ITEM 1. BUSINESS
Pomeroy Computer Resources, Inc. (the "Company") is a Delaware corporation organized in February 1992 to consolidate and reorganize predecessor companies. All of the predecessor companies were controlled by David B. Pomeroy, the Company's Chairman of the Board and Chief Executive Officer.
The Company's business is comprised of (1) the sale of a broad range of desktop computer equipment including hardware, software, and related products, and (2) the provision of information technology (IT) services which support such computer products, and (3) the provision of in-house leasing solutions for the Company's products and services customers. Prior to January 6, 1999, the Company (including its wholly-owned subsidiaries Global Combined Technologies, Inc., Pomeroy Computer Resources of South Carolina, Inc. ("PCR-SC") and Technology Integration Financial Services, Inc. ("TIFS")) operated the IT products and services business as a single integrated business. In December, 1998, the Company formed a new subsidiary, Pomeroy Select Integration Solutions, Inc. ("Pomeroy Select"), for the purpose of operating independently the IT services business previously operated by the Company other than procurement and configuration services which are directly related to the sale of products. On January 6, 1999, the Company transferred the assets, liabilities, business, operations and personnel comprising its IT services business (excluding procurement and configuration services) in exchange for 10 million shares of Class B common stock of Pomeroy Select. The separation of the IT services business is a part of the Company's ongoing strategy to expand its services revenue. In October 1999, the legal structure of the Company was changed for the purpose of increasing efficiencies. The Company formed the following wholly owned subsidiaries: Pomeroy Computer Resources Holding Company, Inc. ("PCR Holding") and Pomeroy Computer Resources Sales Company, Inc. ("PCR Sales"). In addition, the Company formed Pomeroy Select Advisory Services, Inc. ("PSAS"), a wholly-owned subsidiary of Pomeroy Select, Acme Data Services, LLC ("Acme Data"), a wholly-owned subsidiary of PCR Sales, T.I.F.S. Advisory Services, Inc. ("TIFS Advisory"), a wholly-owned subsidiary of TIFS, and Pomeroy Computer Resources LLP ("PCR Ops"), a partnership between the Company and PCR Holding. PCR-SC and Global Combined Technologies, Inc. were merged into PCR Sales. In fiscal 2000, the Company and its wholly owned subsidiary Pomeroy Select acquired all the outstanding stock of The Linc Corporation ("The Linc"), a network design, consulting and systems engineering provider located in Birmingham, Alabama and Val Tech Computer Systems, Inc. ("Val Tech"), a leasing company also located in Birmingham, Alabama.
The Company operates in three industry segments: products, services and leasing. The products segment is primarily engaged in the sale and distribution of computers, hardware, software and related products. The Company offers products from an array of manufacturers including Cisco, Computer Associates, Sun, Oracle, EMC, Compaq, Hewlett-Packard, IBM, Microsoft, Nortel Networks, Novell and Palm Computing. As a service solution provider, the Company offers five categories of service: internet infrastructure services, network infrastructure services(LAN/WAN/MAN), network integration services, e-business application development and desktop management services. Internet infrastructure solutions include services to assist customers in implementing network and server infrastructure components, enterprise management services that monitor the
network buildup and broadband implementation services. Network infrastructure services include LAN/WAN/MAN implementation services. These services assist the customer in installing and implementing an internal network infrastructure that includes cabling, network equipment consulting, implementation and support; IP telephony services for maximizing voice/data circuits, wireless LAN implementation and storage services that provide consulting, design, implementation and support on storage area networks and network attached storage implementations. Network integration solutions provide services to assist customers in implementing thin client/server based computing, groupware implementation and system/application enablement. E-business application development includes the infrastructure platform consulting, design and implementation. Desktop management services include assisting customers in project roll-outs, installation of personal computer systems, peripherals and accessories; warranty and non-warranty repair and maintenance, redeployment and end-of-life services. The Company has achieved Gold Authorization from Cisco. The Company has also been awarded 2 specialization's from Cisco; Voice Access and IP Telephony, which gives customers access to specialized knowledge and expertise to consult, design and implement converged voice and data telephony circuits and wireless LAN implementations. The leasing segment primarily provides in-house leasing services to the Company's products and services customers. The Company leases many types of equipment with the predominant focus on notebook and desktop personal computers, communication products and high-powered servers. The Company provides products and services primarily to large and medium sized corporate, health care, governmental, financial and educational customers. See Note 18 of Notes to Consolidated Financial Statements for a presentation of segment financial information.
The Company's strategy for building shareholder value is to provide comprehensive solutions to improve the productivity of its clients' information technology systems. Key elements of the Company's strategy are: (1) to generate higher margin revenues by leveraging existing client relationships, (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.
