performance File Servers - Pomeroy has the experience and ability to ------------------------------- implement and support mid-range servers including clustering and server consolidation.
Voice, Video, Data & Network Integration - Pomeroy enables businesses, --------------------------------------------- especially call centers, to increase productivity, save costs through management of one data source, and increase customer satisfaction with integration of data, voice and video on a single IP based network. Pomeroy also architects and installs wireless network connections throughout or between buildings to provide more flexibility and productivity.
Storage Strategies - Pomeroy understands the impact enterprise storage can ------------------- have on a company's infrastructure and applications. Pomeroy has a team of storage architects and engineers across best of breed technologies to help its customers select the best option for their environments.
Security Solutions - Pomeroy's Security Solution consists of a layered ------------------- approach, offering products and services that when combined create a comprehensive security program. Business Continuity and Disaster Recovery Planning are two of those six layers.
Thin Client - Pomeroy provides solutions and services for secure deployment ----------- of server-based applications via a web browser. These solutions are low in cost compared to traditional desktop computers and provide a centralized area for data backup and application upgrades.
Managed Services - Pomeroy can be the single source provider for its ----------------- customers' electronic interaction and commerce needs. Services offered include WAN Monitoring, Hosted Applications, and Remote LAN Monitoring.
Cabling Solutions - Pomeroy's Cabling Division is equipped to support all ------------------ aspects of its customers' communication cable system such as move/add change support for cabling, telephones and PCs. We are experienced to support all communication media types including shielded and unshielded copper cable, coaxial cable and fiber optic cable.
Lifecycle Services - ------------------- Pomeroy has a long history of proven performance with technology refreshes, roll-outs, and desktop services.
The lifecycle services group offers the following comprehensive portfolio of services: Strategic Sourcing - Pomeroy's experienced strategic sourcing group can ------------------- assist its customers with platform selection, sourcing, and order management.
Integration & Distribution Logistics - Pomeroy takes great pride in --------------------------------------- preparing its customers' equipment to the exact specifications needed. We have a 170,000 square feet distribution and configuration facility to accommodate large rollouts.
Implementation Services - Pomeroy understands the importance of a flawless ------------------------ implementation and uses solid project management methodology to ensure a reduction in project time lines, revisits and costs for our customers.
Technical Support Services - Pomeroy provides an array of support services --------------------------- including: help desk, desk side support, moves/adds/changes, and asset management. Pomeroy Extended Care enables customers to have extended warranties that are more customizable and less expensive than what they would receive from the manufacturer.
DoD Drive Wiping Services - Pomeroy offers a DoD Drive Wiping service as a -------------------------- part of our Brokerage/End-of-Life offering. A DoD (Department of Defense) wipe is a method of drive clearing and sanitization to the same standard (DoD 5220.22-M) which is used by the US Department of Defense (DoD), US Department of Energy (DoE), the US Nuclear Regulatory Commission (NRC), the US Central Intelligence Agency (CIA), and the National Security Administration (NSA).
In a typical DoD wipe (3 pass over-wipe with random binary patterns), all addressable hard drive locations are overwritten with a character, its complement, and then a random character and verify. The process repeats 3 times, thus guaranteeing that no data can be recovered by either a member of the public or by a commercial enterprise.
By using this type of wipe, our customers can be confident that any protected information contained on a drive will be made irretrievable.
Technology Disposition - Pomeroy provides customers with a range of ----------------------- solutions for disposition of equipment. These solutions include redeployment to another department within their companies, brokering the equipment, donating the equipment or disposing of the equipment in compliance with applicable EPA regulations.
Our Technical Team - -------------------- Pomeroy's technical personnel maintain some of the highest credentials. Maintaining a knowledgeable and resourceful technical staff is an ideal that Pomeroy cultivates through career development programs that promote education and skills training. These certifications include:
CISCO: CCIE, CCNA, CCNP, CCDP, CCDA, CCSP, INFOSEC Professional including IP Communications, Wireless LAN, and VPN Security Specializations NOVELL: CNE, MCNE, CNA, and Certified GroupWise Engineer MICROSOFT: MCP, MCSA, MCSA Security Specialization, MCSE Messaging Specialization, MCSE, MCSE+1, MCDBA and CRM Professional IBM: xSeries Certified System Engineer, IBM Technical Specialist RS 6000 SP, IBM Advanced Technical Expert RS 6000, WebSphere System Expert HEWLETT PACKARD: HP Certified Professionals (NT, NetWare, Alpha/Unix, and StorageWorks), HP Accredited Integration Specialist and Master Accredited Systems Engineers - SAN Architect COMPUTER ASSOCIATES: CUE NORTEL: Networks Specialist, Nortel Networks Certified Support Expert, Nortel Certified Design Expert LOTUS: Notes Professional COMPTIA: A+ Certified Technicians, Network+, IT Project+, Linux+, Server+, i-Net+ and Security+ SUN: Storage Engineers, Solaris System and Network Administrator (ISC)2 Certified Information Systems Security Professional (CISSP) ORACLE: Oracle Certified Professional (OCP) EMC: Master Operator and Builder ALTIRIS: Certified Practitioner ISACA: Certified Information Systems Auditor (CISA), Certified Information Security Manager (CISM) CITRIX: Certified Enterprise Administrator (CCEA), Certified Administrator (CCA) NETWORKS: Product Specialist HELP DESK INSTITUTE: Helpdesk Manager and Helpdesk Analyst QLOGIC: SAN Solution Certified PMI: Project Management Professional (PMP) SYMANTEC: Certified System Engineer, Certified Security Practitioner VMWARE: VMware Certified Professional
Pomeroy has entered into dealer agreements with substantially all of its major vendors/manufacturers. These agreements are typically subject to periodic renewal and to termination on short notice. Substantially all of Pomeroy's dealer agreements may be terminated by the vendor without cause upon 30 to 90 days advance notice, or immediately upon the occurrence of certain events. A vendor could also terminate an authorized dealer agreement for reasons unrelated to Pomeroy's performance. Although Pomeroy has never lost a major vendor/manufacturer, the loss of such a vendor/product line or the deterioration of Pomeroy's relationship with such a vendor/manufacturer would have a material adverse effect on Pomeroy.
Pomeroy's revenues from its service and support activities have grown, as a percentage of its consolidated net sales and revenues, over the last several years. For fiscal years 2004, 2003 and 2002, revenues from service and support activities were approximately $197.2 million, $127.9 million and $131.3 million, respectively, and accounted for approximately 26.6%, 21.4% and 18.7%, respectively, of the consolidated net sales and revenues of Pomeroy in such years.
LEASING SEGMENT Pomeroy helps customers from strategy to procurement. Pomeroy provides assistance with determining the best method to finance projects based on the customer's objectives. Pomeroy offers a variety of options including standard leasing via an agency agreement with a financial institution located in Cincinnati.
For fiscal years 2004, 2003 and 2002, leasing revenues were approximately $0.1 million, $0.2 million and $3.3 million, respectively, and accounted for approximately 0.02%, 0.03% and 0.5%, respectively, of the consolidated net sales and revenues of Pomeroy.
BUSINESS STRATEGY Pomeroy's strategy for building shareholder value is to provide comprehensive solutions to improve the productivity of its customers' IT systems thus reducing their overall IT costs. Key elements of the Company's strategy are: (1) to be the low cost provider of the complete solutions which are developed, integrated and managed for its customers, (2) to expand service offerings particularly in the higher end services and networking areas, (3) to expand offerings and grow the customer base through strategic acquisitions, and (4) to maintain and enhance technical expertise by hiring and training highly qualified technicians and systems engineers.
Pomeroy's sales are generated primarily by its 259 person direct sales and sales support personnel. Pomeroy's business strategy is to provide its customers with a comprehensive portfolio of product and service offerings, including, enterprise consulting services, complete infrastructure solutions and lifecycle services. The Company believes that its ability to combine competitive pricing of computer hardware, software and related products with comprehensive higher margin services allows it to compete effectively against a variety of competitors, including independent dealers, superstores, mail order and direct sales by manufacturers. With many businesses seeking assistance to optimize their information technology investments, Pomeroy is using its resources to assist customers in their decision-making, project implementation and management of IT capital.
Most microcomputer products are sold pursuant to purchase orders. For larger procurements, the Company may enter into written contracts with customers. These contracts typically establish prices for certain equipment and services and require short delivery dates for equipment and services ordered by the customer. These contracts do not require the customer to purchase microcomputer products or services exclusively from Pomeroy and may be terminated without cause upon 30 to 90 days notice. Most contracts are for a term of 12 to 24 months and, in order to be renewed, may require submission of a new bid in response to the customer's request for proposal. As of January 5, 2005, the Company has been awarded contracts it estimates will result in an aggregate of approximately $153.7 million of net sales and revenues after January 5, 2005. $108.4 million in net sales and revenues were generated in 2004 from these contracts. Of the aggregate total, the Company estimates that approximately $110.2 million of net sales and revenues will be generated in fiscal 2005. By comparison, as of January 5, 2004, the Company had been awarded contracts that it estimated would result in an aggregate of approximately $106.0 million of net sales and revenues after January 5, 2004. Of this amount, the Company estimated that $102.1 million of net sales and revenues would be generated during fiscal 2004. The estimates of management could be materially less than stated as a result of factors which would cause one or more of these customers to order less product or services than is anticipated. Such factors include the customer finding another supplier for the desired products at a lower price or on better terms, a change in internal business needs of the customer causing the customer to require less or different products and services, or the occurrence of a significant change in technology or other industry conditions which alters the customer's needs or timing of purchases.
Pomeroy has also established relationships with industry leaders relating to its services segment including the authorization to perform warranty and non-warranty repair work for several vendors. In some cases, the authorization of Pomeroy to continue performing warranty work for a particular manufacturer's products is dependent upon the performance of Pomeroy under a dealer agreement with that manufacturer.
Pomeroy provides its services to its customers on a time-and-materials basis and pursuant to written contracts or purchase orders. Either party can generally terminate these service arrangements with limited or no advance notice. Pomeroy also provides some of its services under fixed-price contracts rather than contracts billed on a time-and-materials basis. Fixed-price contracts are used when Pomeroy believes it can clearly define the scope of services to be provided and the cost of providing those services.
COMPETITION
The microcomputer products and services market is highly competitive. Distribution has evolved from manufacturers selling directly to customers, to manufacturers selling to aggregators (wholesalers), resellers and value-added resellers. Competition, in particular the pressure on pricing, has resulted in industry consolidation. In the future, Pomeroy may face fewer but larger competitors as a consequence of such consolidation. These competitors may have access to greater financial resources than Pomeroy. In response to continuing competitive pressures, including specific price pressure from the direct telemarketing, internet and mail order distribution channels, the microcomputer distribution channel is currently undergoing segmentation into value-added resellers who emphasize advanced systems together with service and support for business networks, as compared to computer "superstores," who offer retail purchasers a relatively low cost, low service alternative and direct-mail suppliers which offer low cost and limited service. Certain direct response and internet-based fulfillment organizations have expanded their marketing efforts to target segments of the Company's customer base, which could have a material adverse impact on Pomeroy's operations and financial results. While price is an important competitive factor in Pomeroy's business, Pomeroy believes that its sales are principally dependent upon its ability to provide comprehensive customer support services. Pomeroy's principal competitive strengths include: (i) quality assurance; (ii) service and technical expertise, reputation and experience; (iii) competitive pricing of products through alternative distribution sources; (iv) prompt delivery of products to customers; (v) various financing alternatives; and (vi) its ability to provide prompt responsiveness to customers services needs and to build performance guarantees into services contracts.