The Company is an authorized dealer or reseller for the products of over 37 major vendors. The Company believes that its access to such vendors enables it to offer a wide range of products to meet the diverse requirements of its customers. However, the increasing demand for microcomputers has resulted in significant product supply shortages 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 which 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.
The Company's sales are generated primarily by its 275 person direct sales and sales support personnel located in 31 regional offices in 16 states throughout the Southeast and Midwest United States. The Company's business strategy is to provide its customers with a complete package of personal computers and network infrastructure products, internet infrastructure services, network infrastructure services, network integration services, e-business application development and desktop management services. In addition, the Company attempts to offer standard leasing services and custom tailored leasing solutions for our customers. Leases generally range from twelve to thirty-six months. Coupled with the products and services segments, the Company has the ability to provide turnkey information technology solutions with all components including equipment configuration, delivery, installation, maintenance, Internet training, and de-installation services all included in a periodic payment. The Company believes that its ability to combine competitive pricing of computer hardware, software and related products with sophisticated higher margin services allows it to compete effectively against a variety of alternative microcomputer distribution channels, including independent dealers, superstores, mail order and direct sales by manufacturers. With many businesses seeking assistance to optimize their information technology investments and control ongoing costs throughout the life cycle of technology systems, the Company is using its resources to assist customers in their decision-making, project implementation and equipment and information management.
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 the Company 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, 2001, the Company has been awarded contracts it estimates will result in an aggregate of approximately $185.1 million of net sales and revenues after January 5, 2001, $215.7 million
in net sales and revenues was generated in 2000 from these contracts. Of the aggregate total, the Company estimates that approximately $121.3 million of net sales and revenues will be generated in fiscal 2001. By comparison, as of January 5, 2000, the Company had been awarded contracts that it estimated would result in an aggregate of approximately $156.3 million of net sales and revenues after January 5, 2000. Of this amount, the Company estimated that $129.5 million of net sales and revenues would be generated during fiscal 2000. 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 that the customer finds another supplier for the desired products at a lower price or on better terms, the internal business needs of the customer change causing the customer to require less or different products and services, or a significant change in technology or other industry conditions occurs which alters the customer's needs or timing of purchases.
The Company 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 Select to continue performing warranty work for a particular manufacturer's products is dependent upon the performance of the Company under a dealer agreement with that manufacturer. The Company's technical personnel currently have an aggregate of more than 180 Microsoft certifications, more than 300 Novell certifications, 31 Bay/Nortel Networks Specialist certifications, 19 IBM Professional Service Expert certifications, 54 Compaq Accredited Systems Engineer certifications, 20 Hewlett-Packard Network Technical Professional certifications, 2 Citrix Certified Administrator certifications, 81 Cisco Certified Network Associates certifications, 31 Cisco Certified Network Professional certificates, 6 Cisco Certified Internetwork Expert certificates, 12 Cisco Certified Design Associates certifications, 9 Cisco Certified Design Professionals, 7 Computer Associates Certified Unicenter Engineer certifications and one of each of the following advanced certifications: Protean Router, Network General Sniffer, Fore Systems and Oracle Advanced SQL.
The Company provides its services to its customers on a time-and-materials basis and pursuant to written contracts or purchase orders. Either party with limited or no advance notice generally can terminate the Company's arrangements with its customers. The Company 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 the Company believes it can clearly define the scope of services to be provided and the cost of providing those services.
The Company has initiated a program known as the Pomeroy Preferred Partner Program to better serve its customers. Through the program, the Company has the ability to focus on the group of manufacturers which it has deemed "best in class" through its research, customer feedback, and its experience in the industry. By focusing on these "preferred" manufacturers, the company is building mutual business commitments that will benefit the customers. Such benefits include access to favorable pricing and key decision-makers, better terms and conditions and enhanced sales and technical training.
The Company has entered into dealer agreements with substantially all of our major vendors/manufacturers. These agreements are typically subject to periodic renewal and to termination on short notice. Substantially all of the Company'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 the Company's performance. Although the Company has never lost a major vendor/manufacturer, the loss of such a vendor/product line or the deterioration of the Company's relationship with such a vendor/manufacturer would have a material adverse effect on the Company.
For fiscal years 1998, 1999 and 2000, sales of computer hardware, software, and related products were approximately $554.0 million, $648.9 million, and $775.3 million, respectively, and accounted for approximately 88.3%, 85.8% and 83.8%, respectively, of the consolidated net sales and revenues of the Company. The Company'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 1998, 1999 and 2000, revenues from service and support activities were approximately $72.5 million, $103.8 million and $139.4 million, respectively, and accounted for approximately 11.6%, 13.7% and 15.1%, respectively, of the consolidated net sales and revenues of the Company. The Company's revenue from its leasing services have grown, as a percentage of its consolidated net sales and revenues, since its inception in 1997. For fiscal years 1998, 1999 and 2000, leasing revenues were approximately, $1.4 million, $4.0 million, and $10.4 million, respectively, and accounted for approximately 0.1%, 0.5%, and 1.1%, respectively, of the consolidated net sales and revenues of the Company.