Pomeroy competes for product sales directly with local and national distributors and resellers. In addition, Pomeroy competes with microcomputer manufacturers that sell product through their own direct sales forces to end users and to distributors. Although Pomeroy believes its prices and delivery terms are competitive, certain competitors offer more aggressive hardware pricing to their customers.
Pomeroy's services solutions segment competes, directly and indirectly, with a variety of national and regional service providers, including services organizations of established computer product manufacturers, value-added resellers, systems integrators, internal corporate management information systems and consulting firms. Pomeroy believes that the principal competitive factors for information technology services include technical expertise, the availability of skilled technical personnel, breadth of service offerings, reputation, financial stability and price. To be competitive, Pomeroy must respond promptly and effectively to the challenges of technological change, evolving standards and its competitors' innovations by continuing to enhance its service offerings and expand sales channels. Any pricing pressures, reduced margins or loss of market share resulting from Pomeroy's failure to compete effectively could have a material adverse effect on Pomeroy's operations and financial results.
Pomeroy believes its services solutions segment competes successfully by providing a comprehensive solution portfolio for its customers' information technology asset management and networking services needs. Pomeroy delivers cost-effective, flexible, consistent, reliable and comprehensive solutions to meet customers' information technology infrastructure service requirements. Pomeroy also believes that it distinguishes itself on the basis of its technical expertise, competitive pricing and its ability to understand its customers' needs.
CERTAIN BUSINESS FACTORS
The following business factors, among others, are likely to affect Pomeroy's operations and financial results and should be considered in evaluating Pomeroy's outlook.
Growth and Future Acquisitions - --------------------------------- In the past, Pomeroy has grown both internally and through acquisitions. During fiscal 2004, Pomeroy experienced growth in its products and services segments. Pomeroy continues to focus on customer satisfaction as well as execution of its market development and penetration strategies. Additionally, Pomeroy is beginning to recognize synergies and strategic benefits from the integration of Alternative Resources Corporation ("ARC"). Pomeroy's business strategy is to continue to grow both internally and through acquisitions. There can be no assurance that, in the future, Pomeroy will be successful in repeating the growth experienced in prior years. Pomeroy expects future growth will result from acquisitions in addition to organic growth. In fiscal 2004, Pomeroy completed one acquisition and continues to evaluate expansion and acquisition opportunities that would complement its ongoing operations. As part of Pomeroy's growth strategy, it plans to continue to make investments in complementary companies, assets and technologies, although there can be no assurance that Pomeroy will be able to identify, acquire or profitably manage additional companies or successfully integrate such additional companies into Pomeroy without substantial costs, delays or other problems. In addition, there can be no assurance that companies acquired in the future will be profitable at the time of their acquisition or will achieve levels of profitability that justify the investment therein. Acquisitions may involve a number of special risks, including, but not limited to, adverse short-term effects on Pomeroy's reported operating results, disrupting ongoing business and distracting management and employees, incurring debt to finance acquisitions or issuing equity securities which could be dilutive to existing stockholders, dependence on retaining, hiring and training key personnel, incurring unanticipated problems or legal liabilities and amortization of acquired intangible assets. Some or all of these special risks could have a material adverse effect on Pomeroy's operations and financial results.
Vendor Receivables - ------------------- Any change in the level of vendor rebates or manufacturer market development funds offered by manufacturers that results in the reduction or elimination of rebates or manufacturer market development funds currently received by Pomeroy could have a material adverse effect on Pomeroy's operations and financial results. In particular, a reduction or elimination of rebates related to government and educational customers could adversely affect Pomeroy's ability to serve those customers profitably. In addition, there are specific risks, discussed below, related to the individual components of vendor receivables that include vendor rebates, manufacturer market development funds and warranty receivables. During fiscal year 2002, the Company recorded a $3.3 million allowance, related to the collectibility of vendor receivables resulting in $2.1 million reduction in net income. The determination of an appropriate allowance was based on the deterioration in the aging of the vendor receivables, the expected resolution of the disallowed claims (see primary reasons for vendor rebate claims being disallowed in "Vendor Rebates" below) and the general posture of the OEMs regarding resolution.
Vendor Rebates --------------- The most significant component of vendor receivables is vendor rebates. Vendor rebate programs are developed by OEMs allowing them to modify product pricing on a case-by-case basis (generally determined by individual customers) to maintain their competitive edge on specific transactions. Pomeroy contacts the OEM to request a rebate, for a specific transaction, and if approved, the OEM provides Pomeroy with a document authorizing a rebate to be paid to Pomeroy at a later date when a claim is filed. If the business is won, Pomeroy records the sale and the cost of the sale is reduced by the amount of the rebate, which is recorded as a vendor receivable. Rebate programs involve a complex set of rules varying by manufacturer. As a result of the rules and complexity of applying the rules to each item sold, claims are often rejected and require multiple submissions before credit is given resulting in longer aging of vendor receivables than other types of receivables. In addition, sometimes a claim is rejected altogether and no credit is given. Primary reasons for claims being disallowed and corresponding re-files include serial number issues (missing, incomplete, transposed, data base match-up discrepancies, etc.), pricing issues (dispute in calculation of rebate amounts) and other missing or incomplete documentation (bid letters, customer information, etc.) Pomeroy has made substantial process and system enhancements geared towards minimizing refiling rebate claims, but there is no assurance that Pomeroy will be able to successfully claim all of the vendor rebates that were passed along to the customers in a form of a reduction in sales price. Pomeroy has written off vendor receivables in the past and may do so in the future.
Manufacturer Market Development Funds ---------------------------------------- Several manufacturers offer market development funds, cooperative advertising and other promotional programs to distribution channel partners. Pomeroy utilizes these programs to fund some of its advertising and promotional programs. While such programs have been available to the Company in the past, there is no assurance that these programs will be continued.
The Emerging Issues Task Force ("EITF") reached a consensus opinion on EITF 02-16, "Accounting by a Customer (including a reseller) for Certain Consideration Received from a Vendor." EITF 02-16 requires that cash payments, credits, or equity instruments received as consideration by a customer from a vendor should be presumed to be a reduction of cost of sales when recognized by the customer in the income statement. In certain situations, the presumption could be overcome and the consideration recognized either as revenue or a reduction of a specific cost incurred. The consensus is applied prospectively to new or modified arrangements entered into after December 31, 2002.
The Company had been participating in a vendor program that expired in November of 2003. For those programs that were initiated prior to December 31, 2002, the Company had classified these vendor program payments as a reduction in selling, general and administrative expenses. Under any new agreements, the Company classifies these vendor program payments under cost of sales in accordance with EITF 02-16.
Warranty Receivables --------------------- The Company performs warranty service work on behalf of the OEM on customer product. Any labor cost or replacement parts needed to repair the product is reimbursable to Pomeroy by the OEM. It is the Company's responsibility to file for and collect these claims. The inability of the Company to properly track and document these claims could result in the loss of reimbursements.
Management Information System - ------------------------------- Pomeroy relies upon the accuracy and proper utilization of its management information system to provide timely distribution services, manage its inventory, track vendor receivables and track its financial information. To manage its growth, Pomeroy is continually evaluating the adequacy of its existing systems and procedures. Pomeroy selected the Siebel solution to provide a customer relationship management ("CRM") and Professional Service Management system. Pomeroy made this selection and acquired the software in the third quarter of 2002 and deployed the solution in phases throughout 2003. In 2004, the Company invested in software products and process engineering to accommodate greater revenue volume and enhance efficiencies in many service areas including remote service desk, outsourcing and staff augmentation offerings. This development is ongoing into 2005. Pomeroy anticipates that it will regularly need to make capital expenditures to upgrade and modify its management information system, including software and hardware, as Pomeroy grows and the needs of its business change. There can be no assurance that Pomeroy will anticipate all of the demands which expanding operations may place on its management information system. The occurrence of a significant system failure or Pomeroy's failure to expand or successfully implement its systems could have a material adverse effect on Pomeroy's operations and financial results.
Dependence on Technical Employees - ------------------------------------ The future success of Pomeroy's services business depends in large part upon the Company's ability to attract and retain highly skilled technical employees in competitive labor markets. There can be no assurance that Pomeroy will be able to attract and retain sufficient numbers of skilled technical employees. The loss of a significant number of Pomeroy's existing technical personnel or difficulty in hiring or retaining technical personnel in the future could have a material adverse effect on the Company's operations and financial results.
Inventory Management - --------------------- Rapid product improvement and technological change resulting in relatively short product life cycles and rapid product obsolescence characterize the information technology industry. While most of the inventory stocked by Pomeroy is for specific customer orders, inventory devaluation or obsolescence could have a material adverse effect on Pomeroy's operations and financial results. Current industry practice among manufacturers is to provide price protection intended to reduce the risk of inventory devaluation, although such policies are subject to change at any time and there can be no assurance that such price protection will be available to Pomeroy in the future. In prior fiscal years, many manufacturers reduced the number of days for which they provided price protection. During fiscal 2004, most of the reductions stabilized, however, current terms and conditions remain subject to change. In addition to the price protection mentioned above, subject to certain limitations, Pomeroy currently has the option of returning inventory to certain manufacturers and distributors. The amount of inventory that can be returned to manufacturers without a restocking fee varies under Pomeroy's agreements and such return policies may provide only limited protection against excess inventory. There can be no assurance that new product developments will not have a material adverse effect on the value of the Company's inventory or that the Company will successfully manage its existing and future inventory. In addition, Pomeroy stocks parts inventory for its services business. Parts inventory is more likely to experience a decrease in valuation as a result of technological change and obsolescence. Price protection practices are not ordinarily offered by manufacturers with respect to service parts.
Dependence on Vendor Relationships - ------------------------------------- The Company's current and future success depends, in part, on its relationships with leading hardware and software vendors and on its status as an authorized service provider. Pomeroy is currently authorized to service the products of many industry-leading hardware, software and internetworking product vendors. Without these relationships, the Company would be unable to provide its current range of services, principally warranty services.
The Company may not be able to maintain, or attract new relationships with the computer hardware and software vendors that they believe are necessary for their business. Since Pomeroy utilizes vendor relationships as a marketing tool, any negative change in these relationships could adversely affect its financial condition and results of operations while it seeks to establish alternative relationships. In general, authorization agreements with vendors include termination provisions, some of which are immediate. The Company cannot assure that vendors will continue to authorize them as an approved service provider. In addition, the Company cannot assure that vendors, which introduce new products, will authorize them as an approved service provider for such new products.
Significant product supply shortages have resulted from time to time because manufacturers have been unable to produce sufficient quantities of certain products to meet demand. The Company expects to experience some difficulty in obtaining an adequate supply of products from its major vendors, which may result in delays in completing sales.
The loss of any vendor relationship, product line, or product shortage could reduce the supply and increase costs of products sold by Pomeroy and adversely impact the Company's competitive position.
Pricing Pressures - ------------------ Pomeroy believes its prices and delivery terms are competitive; however, certain competitors may offer more aggressive pricing to their customers. The Company has experienced and expects continued pricing pressure in its products segment due to industry consolidation and the efforts of manufacturers to sell directly to Pomeroy's customers. In addition, the general weakness in the U.S. economy has impacted Pomeroy's business. In an attempt to stimulate sales to existing and new customers, the Company believes that pricing pressures may increase in the future, which could require the Company to reduce prices, which may have an adverse impact on its operating results. Decreasing prices of Pomeroy's products and services offerings will require the Company to sell a greater number of products and services to achieve the same level of net sales and gross profit.
Government Contracts - --------------------- A portion of Pomeroy's revenue is derived from contracts with state and local governments and government agencies. In the event of a dispute, the Company would have limited recourse against the government or government agency. Furthermore, future statutes and/or regulations may reduce the profitability of such contracts. In addition, certain of the Company's government contracts have no contractual limitation of liability for damages resulting from the provision of services.
Dependence on Major Customers - -------------------------------- During fiscal 2004, approximately 23.4% of Pomeroy's total net sales and revenues were derived from its top 10 customers. No customer accounted for more than 10% of Pomeroy's total net sales and revenues. The loss of one or more significant customers could have a material adverse impact on the Company's operating results.
Dependence on Key Personnel - ------------------------------ The success of Pomeroy is dependent on the services of Stephen E. Pomeroy, Chief Executive Officer, President and Chief Operating Officer of the Company and Chief Executive Officer of Pomeroy Select, and other key personnel. The loss of the services of Stephen E. Pomeroy, or other key personnel could have a material adverse effect on Pomeroy's business. Pomeroy has entered into employment agreements with certain of its key personnel, including Stephen E. Pomeroy. Pomeroy's success and plans for future growth will also depend on its ability to attract and retain highly skilled personnel in all areas of its business.
On June 10, 2004, the Company announced that Stephen E. Pomeroy had been elected to the position of Chief Executive Officer and that David B. Pomeroy had resigned as CEO. David B. Pomeroy continues to serve as the Chairman of the Board of the Company. On January 31, 2005, the Company entered into a consulting agreement with David B. Pomeroy.
Stock Price - ------------ Pomeroy's stock price is affected by a number of factors, including quarterly variations in revenue, gross profit and operating income, general economic and market conditions, and estimates and projections by the investment community. As a result, Pomeroy's common stock may fluctuate in market price.
EMPLOYEES
As of January 5, 2005, Pomeroy had 3,526 full-time employees consisting of the following: 1,976 technical personnel; 259 direct sales representatives and sales support personnel; 268 management personnel; and 1,023 administrative and distribution personnel. Pomeroy offers its full-time employees the options to participate in health and dental insurance, short and long term disability insurance, life insurance, 401(k) plan and an employee stock purchase plan. Pomeroy has no collective bargaining agreements and believes its relations with its employees are good.
BACKLOG
Other than future sales and revenues from existing long-term contracts, Pomeroy does not have a significant backlog of business since it normally delivers and installs products purchased by its customers within 10 days from the date of order. Accordingly, backlog is not material to Pomeroy's business or indicative of future sales. From time to time, Pomeroy experiences difficulty in obtaining products from its major vendors as a result of general industry conditions. These delays have not had, and are not anticipated to have, a material adverse effect on Pomeroy's results of operations.
PATENTS AND TRADEMARKS
The Company owns no trademarks or patents. Although Pomeroy's various dealer agreements do not generally allow the Company to use the trademarks and trade names of these various manufacturers, the agreements do permit the Company to refer to itself as an "authorized representative" or an "authorized service provider" of the products of those manufacturers and to use their trademarks and trade names for marketing purposes. Pomeroy considers the use of these trademarks and trade names in its marketing efforts to be important to its business.
ACQUISITIONS
Acquisitions have contributed significantly to Pomeroy's growth. The Company believes that acquisitions are one method of increasing its presence in existing markets, expanding into new geographic markets, adding experienced service personnel, gaining new product offerings and services, obtaining more competitive pricing as a result of increased purchasing volumes of particular products and improving operating efficiencies through economies of scale. In recent years, there has been consolidation among providers of microcomputer products and services and Pomeroy believes that this consolidation will continue, which, in turn, may present additional opportunities for the Company to grow through acquisitions. The Company continually seeks to identify and evaluate potential acquisition candidates.
During fiscal 2004, the Company completed one acquisition. The total consideration paid consisted of $46.1 million, which was funded from cash on hand and borrowings from Pomeroy's existing line of credit.
The results of operations of the acquisition are included in the fiscal 2004 consolidated statement of income from the respective date of the acquisition. See Note 13 to the Consolidated Financial Statements for unaudited pro forma results of operations of the Company as if the fiscal 2004 acquisition had occurred on January 6, 2003.
ITEM 2.
ITEM 2. PROPERTIES
Pomeroy's principal executive offices, distribution facility and national training center comprised of approximately 36,000, 161,000 and 22,000 square feet of space, respectively, are located in Hebron, Kentucky. These facilities are leased from Pomeroy Investments, LLC ("Pomeroy Investments"), a Kentucky limited liability company controlled by David B. Pomeroy, II, Chairman of the Board, under a ten-year triple-net lease agreement, which expires in July 2010. The lease agreement provides for 2 five-year renewal options.
The Company is currently negotiating terms with a related party, Pomeroy Investments, for an additional 70,000 square feet of space at the Company's facilities in Hebron, Kentucky. The lease is expected to be a ten-year triple-net lease with fair market value rent payments. The final version of the lease will be subject to approval of the Company's Audit Committee.
Pomeroy also has non-cancelable operating leases for its regional offices, expiring at various dates between 2005 and 2009. Pomeroy believes there will be no difficulty in negotiating the renewal of its real property leases as they
expire or in finding other satisfactory space. In the opinion of management, the properties are in good condition and repair and are adequate for the particular operations for which they are used. Pomeroy does not own any real property.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Various legal actions arising in the normal course of business have been brought against Pomeroy. Management believes these matters will not have a material adverse effect on Pomeroy's consolidated financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The following table sets forth, for the periods indicated, the high and low sales price for the Common Stock for the quarters indicated as reported on the NASDAQ National Market.
As of February 28, 2005, there were approximately 328 holders of record of Pomeroy's common stock.
Dividends - --------- During 2004, the Company did not pay any cash dividends. Pomeroy has no plans to pay cash dividends in the foreseeable future, and the payment of such dividends are restricted under Pomeroy's current credit facility. Under such credit facility, cash dividends and stock redemptions are limited to $5 million annually.
During 2003, the Company paid a one-time cash dividend of $9.8 million, or $0.80 per share, to shareholders of record as of July 28, 2003.
Securities authorized for issuance under equity compensation plans - ------------------------------------------------------------------------- During 2004, the Company granted options exercisable for approximately 1.2 million shares of common stock under the 2002 Amended and Restated Stock Incentive Plan and 2002 Outside Directors' Stock Option Plan. As of January 5, 2005, the following shares of common stock were authorized for issuance under equity compensation plans:
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
QUARTERLY RESULTS OF OPERATIONS - UNAUDITED (in thousands, except per share data)
The following table sets forth certain unaudited operating results of each of the eight prior quarters. This information is unaudited, but in the opinion of management includes all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the results of operations of such periods.
ITEM 7.
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the Company's results of operation and financial position should be read in conjunction with its consolidated financial statements included elsewhere in this report. In addition, the Certain Business Factor's described under "Business" should be considered in evaluating the Company's outlook.
CRITICAL ACCOUNTING POLICIES In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Management believes that it consistently applies judgments and estimates and such consistent application results in financial statements and accompanying notes that fairly represent all periods presented. However, any errors in these judgments and estimates may have a material impact on the Company's statement of operations and financial condition. Critical accounting policies, as defined by the Securities and Exchange Commission, are those that are most important to the portrayal of the Company's financial condition and results of operations and require management's most difficult and subjective judgments and estimates of matters that are inherently uncertain. The Company considers its critical accounting policies to be (1) vendor and trade receivable allowances, (2) valuation of long-lived assets and (3) income taxes.
Vendor and trade receivable allowances Pomeroy maintains allowances for doubtful accounts on both vendor and trade receivables for estimated losses resulting from the inability of its customers or vendors to make required payments. The determination of a proper allowance for vendor receivables is based on an ongoing analysis as to the recoverability of the Company's vendor receivable portfolio based primarily on account aging. The determination of a proper allowance for trade receivables is based on an ongoing analysis as to the credit quality and recoverability of the Company's trade receivable portfolio. Factors considered are account aging, historical bad debt experience, current economic trends and others. The analysis is performed on both vendor and trade receivable portfolios. A separate allowance account is maintained based on each analysis.
Valuation of long-lived assets Long-lived assets, including property and equipment, goodwill and other intangible assets are reviewed for impairment when events or changes in facts and circumstances indicate that their carrying amount may not be recoverable. Events or changes in facts and circumstances that Pomeroy considers as impairment indicators include the following:
- Significant underperformance of the Company's operating results relative to expected operating results; - Net book value compared to its market capitalization; - Significant adverse economic and industry trends; - Significant decrease in the market value of the asset; - Significant changes to the asset since the Company acquired it; - And the extent that the Company may use an asset or changes in the manner that the Company may use it.
When the Company determines that one or more impairment indicators are present for its long-lived assets, excluding goodwill, Pomeroy compares the carrying amount of the asset to the net future undiscounted cash flows that the asset is expected to generate. If the carrying amount of the asset is greater than the net future undiscounted cash flows that the asset is expected to generate, Pomeroy would recognize an impairment loss to the extent the carrying value of the asset exceeds its fair value. An impairment loss, if any, would be reported in the Company's future results of operations.
When the Company determines that one or more impairment indicators are present for its goodwill, Pomeroy compares its reporting unit's carrying value to its fair value. The Company has two reporting units for goodwill testing which are a products reporting unit and a services reporting unit. The Company has adopted January 6 as the valuation date for the annual testing. Currently, the Company has engaged a third-party valuation specialist to perform the annual goodwill impairment testing as of January 6, 2005. An impairment loss, if any, would be reported in the Company's results of operations at the date it is determined.
Income taxes Pomeroy is required to estimate income taxes in each of the jurisdictions in which the Company operates. This process involves estimating the Company's actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the Company's consolidated balance sheet. The Company must then assess the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent that the Company believes recovery is not likely, the Company must establish a valuation allowance. To the extent the Company establishes a valuation allowance in a period, the Company must include an expense within the tax provision in the statement of operations. Pomeroy has not recorded a valuation allowance to reduce the carrying amount of recorded deferred tax assets representing future deductions, as the Company believes it will have sufficient taxable income in the future to realize these deductions. Pomeroy considers future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. In the event Pomeroy were to determine that it would not be able to realize its deferred tax assets in the future, an adjustment to the deferred tax asset would decrease income in the period such determination was made.