COMPETITION
The microcomputer products, services and leasing 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, the Company may face fewer but larger competitors as a consequence of such consolidation. These competitors may have access to greater financial resources than the Company. 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 superstores have expanded their marketing efforts to target segments of the Company's customer base, which could have a material adverse impact on the Company's operations and financial results. While price is an important competitive factor in the Company's business, the Company believes that its sales are principally dependent upon its ability to provide comprehensive customer support services. The Company'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.
The Company competes for product sales directly with local, national and international distributors and resellers. In addition, the Company competes with microcomputer manufacturers that sell product through their own direct sales forces and to distributors. Although the Company believes its prices and delivery terms are competitive, certain competitors offer more aggressive hardware pricing to their customers.
The Company'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, to a lesser extent, consulting firms, aggregators and distributors. The Company 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, the Company 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 the Company's failure to compete effectively could have a material adverse effect on the Company's operations and financial results.
The Company believes its services solutions segment competes successfully by providing a comprehensive solution portfolio for its customers' information technology asset management and networking services needs. The Company delivers cost-effective, flexible, consistent, reliable and comprehensive solutions to meet customers' information technology infrastructure service requirements. The Company also believes that it distinguishes itself on the basis of its technical expertise, competitive pricing and its ability to understand its customers' needs.
The Company's leasing segment competes directly and indirectly with various lenders. Manufacturing competitors generally have their own leasing companies, which include private label services provided by other organizations. In addition, a number of independent finance companies have sales forces to originate leases, as well as alignment with manufacturers and resellers to provide private label leasing solutions. The leasing segment also competes with bank leasing companies. The Company believes its leasing segment competes successfully by providing flexible financing alternatives and offering turnkey solutions.
CERTAIN BUSINESS FACTORS
DEPENDENCE ON MAJOR CUSTOMERS
During fiscal 2000, approximately 29.6% of the Company's total net sales and revenues were derived from its top 10 customers. No customer accounted for more than 10% of the Company's total net sales and revenues. During fiscal 2000, MCI Worldcom accounted for approximately 10.4% of the total net sales and revenues for the products segment and Columbus Public Schools accounted for approximately 23.4% of the total net sales and revenues for the leasing segment.
RAPID GROWTH
The Company has grown rapidly both internally and through acquisitions, and the Company intends to continue to pursue both types of growth opportunities as part of its business strategy. There can be no assurance that the Company will be successful in maintaining its rapid growth in the future. The Company expects future growth will result from acquisitions in addition to continued organic growth. In fiscal 2000, the Company completed four acquisitions and continues to
evaluate expansion and acquisition opportunities that would complement its ongoing operations. There can be no assurance that the Company will be able to identify, acquire or profitably manage additional companies or successfully integrate such additional companies into the Company 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 the Company's reported operating results, diversion of management's attention, dependence on retaining, hiring and training key personnel, risks associated with unanticipated problems or legal liabilities and amortization of acquired intangible assets, some or all of which could have a material adverse effect on the Company's operations and financial results.
VENDOR REBATES AND VOLUME DISCOUNTS
The Company's profitability has been favorably affected by its ability to obtain rebates and volume discounts from manufacturers and through aggregators and distributors. Any change in the level of rebates, volume discount schedules or other marketing programs offered by manufacturers that results in the reduction or elimination of rebates or discounts currently received by the Company could have a material adverse effect on the Company's operations and financial results. In particular, a reduction or elimination of rebates related to government and educational customers could adversely affect the Company's ability to serve those customers profitably.
MANUFACTURER MARKET DEVELOPMENT FUNDS
Several manufacturers offer market development funds, cooperative advertising and other promotional programs to computer resellers such as the Company. The Company utilizes these programs to fund some of its advertising and promotional programs. The funds received from manufacturers are offset directly against the expense, thereby reducing selling, general and administrative expenses and increasing net income. While such programs have been available to the Company in the past, there is no assurance that these programs will be continued. Any discontinuance or material reduction of these programs could have an adverse effect on the Company's operations and financial results.
MANAGEMENT INFORMATION SYSTEM
The Company relies upon the accuracy and proper utilization of its management information system to provide timely distribution services, manage its inventory and track its financial information. To manage its growth, the Company is continually evaluating the adequacy of its existing systems and procedures.
The Company anticipates that it will regularly need to make capital expenditures to upgrade and modify its management information system, including software and hardware, as the Company grows and the needs of its business change. There can be no assurance that the Company will anticipate all of the demands, which its expanding operations will place on its management information system. The occurrence of a significant system failure or the Company's failure to expand or successfully implement its systems could have a material adverse effect on the Company's operations and financial results.