RESULTS OF OPERATIONS The following table sets forth for the periods presented information derived from our consolidated statements of income expressed as a percentage of net sales and revenues:
FISCAL YEAR 2004 COMPARED TO FISCAL YEAR 2003
Total Net Sales and Revenues. Total net sales and revenues increased $143.9 million, or 24.0%, to $742.3 million in fiscal 2004 from $598.4 million in fiscal 2003. This increase was a result primarily of increased industry-wide technology spending and the acquisition of Alternative Resources Corporation ("ARC") on July 23, 2004. Excluding the acquisition completed in fiscal year 2004, total net sales and revenues increased 13.4%.
Products and leasing sales increased $74.6 million, or 15.9%, to $545.1 million in fiscal 2004 from $470.5 million in fiscal 2003. Excluding acquisitions completed in fiscal year 2004, total product and leasing net sales and revenues increased 14.3%. Service revenues increased $69.3 million, or 54.2%, to $197.2 million in fiscal 2004 from $127.9 million in fiscal 2003. Excluding acquisitions completed in fiscal year 2004, total service net sales and revenues
increased 10.2%. The net increase in products and leasing net sales and revenue was primarily a result of increased industry-wide technology spending and the increase in service revenue was primarily a result of the acquisition of Alternative Resources Corporation on July 23, 2004.
Gross Profit. Gross profit margin was 12.8% in fiscal 2004 compared to 11.8% in fiscal 2003. This increase in gross profit resulted primarily from the increase in service revenues as a percentage of total revenues and the increase in service gross margin as a percentage of total gross margins due to the acquisition of Alternative Resources Corporation and by the adoption of EITF 02-16. On a forward looking basis, the Company expects to continue its aggressive product pricing in order to gain existing market share which will have a continued impact on product gross margin. The competitive environment as well as less than maximum technical employee utilization rate has also resulted in downward pressure on service margins. Additionally, the Company expects to continue increasing the breadth and depth of its service offerings, which will have a continued impact on service gross margin. Service gross margin increased to 56.8% of total gross margin in fiscal 2004 from 49.6% in fiscal 2003. Factors that may have an impact on gross margin in the future include the continued changes in hardware margins, change in technical employee utilization rates, the mix of the type of products sold and services provided, the percentage of equipment or service sales with lower-margin customers, the ratio of service revenues to total net sales and revenues, and the Company's decision to aggressively price certain products and services.
As a consequence of adopting EITF 02-16, the Company recorded approximately $734 thousand during fiscal 2004 of vendor considerations as a reduction of cost of sales, which would previously have been recorded as a reduction of selling, general and administrative expenses. Excluding the impact of EITF 02-16, and therefore on a non-GAAP basis, the gross profit would have been 12.7% during fiscal 2004 compared to 11.7% during fiscal 2003. The non-GAAP gross profit margin is included in this discussion to provide meaningful comparison to prior periods.
Operating Expenses. Selling, general and administrative expenses (including rent expense and provision for doubtful accounts) expressed as a percentage of total net sales and revenues increased to 9.4% in fiscal 2004 from 8.4% for fiscal 2003. Total operating expenses expressed as a percentage of total net sales and revenues increased to 10.3% in fiscal 2004 from 9.3% for fiscal 2003. The increases are primarily the result of the acquisition of Alternative Resources Corporation and recording a $2.4 million restructuring charge in the third quarter of fiscal 2004 and the adoption of EITF 02-16 offset by higher net sales and revenues in fiscal 2004 as compared to fiscal 2003. On a forward-looking basis, the Company expects to continue monitoring its selling, general and administrative expenses for strict cost controls.
As noted above, as a result of adopting EITF 02-16, the Company reclassified approximately $734 thousand of vendor consideration to a reduction of cost of sales, which would previously have been recorded as a reduction of selling, general and administrative expenses. Excluding the impact of EITF 02-16, and therefore on a non-GAAP basis, operating expenses would have been 10.2% during fiscal 2004 as compared to 9.3% during fiscal 2003. This non-GAAP measurement is included to provide a more meaningful comparison to prior periods.
Litigation Settlement. No litigation settlement expenses were recorded in fiscal 2004. $0.2 million was recorded in fiscal 2003. For fiscal 2003, the litigation settlement relates to a single bankruptcy preference claim.
Restructuring and Severance Charges. Restructuring and severance charges reported were $2.4 million for fiscal 2004. During fiscal 2004, in connection with certain strategic initiatives, the Company recorded restructuring and severance charges of $1.0 million. The restructuring charge is associated with costs of facilities and processes of Pomeroy that have or will become duplicative or redundant as ARC operations are integrated into the Company. The Company also recorded a non-recurring, one-time charge for severance in the amount of $1.4 million related to the resignation of David B. Pomeroy II as CEO of the Company. David B. Pomeroy II continues to serve as Chairman of the Board of the Company.
Income from Operations. Income from operations increased $3.6 million, or 24.3%, to $18.4 million in fiscal 2004 from $14.8 million in fiscal 2003. The Company's operating margin remained constant in fiscal 2004 and 2003 at 2.5%, primarily due to the increase in gross margin, offset by increase in operating expenses.
Net Interest Income/Expense. Net interest expense was $0.25 million during fiscal 2004 as compared to interest income of $0.08 million during fiscal 2003. This increase in net interest expense was a result of increased borrowings under our credit facility relating to the ARC acquisition and lower interest rates on invested funds.
Income Taxes. The Company's effective tax rate was 39.75% in fiscal 2004 compared to 39.0% in fiscal 2003. This increase was principally related to the increase in state and local income taxes.
Net Income. Net income increased $1.8 million, or 19.8%, to $10.9 million in fiscal 2004 from $9.1 million in fiscal 2003. The increase was a result of the factors described above.
FISCAL YEAR 2003 COMPARED TO FISCAL YEAR 2002
Total Net Sales and Revenues. Total net sales and revenues decreased $104.4 million, or 14.9%, to $598.4 million in fiscal 2003 from $702.8 million in fiscal 2002. This decrease was a result primarily of a continued industry-wide slowdown in technology spending due to the general weakness in the U.S. economy and the decrease in leasing revenue due to the sale of TIFS during fiscal 2002. Further, the Company sometimes elects to take a commission from the manufacturers for arranging sales transactions where it judges the gross profit to be inadequate for its participation in the sales transaction. In fiscal year 2003, Pomeroy elected to take such commissions on transactions whose sales would otherwise have been $10.6 million. Excluding acquisitions completed in fiscal year 2003, total net sales and revenues decreased 19.3%
Products and leasing sales decreased $101 million, or 17.7%, to $470.5 million in fiscal 2003 from $571.5 million in fiscal 2002. Excluding acquisitions completed in fiscal year 2003, total product and leasing net sales and revenues decreased 22.7%. Service revenues decreased $3.4 million, or 2.6%, to $127.9 million in fiscal 2003 from $131.3 million in fiscal 2002. Excluding acquisitions completed in fiscal year 2003, total service net sales and revenues decreased 4.6% These net decreases were primarily a result of an industry-wide slowdown in technology spending due to the general weakness in the U.S. economy and the sale of TIFS.
Gross Profit. Gross profit margin was 11.8% in fiscal 2003 compared to 12.5% in fiscal 2002. This decrease in gross profit resulted primarily from the decrease in hardware and service margins, but was offset somewhat by the adoption of EITF 02-16 and somewhat by the higher proportion of service gross margin to total gross margin. The decrease in product and leasing gross margin is primarily associated with the Company's strategic decision to aggressively price its hardware business in order to maintain and capture market share and to the weakened economic conditions of the IT industry, and offset somewhat by the adoption of EITF 02-16. On a forward looking basis, the Company expects to continue its aggressive product pricing in order to gain existing market share which will have a continued impact on product gross margin. The competitive environment as well as less than maximum technical employee utilization rate has also resulted in downward pressure on service margins. Additionally, the Company expects to continue increasing the breadth and depth of its service offerings, which will have a continued impact on service gross margin. Service gross margin increased to 49.6% of total gross margin in fiscal 2003 from 46.1% in fiscal 2002. Factors that may have an impact on gross margin in the future include the continued changes in hardware margins, change in personnel utilization rates, the mix of products sold and services provided, a change in unit prices, the percentage of equipment or service sales with lower-margin customers, the ratio of service revenues to total net sales and revenues, and the Company's decision to aggressively price certain products and services.
As a consequence of adopting EITF 02-16, the Company recorded approximately $324 thousand during fiscal 2003 of vendor considerations as a reduction of cost of sales, which would previously have been recorded as a reduction of selling, general and administrative expenses. Excluding the impact of EITF 02-16, and therefore on a non-GAAP basis, the gross profit would have been 11.7% during fiscal 2003 compared to 12.5% during fiscal 2002. The non-GAAP gross profit margin is included in this discussion to provide meaningful comparison to prior periods.
Operating Expenses. Selling, general and administrative expenses (including rent expense and provision for doubtful accounts) expressed as a percentage of total net sales and revenues increased to 8.4% in fiscal 2003 from 7.9% for fiscal 2002. This increase is the result of lower than expected total net sales and revenues in fiscal 2003 as compared to fiscal 2002 and the adoption of EITF 02-16.
As a result of adopting EITF 02-16, the Company reclassified approximately $324 thousand of vendor consideration to a reduction of cost of sales, which would previously have been recorded as a reduction of selling, general and administrative expenses. Excluding the impact of EITF 02-16, and therefore on a non-GAAP basis, selling, general and administrative expenses would have been 8.3% during fiscal 2003 as compared to 7.9% during fiscal 2002. This non-GAAP measurement is included to provide a more meaningful comparison to prior periods.
Total operating expenses expressed as a percentage of total net sales and revenues remained the same for fiscal 2003 and fiscal 2002 at 9.3%. However, the composition of the fiscal 2003 total operating expenses changed from fiscal 2002. With the exception of depreciation expense, all other operating expenses decreased in fiscal 2003 as compared to fiscal 2002. Excluding the impact of EITF 02-16, and therefore on a non-GAAP basis, total operating expenses would have been 9.2% during fiscal 2003 as compared to 9.3% during fiscal 2002. This non-GAAP
measurement is included to provide a more meaningful comparison to prior periods. On a forward-looking basis, the Company expects to continue monitoring its selling, general and administrative expenses for strict cost controls.
Litigation Settlement. Litigation settlement expense decreased $0.1 million or 33.3% to $0.2 million in fiscal 2003 from $0.3 million in fiscal 2002. For both fiscal 2003 and fiscal 2002, the litigation settlement relates to a single bankruptcy preference claim.
Provision for Vendor Receivables and Restructuring Charge. In fiscal 2002 the Company expensed $3.3 million to increase the vendor receivable reserve based on the deterioration of the aging of the vendor receivables, the expected resolution of the disputed vendor rebate claims and the general posture of the OEMs regarding resolution. In fiscal 2002 the Company also recorded restructuring expenses of $.7 million to consolidate and relocate operations in various geographical locations. No such expenses were recorded in fiscal 2003.
Income from Operations. Income from operations decreased $7.4 million, or 33.3%, to $14.8 million in fiscal 2003 from $22.2 million in fiscal 2002. The Company's operating margin decreased to 2.5% in fiscal 2003 from 3.2% in fiscal 2002. This decrease is primarily due to the decrease in gross margin and the lower than expected total net sales and revenues , offset by decrease in operating expenses.
Net Interest Income/Expense. Interest income was $0.08 million during fiscal 2003 as compared to interest expense of $0.5 million during fiscal 2002. This change was due to reduced borrowings as a result of improved cash flow management, the sale of certain TIFS assets and interest income earned on cash balances.
Income Taxes. The Company's effective tax rate was 39.0% in fiscal 2003 compared to 31.0% in fiscal 2002. This increase was principally related to a tax benefit of $1.6 million in fiscal 2002 associated with an increase in the tax basis of leased assets as a result of an accounting method change for tax purposes in fiscal 2002.
Net Income. Net income decreased $5.9 million, or 39.3%, to $9.1 million in fiscal 2003 from $15.0 million in fiscal 2002. The increase was a result of the factors described above.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities was $5.8 miIlion in fiscal 2004. Cash used in investing activities was $18.8 million, which included $16.4 million for acquisitions completed in fiscal 2004 and prior years and $2.4 million for capital expenditures. Cash used in financing activities was $9.5 million which included $31.4 million of payments on notes payable, $0.5 million for the purchase of treasury stock, and was offset by $20.2 million in proceeds from short-term borrowings, $1.8 million from the exercise of stock options, and $0.4 million proceeds from the employee stock purchase plan.
A significant part of Pomeroy's inventories are financed by floor plan arrangements with third parties. At January 5, 2005, these lines of credit totaled $85.0 million, including $75.0 million with GE Commercial Distribution Finance ("GECDF") and $10.0 million with IBM Credit Corporation ("ICC"). Borrowings under the GECDF floor plan arrangements are made on thirty-day notes. Borrowings under the ICC floor plan arrangements are made on fifteen-day notes. All such borrowings are secured by the related inventory. Financing on substantially all of the arrangements is interest free due to subsidies by manufacturers. Overall, the average rate on these arrangements is less than 1.0%. The Company classifies amounts outstanding under the floor plan arrangements as accounts payable.
On June 28, 2004, the Company finalized a new $165 million Syndicated Credit Facility Agreement with GECDF. The new credit facility has a three-year term and its components include a maximum of $75 million for inventory financing and a revolving line of credit, collateralized primarily by accounts receivable, of up to $110 million; provided that the total amount outstanding at any time under the inventory financing facility and the revolving line of credit may not exceed $165 million. Under the new agreement, the credit facility provides a letter of credit facility of $5 million. Under the credit facility, the interest rate is based on the London InterBank Offering Rate ("LIBOR") and a pricing grid. As of January 5, 2005 the adjusted LIBOR rate was 4.4%. This credit facility expires June 28, 2007.
At January 5, 2005, the Company's balance outstanding under the credit facility was approximately $20.2 million. At January 5, 2004, the Company did not have an outstanding balance under its previous credit facility. The credit facility is collateralized by substantially all of the assets of Pomeroy, except those assets that collateralize certain other financing arrangements. Under the terms of the credit facility, Pomeroy is subject to various financial covenants. Currently, Pomeroy is not in violation of any financial covenants.
On July 23, 2004, the Company and Pomeroy Acquisition Sub, Inc. ("PAS"), a wholly owned subsidiary the Company, completed a merger with Alternative Resources Corporation ("ARC"). On May 11, 2004, the parties entered into a definitive merger agreement for PAS to acquire all of the issued and outstanding shares of capital stock of ARC. The merger was approved by ARC shareholders at a meeting held on July 22, 2004. As a result of the merger, ARC is now a wholly-owned subsidiary of the Company. The cash consideration paid at closing, including the cost of all stock, stock options and warrants purchased and the amount of ARC net debt retired, was approximately $46.1 million, which was funded from cash on hand and borrowings from Pomeroy's existing line of credit.
Pomeroy believes that the anticipated cash flow from operations and current financing arrangements will be sufficient to satisfy Pomeroy's capital requirements for the next twelve months. Historically, Pomeroy has financed acquisitions using a combination of cash, earn outs, shares of its Common Stock and seller financing. Pomeroy anticipates that future acquisitions will be financed in a similar manner.
Off-Balance Sheet Arrangements and Contractual Obligations
Aggregated information about the Company's contractual obligations as of January 5, 2005 are presented in the following table:
The operating leases, shown above, are not recorded on the consolidated balance sheet. Operating leases are utilized in the normal course of business. The expected timing or payment of obligations discussed above is estimated based on current information. Timing of payments and actual amounts paid may be different depending on changes to agreed-upon amounts for some obligations.
Impact of Recent Accounting Pronouncement
In December 2004, the FASB issued FAS 123R. This statement, which will be effective for the Company beginning on July 6, 2005, will change how the Company accounts for share-based compensation, and may have a significant impact on its future results of operations and earnings per share. The Company currently accounts for share-based payments to employees and directors using the intrinsic value method. Under this method, the Company generally does not recognize any compensation expense related to stock option grants it awards under its stock option plans.
FAS 123R will require the Company to recognize share-based compensation as compensation expense in the statement of operations based on the fair values of such equity on the date of the grant, with the compensation expense recognized over the period in which the recipient is required to provide service in exchange for the equity award. This statement will also require the Company to adopt a fair value-based method for measuring the compensation expense related to share-based compensation. The Company has not yet completed its evaluation of the impact of the adoption of FAS 123R on its results of operations. In connection with evaluating the impact of FAS 123R, the Company is considering the potential implementation of different valuation methods to determine the fair value of share-based compensation.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate risk primarily through its credit facility with GECDF. Due to the Company's current cash position, the Company did not experience a material impact from interest rate risk during fiscal 2004.
Currently, the Company does not have any significant financial instruments for trading or other speculative purposes or to manage interest rate exposure.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Registrant hereby incorporates the financial statements required by this item by reference to Item 15 hereof.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
(a)(i) Effective October 3, 2003, Pomeroy IT Solutions, Inc. (the "Company") dismissed Grant Thornton LLP as the Company's independent accountants.
(ii) The reports of Grant Thornton LLP on the Company's consolidated financial statements for the fiscal years ended January 5, 2003 and 2002 contained no adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principle.
(iii) The Audit Committee and the Board of Directors approved the Company's change in independent accountants.
(iv) In connection with the Company's audits for the two fiscal years ending January 5, 2003 and 2002 and through October 7, 2003, the Company has had no disagreements with Grant Thornton LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Grant Thornton LLP would have caused them to make reference thereto in their report on the consolidated financial statements of the Company for such years.
(v) During the Company's two fiscal years ending January 5, 2003 and 2002 and through October 7, 2003, the Company has had no reportable events as defined in Item 304 (a) (1) (v) of Regulation S-K.
(vi) Grant Thornton LLP has furnished the Company with a letter addressed to the Securities and Exchange Commission stating that it agrees with the above statements. A copy of this letter, dated October 7, 2003, was filed as Exhibit 16.1 to the Form 8-K, filed October 7, 2003.
(b)(i) The Company has engaged Crowe Chizek and Company LLC as its new independent accountants effective October 3, 2003.
During the Company's two fiscal years ending January 5, 2003 and 2002 and through October 7, 2003, the Company has not consulted with Crowe Chizek and Company LLC regarding either (i) the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinion that might be rendered on the Company's financial statements, and neither a written report nor oral advice was provided to the Company that Crowe Chizek and Company LLC concluded was an important factor considered by the Company in reaching a decision as to the accounting, auditing or financial reporting issue; or (ii) any matter that was either the subject of a disagreement, as that term is defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions to Item 304 of Regulation S-K, or a reportable event, as that term is defined in Item 304(a)(1)(v) of Regulation S-K.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. With the participation of management, our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15e and 15d - 15e) as of the fiscal year ended January 5, 2005, have concluded that, as of such date, our disclosure controls and procedures were effective.
Internal Control Over Financial Reporting. The Company is currently completing an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's internal control over financial reporting as of the end of the period covered by this report. This evaluation has not yet been completed. The Company is taking advantage of the SEC's exemptive order and intends to file an amended Form 10-K, including its control report, by the extended filing date deadline of May 5, 2005.
Changes in Internal Controls. During the fourth quarter ended January 5, 2005, there were no changes in our internal control over financial reporting that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION None
PART III ITEMS 10-14.
The Registrant hereby incorporates the information required by Form 10-K, Items 10-14 by reference to the Company's definitive proxy statement for its 2005 Annual Meeting of shareholders, which will be filed with the Commission on or before May 5, 2005.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as a part of this report:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pomeroy IT Solutions, Inc.
By: /s/ Stephen E. Pomeroy ----------------------------------------------- Stephen E. Pomeroy President and Chief Executive Officer
By: /s/ Michael E. Rohrkemper ----------------------------------------------- Michael E. Rohrkemper Chief Financial Officer and Chief Accounting Officer
Dated: April 5, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders Pomeroy IT Solutions, Inc.
We have audited the accompanying consolidated balance sheets of Pomeroy IT Solutions, Inc. and subsidiaries as of January 5, 2005 and 2004, and the related consolidated statements of income, equity and cash flows for each of the two years in the period ended January 5, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pomeroy IT Solutions, Inc. and subsidiaries as of January 5, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the two years in the period ended January 5, 2005 in conformity with accounting principles generally accepted in the United States of America.
Crowe Chizek and Company LLC
/s/ Crowe Chizek and Company LLC
Louisville, Kentucky March 31, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders Pomeroy IT Solutions, Inc.
We have audited the accompanying consolidated statements of income, equity and cash flows of Pomeroy IT Solutions, Inc. (formerly Pomeroy Computer Resources, Inc.) for the year ended January 5, 2003. These statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the statements of income, equity and cash flows are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the statements of income, equity and cash flows. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the results of operations. We believe that our audit of the statements of income, equity and cash flows provides a reasonable basis for our opinion.
In our opinion, the statements of income, equity and cash flows referred to above present fairly, in all material respects, the consolidated results of operations of Pomeroy IT Solutions, Inc. (formerly Pomeroy Computer Resources, Inc.) for the year ended January 5, 2003, in conformity with accounting principles generally accepted in the United States of America.
Grant Thornton LLP
/s/ Grant Thornton LLP
Cincinnati, Ohio February 7, 2003
See notes to consolidated financial statements.
See notes to consolidated financial statements.
See notes to consolidated financial statements.
See notes to consolidated financial statements.
POMEROY IT SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FISCAL YEARS ENDED JANUARY 5, 2005 JANUARY 5, 2004 AND JANUARY 5, 2003
1. Company Description
Pomeroy IT Solutions, Inc. (formerly, Pomeroy Computer Resources, Inc.) is a Delaware corporation organized in February 1992. Pomeroy IT Solutions, Inc., collectively with its subsidiaries, ("Pomeroy" or the "Company") is a provider of enterprise-wide information technology ("IT") solutions that leverage its portfolio of professional services to create long-term relationships.
The Company's target markets include Fortune 1000 and small and medium business ("SMB") customers. These customers fall into government and education, financial services, health care and other sectors. The Company's customers are located throughout the United States with an emphasis in the Southeast and Midwest regions. The Company grants credit to substantially all customers in these areas.
The Company operates in three industry segments: products, services and leasing. See Note 14 of the Notes to Consolidated Financial Statements for discussion of the 2002 sale of the majority of leasing segment net assets. See Note 21 of Notes to Consolidated Financial Statements for a presentation of segment financial information.
2. Summary of Significant Accounting Policies
Principles of Consolidation - The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Fiscal Year - The Company's fiscal year is a 12 month period ending January 5. References to fiscal 2004, 2003 and 2002 are for the fiscal years ended January 5, 2005, January 5, 2004 and January 5, 2003, respectively.
Cash and Cash Equivalents - Cash and cash equivalents includes highly liquid, temporary cash investments having original maturity dates of three months or less.
Goodwill - Effective January 6, 2002, the Company adopted the new accounting pronouncement related to goodwill (See Note 6). In lieu of amortization, the Company tests goodwill for impairment annually or more frequently if certain conditions exist.
Other Intangible Assets - Effective January 6, 2002, the Company adopted the new accounting pronouncement related to other intangible assets (See Note 6). The Company's other intangible assets consist only of intangibles with definitive lives that are being amortized using the straight-line method over periods up to fifteen years.
Equipment and Leasehold Improvements - Equipment and leasehold improvements are stated at cost. Depreciation on equipment is computed using the straight-line method over estimated useful lives ranging from three to seven years. Depreciation on leasehold improvements is computed using the straight-line method over estimated useful lives or the term of the lease, whichever is less, ranging from two to ten years. Depreciation expense associated with the leasing segment's operating leases is classified under cost of sales. Expenditures for repairs and maintenance are charged to expense as incurred and additions and improvements that significantly extend the lives of assets are capitalized. Expenditures related to the acquisition or development of computer software to be utilized by the Company are capitalized or expensed in accordance with Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The Company reviews equipment and leasehold improvements for potential impairment in accordance with Statement of Financial Accounting Standard (SFAS) 144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of". Upon sale or retirement of depreciable property, the cost
and accumulated depreciation are removed from the related accounts and any gain or loss is reflected in the results of operations.
Income Taxes - Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Vendor Rebates - The most significant component of vendor receivables is vendor rebates. Vendor rebate programs are developed by original equipment manufacturers ("OEM') allowing them to modify product pricing on a case by case basis (generally determined by individual customers) to maintain their competitive edge on specific transactions. The Company will contact the OEM to request a rebate, for a specific transaction, and if approved, the OEM will provide the Company with a document authorizing a rebate to be paid to the Company at a later date when a claim is filed. At the time the Company records product sales, cost of sales is reduced by the amount of the rebate. Rebate programs involve complex sets of rules varying by manufacturer. As a result of the rules and complexity of applying the rules to each item sold, claims are often rejected and require multiple submissions before credit is given. Pomeroy maintains an allowance for doubtful accounts on vendor receivables for estimated losses resulting from the inability of its vendors to make required payments. The determination of a proper allowance for vendor receivables is based on an ongoing analysis as to the recoverability of the Company's vendor receivable portfolio based primarily on account aging. Primary reasons for claims being disallowed and corresponding re-files include serial number issues (missing, incomplete, transposed, data base match-up discrepancies, etc.), pricing issues (dispute in calculation of rebate amounts) and other missing or incomplete documentation (bid letters, customer information, etc.).
Manufacturer Market Development Funds - Several OEM's offer market development funds, cooperative advertising and other promotional programs to distribution channel partners. The Company utilizes these programs to fund some of its advertising and promotional programs. The Company recognizes these anticipated funds as vendor receivables when it has completed its obligation to perform under the specific arrangement. The anticipated funds to be received from manufacturers are offset directly against the expense, thereby reducing selling, general and administrative expenses. In total, advertising costs associated with these programs are charged to expense as incurred and amounted to $114 thousand, $22 thousand, and $410 thousand for the fiscal years 2004, 2003 and 2002, respectively.
Warranty Receivable - The Company performs warranty service work on behalf of the OEM on customer product. Any labor cost or replacement parts needed to repair the product is reimbursable to the Company by the OEM. It is the Company's responsibility to file and collect these claims. The Company records the vendor receivables when it has completed its obligation to perform under the specific arrangement. Any OEM reimbursement for warranty labor cost incurred is recognized as revenue when the service is provided.
Inventories - Inventories are stated at the lower of cost or market. Cost is determined by the average cost method. Certain overhead costs are capitalized as a component of inventory.
Translation of Foreign Currencies - Assets and liabilities of the Company's Canadian operations are translated at the rate of exchange in effect on the balance sheet date; income and expenses are translated at the weighted average rates of exchange prevailing during the period. The related foreign currency translation adjustments are reflected as accumulated other comprehensive loss in stockholders' equity. Foreign currency transaction gains and losses for fiscal 2004 were not material.
Revenue Recognition - The Company recognizes revenue on the sale of equipment and supplies or equipment sold under sales-type leases, when the products are shipped. Revenue from products sold under logistical deployment services arrangements is recognized upon completion of the Company's contractual obligations, customer acceptance, title passing and other conditions, which may occur prior to product shipment. Service revenue is recognized when the applicable services are provided or for service contracts, ratably over the lives of the contracts. Leasing fee and financing revenue is recognized on a monthly basis as fees accrue and from financing at level rates of return over the term of the lease or receivable, which are primarily sales-type leases ranging from one to three years. For those equipment sales that include multiple deliverables, such as configuration, training, installation or service, revenue is allocated based on the relative fair values of the individual components in accordance with EITF 00-21.
Stock-Based Compensation - The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of grant over the amount an employee must pay to acquire the stock. The Company adopted SFAS No. 123 for disclosure purposes and for non-employee stock options.
Had compensation cost for the Company's stock option plans been determined based on the fair value of the awards at the grant date consistent with the provisions of SFAS No. 123, as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure," the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
The fair value of options at the date of grant was estimated using the Black-Scholes model with the following weighted average assumptions:
The total fair value of options granted are recognized as pro forma stock-based compensation expense over each option's vesting period.
Earnings per Common Share - The computation of basic earnings per common share is based upon the weighted average number of common shares outstanding during the period. Diluted earnings per common share is based upon the weighted average number of common shares outstanding during the period plus, in periods in which they have a dilutive effect, the effect of common shares contingently issuable, primarily from stock options.
The following is a reconciliation of the number of common shares used in the basic and diluted EPS computations:
Use of Estimates in Financial Statements - In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Accounting estimates in these financial statements include allowances for trade accounts receivable and vendor accounts receivable. Pomeroy maintains allowances for doubtful accounts on both vendor and trade receivables for estimated losses resulting from the inability of its customers or vendors to make required payments. The determination of a proper allowance for vendor receivables is based on an ongoing analysis as to the recoverability of the Company's vendor receivable portfolio based primarily on account aging. The determination of a proper allowance for trade receivables is based on an ongoing analysis as to the credit quality and recoverability of the Company's trade receivable portfolio. Factors considered are account aging, historical bad debt experience, current economic trends and others. The analysis is performed on both vendor and trade
receivable portfolios. A separate allowance account is maintained based on each analysis. Actual results could differ from those estimates.
Reclassifications - Certain reclassifications of prior years' amounts have been made to conform to the current year presentation.
Fair Value Disclosures - The fair value of financial instruments approximates carrying value.
Comprehensive Income - For fiscal 2004, the only component of comprehensive income other than net income is foreign currency translation adjustments.
Derivative Instruments and Hedging Activities - The Company does not currently have any derivative instruments or hedging activities.
Recent Accounting Pronouncements - In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, "Inventory Costs, an Amendment of ARB No. 43, Chapter 4." SFAS No. 151 retains the general principle of ARB No. 43, Chapter 4, "Inventory Pricing," that inventories are presumed to be stated at cost; however, it amends ARB No. 43 to clarify that abnormal amounts of idle facilities, freight, handling costs and spoilage should be recognized as current period expenses. Also, SFAS No. 151 requires fixed overhead costs be allocated to inventories based on normal production capacity. The guidance in SAFS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company believes that implementing SFAS No. 151 should not have any material impact on its financial condition, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"), which replaces SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values, beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption.
SFAS No. 123R will apply to awards granted or modified by the Company after July 5, 2005. Compensation cost will also be recorded for prior option grants that vest after that date. The effect of adopting SFAS 123 on the Company's consolidated results of operations will depend on the level of future option grants and the fair value of the options granted at such future dates, as well as the vesting periods provded by such awards and, therefore, cannot currently be estimated. We are evaluating the requirements of SFAS 123R and have not yet determined the method of adoption or the effect of adopting SFAS 123R, and we have not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123.
3. Accounts Receivable
Trade accounts receivable represent amounts billed or billable to customers. Past due receivables are determined based on contractual terms. The Company generally does not charge interest on its trade receivables. The allowance for doubtful receivables is determined by management based on the Company's historical losses, specific customer circumstances and general economic conditions. Periodically, management reviews accounts receivable and adjusts the allowance based on current circumstances and charges off uncollectible receivables against the allowance when all attempts to collect the receivable have failed. The following table summarizes the activity in the allowance for doubtful accounts for fiscal years 2004, 2003 and 2002:
During fiscal 2002, the Company recorded an increase in allowances of $3.3 million specifically related to the collectibility of vendor receivables. The determination of the increase in allowances was based on the deterioration of the aging of the vendor receivables, the expected resolution of the vendor rebate disallowed claims and the general posture of the OEM's regarding resolution. Primary reasons for vendor rebate claims being disallowed and corresponding re-files include serial number issues (missing, incomplete, transposed, data base match-up discrepancies, etc.), pricing issues (dispute in calculation of rebate amounts) and other missing or incomplete documentation (bid letters, customer information, etc.).
4. Net Investment in Leases
The Company's net investment in leases principally includes sales-type leases. See Note 14 of Notes to Consolidated Financial Statements for information regarding the sale of substantially all of the assets of TIFS. The Company originates financing for customers in a variety of industries and throughout the United States. The Company has a diversified portfolio of capital equipment financing for end users.
Leases consist principally of notebook and desktop personal computers, communication products and high-powered servers with terms generally from one to three years. The following table summarizes the components of the net investment in sales-type leases as of end of fiscal years 2004 and 2003:
The future minimum lease payments for the net investment in leases are as follows:
5. Inventories
Inventories consist of items held for resale and are comprised of the following components as of the end of fiscal years 2004 and 2003:
6. Goodwill and Other Intangible Assets
Intangible assets with definite lives are amortized over their estimated useful lives. The following table provides a summary of the Company's intangible assets with definite lives as of January 5, 2005 and January 5, 2004:
Intangible assets consist of the following:
Amortized intangible assets are being amortized over periods ranging from 1 to 15 years for covenants not-to-compete, 7 to 15 years for customer lists and 7 years for other intangibles. The weighted-average amortization period for all amortized intangible assets acquired in fiscal 2004 and 2003 was 8.8 and 15 years, respectively. For the year ended January 5, 2005, amortization expense related to intangible assets was $364 thousand. For the year ended January 5, 2004, amortization expense related to intangible assets was $404 thousand. For the year ended January 5, 2003, amortization expense related to intangibles assets was $1,041 thousand of which $71 thousand was reported under the caption "cost of sales" or "selling, general and administrative" expenses. Amortization expense associated with assets reported under the caption "other current assets" was $154 thousand.
Projected future amortization expense related to intangible assets with definite lives are as follows:
The changes in the net carrying amount of goodwill for the years ended January 5, 2005 and 2004 by segment are as follows:
During the first quarter of fiscal 2003, the Company changed the allocation of goodwill by reporting unit. As a result of this evaluation process, the Company reallocated approximately $10.3 million of goodwill to the services reporting unit from the products reporting unit. This reallocation had no effect on the result of any previous period's impairment testing. The reallocation is also reflected in the segment information in Note 21.
During fiscal 2004, the Company and Pomeroy Acquisition Sub, Inc. ("PAS"), a wholly owned subsidiary the Company, completed a merger with Alternative Resources Corporation ("ARC"). On May 11, 2004, the parties entered into a definitive merger agreement for PAS to acquire all of the issued and outstanding shares of capital stock of ARC. The merger was approved by ARC shareholders at a meeting held on July 22, 2004. As a result of the merger, ARC is now a wholly-owned subsidiary of the Company. The cash consideration paid at closing, including the cost of all stock, stock options and warrants purchased and the amount of ARC net debt retired, was approximately $46.1 million, which was funded from cash on hand and borrowings from Pomeroy's existing line of credit. The Company recorded $41.9 million of goodwill, which included, among other things, the value of an assembled workforce, related to the acquisition during fiscal 2004. Also during fiscal 2004, the Company recorded $0.3 million of goodwill associated primarily with earn-out payments made in conjunction with prior acquisitions.
During fiscal 2003, the Company acquired all of the outstanding common stock of Micrologic Business Systems of K.C., Inc. ("Micrologic"), a Kansas City based IT solutions and professional services provider. Their primary services include systems network integration, project management, and telephony integration. The Company recorded $3.2 million of goodwill related to the acquisition. In addition, the Company acquired certain assets of eServ Solutions Group, LLC ("eServ"), a Rock Island, Illinois based IT solutions and professional services provider. eServ's primary service offerings include network infrastructure, enterprise storage and server solutions. The Company recorded $1.1 million of goodwill related to the acquisition. Also during fiscal 2003, the Company recorded $2.7 million of goodwill associated with earn-out payments made in conjunction with prior acquisitions.
7. Borrowing Arrangements
A significant part of Pomeroy's inventories are financed by floor plan arrangements with third parties. At January 5, 2005, these lines of credit totaled $85.0 million, including $75.0 million with GE Commercial Distribution Finance ("GECDF") and $10.0 million with IBM Credit Corporation ("ICC"). Borrowings under the GECDF floor plan arrangements are made on thirty-day notes. Borrowings under the ICC floor plan arrangements are made on fifteen-day notes. All such borrowings are secured by the related inventory. Financing on substantially all of the arrangements is interest free due to subsidies by manufacturers. Overall, the average rate on these arrangements is less than 1.0%. The Company classifies amounts outstanding under the floor plan arrangements as accounts payable.
On June 28, 2004, the Company finalized a new $165 million Syndicated Credit Facility Agreement with GECDF. The new credit facility has a three-year term and its components include a maximum of $75 million for inventory financing and a revolving line of credit, collateralized primarily by accounts receivable, of up to $110 million; provided that the total amount outstanding at any time under the inventory financing facility and the revolving line of credit may not exceed $165 million. Under the new agreement, the credit facility provides a letter of credit facility of $5 million. Under the credit facility, the interest rate is based on the London InterBank Offering Rate ("LIBOR") and a pricing grid. As of January 5, 2005, the adjusted LIBOR rate was 4.4%. This credit facility expires June 28, 2007.
At January 5, 2005, the Company's balance outstanding under the revolving line of credit portion of the credit facility was $20.2 million. At January 5, 2004, the Company did not have an outstanding balance under its previous credit facility. The credit facility is collateralized by substantially all of the assets of Pomeroy, except those assets that collateralize certain other financing arrangements. Under the terms of the credit facility, Pomeroy is subject to various financial covenants including maintenance of a minimum level of tangible net worth, a minimum fixed charge coverage ratio and a maximum ratio of total funded indebtedness to EBITDA. As of January 5, 2005, Pomeroy was in compliance with those financial covenants.
Notes payable - Notes payable consist of the following:
8. Restructuring and Severance Charges
During fiscal 2004, in connection with certain strategic initiatives, the Company recorded restructuring and severance charges aggregating $1.0 million. The restructuring and severance charges are associated with legacy Pomeroy costs of facilities and processes that have or will become duplicative or redundant as ARC operations are integrated into the Company. These costs consist of facility closing and involuntary employee termination costs of $576 thousand and $400 thousand, respectively. These costs are accounted for under FAS 146, "Accounting for Costs Associated with Exit or Disposal Activities," and were included as a charge to the results of operations for the year ended January 5, 2005. Any subsequent changes to the estimates of executing the currently approved plans of restructuring will be reflected in current results of operations.
The Company also recorded a non-recurring, one-time charge for severance in the amount of $1.447 million related to the resignation of David B. Pomeroy II as CEO of the Company. Mr. Pomeroy will continue to serve as Chairman of the Board of the Company.
During fiscal 2004, the Company restructuring and severance charges expensed consisted of the following:
Also, the Company's management recorded a restructuring charge liability in connection with the ARC acquisition to eliminate certain duplicative activities and reduced facility requirements. As a result, approximately $6.4 million of costs were recorded as part of the liabilities assumed in the ARC acquisition. The restructuring charge consisted of costs of vacating duplicative leased facilities of ARC and severance costs associated with exiting activities. These costs are
accounted for under EITF 95-3, "Recognition of Liabilities in Connection with Purchase Business Combinations." These costs were recognized as a liability assumed in the purchase business combination and included in the allocation of the cost to acquire ARC. A portion of the restructuring liabilities are classified as long-term liabilities in the accompanying consolidated balance sheet at January 5, 2005. Changes to the estimates of executing the currently approved plans of restructuring through July 23, 2005 will be recorded as an increase or decrease in goodwill with any increases in estimates thereafter charged to operations.
Additionally, as part of the acquisition of ARC, the Company acquired the remaining obligations of ARC's existing restructuring plans, which were initially recorded by ARC in fiscal 2003 and fiscal 2002. The total obligations assumed in connection with these restructuring plans was $2.1 million at July 23, 2004.
As of January 5, 2005, the balance of the ARC fiscal 2003 and fiscal 2002 accrued restructuring costs recorded consisted of the following:
During fiscal 2002, the Company approved a plan to consolidate and relocate operations in various geographical locations and to abandon certain assets associated with modification to strategic initiatives.
The plan resulted in a pre-tax restructuring charge of $714 thousand ($493 thousand after tax). The restructuring costs consist of $484 thousand of losses on equipment and leasehold improvement dispositions, $126 thousand in involuntary employee severance costs, and $104 thousand in lease terminations. Under the plan, the Company eliminated approximately 40 employees.
The execution of the plan began and was completed during fiscal 2002. As of January 5, 2003, the Company had $41 thousand in accrued and unpaid restructuring costs which were paid during fiscal 2003.
9. Income Taxes
The provision for income taxes consists of the following:
During fiscal 2002, the Company recorded an income tax benefit of $1.6 million associated with an increase in the tax basis of leased assets as a result of an accounting method change for tax purposes. This amount is included in the 2002 income tax provision shown above.
The approximate tax effect of the temporary differences giving rise to the Company's deferred income tax assets (liabilities) are:
As of January 5, 2005, the Company's net current deferred tax assets ($1,937) are included in other current assets and the net noncurrent deferred tax liabilities ($97) are presented as such on the balance sheet. As of January 5, 2004, the Company's net current deferred tax liabilities ($1,398) are included in other accrued liabilities and the net noncurrent deferred tax liabilities ($4,780) are presented as such on the balance sheet.
The Company acquired $10,781 of net deferred tax assets, primarily related to the tax effect of federal and state net operating loss carryforwards and restructuring charges, in connection with the acquisition of ARC in July 2004. The Company's ability to use the federal and state net operating loss carryforwards of ARC to reduce its future taxable income is subject to limitations under Section 382 of the Internal Revenue Code associated with acquired federal and state net operating loss carryforwards. The federal net operating loss carryforwards of ARC aggregate $15,880 of which $2,516 will expire in 2020, $8,010 in 2022 and $5,354 in 2023. The Company currently believes it will fully utilize ARC's acquired net operating loss carry forwards and, accordingly, no valuation allowance has been provided as of January 5, 2005. To the extent these ARC net operating loss carryforwards are not utilized to reduce the Company's taxable income in future periods or expire unused, goodwill recorded in connection with the acquisition of ARC will be adjusted accordingly. In addition,
the recorded amounts of acquired deferred tax assets and liabilities may be adjusted during fiscal 2005 upon completion of ARC's final income tax returns for the period prior to its acquisition by the Company.
The Company's effective income tax rate differs from the federal statutory rate as follows:
10. Operating Leases and Commitments
Operating Leases- The Company leases office and warehouse space, vehicles and certain office equipment from various lessors including a related party. See Note 15 of Notes to Consolidated Financial Statements for information regarding related parties. Lease terms vary in duration and include various option periods. The leases generally require the Company to pay taxes and insurance. Future minimum lease payments under noncancelable operating leases with initial or remaining terms in excess of one year as of January 5, 2005, including the lease with the related party, are as follows:
Employment Agreements- The Company is party to employment agreements with certain executives, which provide for compensation and certain other benefits. The agreements also provide for severance payments under certain circumstances.
Rental expense was $3.4 million, $3.1 million and $3.3 million for 2004, 2003 and 2002 respectively.
11. Employee Benefit Plans
The Company has a savings plan intended to qualify under sections 401(a) and 401(k) of the Internal Revenue Code. The plan covers substantially all employees of the Company. The Company makes contributions to the plan based on a participant's annual pay. Contributions made by the Company for fiscal 2004, 2003 and 2002 were approximately $236 thousand, $136 thousand and $408 thousand, respectively.
The Company has a stock purchase plan (the "1998 plan") under Section 423 of the Internal Revenue Code of 1986, as amended. The 1998 plan, as amended, provides substantially all employees of the Company with an opportunity to purchase through payroll deductions up to 2,000 shares of common stock of the Company with a maximum market value of $25,000. The purchase price per share is determined by whichever of two prices is lower: 85% of the closing market price of the Company's common stock in the first trading date of an offering period (grant date), or 85% of the closing market price of the Company's common stock in the last trading date of an offering period (exercise date). 600,000 shares of common stock of the Company are reserved for issuance under the 1998 plan. The Board of Directors of the Company may at any time terminate or amend the 1998 plan. The 1998 plan will terminate twenty years from the effective date unless sooner terminated.
12. Major Customers
During fiscal 2004, 2003, and 2002 no customer accounted for more than 10% of the Company's total net sales and revenues.
13. Acquisitions
During fiscal 2004, the Company completed one acquisition. The Company and Pomeroy Acquisition Sub, Inc. ("PAS"), a wholly owned subsidiary of the Company, completed a merger with Alternative Resources Corporation ("ARC"). On May 11, 2004, the parties entered into a definitive merger agreement for PAS to acquire all of the issued and outstanding shares of capital stock of ARC. The merger was approved by ARC shareholders at a meeting held on July 22, 2004. As a result of the merger, ARC is now a wholly-owned subsidiary of the Company. The cash consideration paid at closing, including the cost of all stock, stock options and warrants purchased and the amount of ARC net debt retired, was approximately $46.1 million, which was funded from cash on hand and borrowings from Pomeroy's existing line of credit.
The following summarizes the assets purchased and liabilities assumed:
The results of operations of ARC are included in the Company's fiscal 2004 consolidated financial statements from the date of acquisition. If the fiscal 2004 acquisition of ARC and the 2003 acquisitions described below had all occurred on January 6, 2003, the unaudited pro forma results of operations of the Company would have been as follows:
During fiscal 2003, the Company completed two acquisitions. The total consideration paid consisted of $4.9 million in cash and subordinated notes of $1.8 million. Additionally, the purchase price will be adjusted for any potential earn outs. The Company shall pay fifty percent of the net profit before taxes ("NPBT") to the purchaser in excess of the NPBT threshold for the applicable year, subject to a cumulative limitation of $5.5 million during such aggregate earn out period. Interest on the subordinated notes is payable quarterly. Principal in the amount of $1.8 million is payable in two annual installments commencing on the first anniversary of closing. The results of operations of the acquisitions are included in the fiscal 2003 consolidated statement of income from the respective dates of acquisition.
During fiscal 2002, the Company completed one acquisition. The total consideration paid consisted of $0.3 million in cash and subordinated notes of $0.2 million. Additionally, the purchase price will be adjusted for any
potential earn outs. The Company shall pay fifty percent of the net profit before taxes ("NPBT") to the purchaser in excess of the NPBT threshold for the applicable year, subject to a cumulative limitation of $1.0 million dollars during such aggregate period as earn outs. The results of operations of the acquisition are included in the fiscal 2002 consolidated statement of income from the date of acquisition. If the fiscal 2002 acquisition had occurred on January 6, 2002, the pro forma results of operations of the Company would not have been materially different than that reported in the accompanying fiscal 2002 consolidated statement of income.
14. Sale of Technology Integration Financial Services, Inc. ("TIFS")
In April 2002, the Company sold for book value substantially all of the net assets of its wholly owned subsidiary - Technology Integration Financial Services, Inc. ("TIFS") to Information Leasing Corporation ("ILC"), the leasing division of the Provident Bank of Cincinnati, Ohio. Vincent D. Rinaldi, a Director of the Company, is the President of ILC. In addition, ILC assumed and liquidated at the time of the closing approximately $20.0 million of the Company's debt related to leased assets owed by TIFS. As part of the transaction, the Company signed an exclusive seven-year vendor agreement whereby the Company is appointed as an agent for remarketing and reselling of the leased equipment sold. The Company will be paid a commission on future lease transactions referred to and accepted by ILC and will act as the remarketing and reselling agent for such future leased equipment.
15. Related Party Transactions
Leases- The Company leases its headquarters, distribution facility and the national training center from a company that is controlled by the former Chief Executive Officer of the Company. It is a triple net lease agreement, which expires in the year 2010. Base rental for fiscal 2004, 2003 and 2002 was approximately $1.2 million each year. The annual rental for these properties was determined on the basis of a fair market value rental opinion provided by an independent real estate company, which was updated in 2000. In addition, the Company pays for the business use of other real estate that is owned by the former Chief Executive Officer of the Company. During fiscal years 2004, 2003 and 2002, the Company paid $95 thousand each year in connection with this real estate.
The lessor of the headquarters, distribution facility and national training center does not meet the conditions to be considered a variable interest entity in accordance with FIN 46.
A director of the Company is President of ILC. See Note 14 of Notes to Consolidated Financial Statements for information regarding the sale of substantially all of the assets of TIFS to ILC.
Investment in Lease Residuals - The Company participates in a Remarketing and Agency Agreement ("Agreement") with ILC whereby the Company obtains rights to 50% of lease residual values for services rendered in connection with locating the lessee, selling the equipment to ILC and agreeing to assist in remarketing the used equipment.
During fiscal 2004, 2003, and 2002, the Company sold equipment and related support services to ILC, for lease to ILC's customers, in amounts of $22.0 million, $19.5 million and $32.6 million, respectively.
The Company also purchases residuals associated with separate leasing arrangements entered into by ILC. Such transactions do not involve the sale of equipment and related support services by the Company to ILC. Residuals acquired in this manner are accounted for at cost.
The Company signed an exclusive seven-year vendor agreement whereby the Company is appointed as an agent for remarketing and reselling of the leased equipment sold. The Company will be paid a commission on future lease transactions referred to and accepted by ILC and will act as the remarketing and reselling agent for such future leased equipment.
The carrying value of investments in lease residuals is $0.9 million as of January 5, 2005 and 2004, and is included in long-term net investment in leases. Investments in lease residuals are evaluated on a quarterly basis, and are subject only to downward market adjustments until ultimately realized through a sale or re-lease of the equipment.
16. Supplemental Cash Flow Disclosures
Supplemental disclosures with respect to cash flow information and non-cash investing and financing activities are as follows:
17. Treasury Stock
During fiscal 2004, the Company repurchased 40,000 shares of common stock at a cost of $0.5 million under the repurchase program that expired June 1, 2004.
During fiscal 2003, the Company's Board of Directors authorized a program to repurchase up to 1.1 million shares of the Company's outstanding common stock at market price. During fiscal 2003, the Company repurchased 383,000 shares of common stock at a cost of $4.1 million. This repurchase program expired June 1, 2004.
During fiscal 2002, the Company's Board of Directors authorized a program to repurchase up to 350,000 shares of the Company's outstanding common stock at market price. During fiscal 2002, the Company repurchased 280,000 shares of common stock at a cost of $3.4 million.
18. Dividends
On August 7, 2003, the Company paid a one-time cash dividend of $9.8 million or $0.80 per share to shareholders of record as of July 28, 2003.
19. Stockholders' Equity and Stock Option Plans
On March 27, 2002, the Company adopted the 2002 Non-Qualified and Incentive Stock Option Plan and it was approved by the shareholders on June 13, 2002. The plan was amended and renamed the 2002 Amended and Restated Stock Incentive Plan on March 11, 2004 and approved by the Company's shareholders on June 10, 2004. The Company's 2002 Amended and Restated Stock Incentive Plan provides certain employees of the Company with options to purchase common stock of the Company through options at an exercise price equal to the market value on the date of grant. The plan, as amended, also provides for the granting of awards of restricted stock and stock appreciation rights. The maximum aggregate number of shares which may be optioned and sold under the plan is 4,410,905. The plan will terminate on June 13, 2012. Stock options granted under the plan are exercisable in accordance with various terms as authorized by the Compensation Committee. To the extent not exercised, options will expire not more than ten years after the date of grant.
On March 27, 2002, the Company adopted the 2002 Outside Directors' Stock Option Plan and it was approved by the shareholders on June 13, 2002. The plan was amended on March 11, 2004 and approved by the Company's shareholders on June 10, 2004. The Company's 2002 Outside Directors' Stock Option Plan, as amended, provides outside directors of the Company with options to purchase common stock of the Company at an exercise price equal to the market value of the shares at the date of grant. The maximum aggregate number of shares which may be optioned and sold under the plan is 281,356. The plan will terminate on March 26, 2012. Pursuant to the plan, an option to purchase 10,000 shares of common stock will automatically be granted on the first day of the initial term of a director. An additional 5,000 shares of common stock will automatically be granted to an eligible director upon the first day of each consecutive year of service on the
board. Options are fully vested as of the date of grant and must be exercised within two years of the date of grant, subject to earlier termination in the event of termination of the director's service on the Board.
The following summarizes the stock option transactions under the plans for the three fiscal years ended January 5, 2005:
The following summarizes options outstanding and exercisable at January 5, 2005:
The weighted average fair value at date of grant for options granted during fiscal 2004, 2003 and 2002 was $3.48, $4.09 and $4.56, respectively.
The unissued preferred stock carries certain voting rights and has preferences with respect to dividends and liquidation proceeds.
20. Litigation
During fiscal 2003 and 2002, the Company made litigation settlement payments of $ 0.2 million and $0.3 million, respectively.
There are various other legal actions arising in the normal course of business that have been brought against the Company. Management believes these matters will not have a material adverse effect on the Company's financial position or results of operations.
21. Segment Information and Concentrations
Segment Information - The operates in three industry segments: products, services and leasing.
The Company's products segment is comprised of the sale of a broad range of Information Technology products that include desktop computing equipment, servers, infrastructure devices and peripherals.
The services segment entails providing information technology services, which support such computer products. As a service solution provider, the Company offers three groups of services: enterprise consulting, infrastructure solutions, and lifecycle services. The enterprise consulting group offerings consist of: application development, business process re-engineering, ERP solutions, CRM solutions, e-business, business intelligence, and outsourcing. The infrastructure solutions group offerings consist of: high performance file servers, voice, video, data and network integration, storage strategies, security solutions, thin client, managed services, and cabling solutions. Pomeroy's lifecycle services group offers the following comprehensive portfolio of services: strategic sourcing, integration and distribution logistics, implementation services, technical support services, DoD drive wiping services, and technology disposition.
The Company also offers leasing solutions to its customers via an agency agreement with a Cincinnati based regional bank. This bank, in 2002, acquired certain assets and liabilities of the Company's leasing subsidiary. See Note 14 of Notes to Consolidated Financial Statements for information regarding the sale of substantially all of the assets of TIFS, the Company's leasing subsidiary.
The Company has no significant operations outside the United States. The accounting policies of the segments are the same as those discussed in the summary of significant accounting policies. The Company evaluates performance based on operating earnings of the respective business units. Intersegment sales and transfers are not significant.
During the first quarter of fiscal 2003, the Company revised its segment methodologies for allocating operating expenses between segments to reflect ongoing changes in the operating activities giving rise to such expenses. This change resulted in a decrease of approximately $6.0 million year-to-date of allocated operating expenses to the product segment and a corresponding increase by the same amount to the services segment. In addition, the Company revised its allocation of assets between segments to reflect the use of assets in those segments. The assets affected were principally goodwill, tax-related assets and equipment and leasehold improvements.
Summarized financial information concerning the Company's reportable segments is shown in the following table. (in thousands)
Concentrations - During fiscal 2004, 2003, and 2002 approximately 23.4%, 20.9%, and 28.1%, respectively, of the Company's total net sales and revenues were derived from its top ten customers.
During fiscal 2004, 2003 and fiscal 2002, no customer accounted for more than 10% of the Company's net sales and revenues for either the products or services segments.