DEPENDENCE ON TECHNICAL EMPLOYEES
The success of the Company'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 the Company will be able to attract and retain sufficient numbers of skilled technical employees. The loss of a significant number of the Company'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 the Company is for specific customer orders, inventory devaluation or obsolescence could have a material adverse effect on the Company'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 the Company in the future. During fiscal 2000, many manufacturers reduced the number of days for which they provided price protection. In addition to the price protection mentioned above, the Company currently has the option of returning inventory to certain manufacturers and distributors, subject to certain limitations. The amount of inventory that can be returned to manufacturers without a restocking fee varies under the Company'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, the Company 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 parts.
DEPENDENCE ON KEY PERSONNEL
The success of the Company is dependent on the services of David B. Pomeroy, II, the CEO and Chairman of the Board, Stephen E. Pomeroy, President and Chief Operating Officer of the Company and Chief Executive Officer of Pomeroy Select, Victor Eilau, President of TIFS and other key personnel. The loss of the services of David Pomeroy, Stephen Pomeroy, Victor Eilau or other key personnel could have a material adverse effect on the Company's business. The Company maintains $1.0 million in key man life insurance insuring the life of David B. Pomeroy. In addition, the company maintains $700 thousand in key man life insurance insuring the life of Stephen E. Pomeroy and $500 thousand in key man life insurance insuring the life of Victor Eilau. The Company has entered into employment agreements with certain of its key personnel, including David B. Pomeroy, Stephen E. Pomeroy and Victor Eilau. The Company'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.
EMPLOYEES
As of January 5, 2001, the Company had 2,138 full-time employees consisting of the following: 1,428 technical personnel; 275 direct sales representatives and sales support personnel; 54 management personnel; and 381 administrative and distribution personnel. The Company has no collective bargaining agreements and believes its relations with its employees are good.
BACKLOG
The Company 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 the Company's business or indicative of future sales. From time to time, the Company 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 the Company's results of operations.
PATENTS AND TRADEMARKS
The Company owns no trademarks or patents. Although the Company'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. The Company 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 the Company'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 the Company 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 2000, the Company completed four acquisitions. The total consideration given consisted of $15.2 million in cash and subordinated notes of $4.8 million. Interest on the subordinated notes is payable quarterly. Principal in the amount of $.2 million was a 90 day note paid in full in 2000, and the $4.6 million of principal is payable in equal annual installments commencing on the first anniversary of closing.
On January 11, 2001, the Company announced it had entered into a letter of intent to purchase certain operating assets and the systems integration and consulting business of Osage Systems Group, Inc. ("Osage"). The transaction is subject to a number of consents. It is contemplated that the transaction will
also be effected through the provisions of the U.S. Bankruptcy Code and will, accordingly, be subject to Court approval. If the sale is completed, the Company anticipates that the systems integration and consulting business of Osage will operate as additional branch offices of the Company and the results of operations from the acquisition will be included in the consolidated statement of income from the date of acquisition. In addition, the Company is currently engaged in preliminary discussions with other potential acquisition candidates. Although it has no binding commitments to acquire such candidates, management believes that the Company may acquire one or more of these candidates in the future.
ITEM 2.
ITEM 2. PROPERTIES
The Company's principal executive offices, distribution facility and national training center comprised of approximately 36,000, 161,417 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, Chief Executive Officer of the Company, 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 also has non-cancelable operating leases for its regional offices, expiring at various dates between 2001 and 2008. The Company 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. The Company 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 the Company. Management believes these matters will not have a material adverse effect on the Company'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 THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
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.
1999 2000 -------------------- -------------------- High Low High Low ------ ------ ------ ------ First Quarter $23.13 $11.50 $21.75 $12.50 Second Quarter $15.00 $11.50 $18.25 $13.38 Third Quarter $16.63 $10.75 $30.13 $15.00 Fourth Quarter $13.88 $ 9.56 $19.50 $12.50
As of February 28, 2001, there were approximately 370 holders of record of the Company's common stock.
Dividends - ---------
The Company has not paid any cash dividends since its organization and the completion of its initial public offering. The Company has no plans to pay cash dividends in the foreseeable future, and the payment of such dividends are restricted under the Company's current borrowing agreement.
QUARTERLY RESULTS OF OPERATIONS (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
FISCAL YEAR 2000 COMPARED TO FISCAL YEAR 1999
Total Net Sales and Revenues. Total net sales and revenues increased $168.3 million, or 22.2%, to $925.1 million in fiscal 2000 from $756.8 million in fiscal 1999. This increase was attributable to an increase in sales to existing and new customers and to acquisitions completed in fiscal year 2000. Excluding acquisitions completed in fiscal year 2000, total net sales and revenues increased 21.4%.
Products and leasing sales increased $132.7 million, or 20.3%, to $785.7 million in fiscal 2000 from $653.0 million in fiscal 1999. Excluding acquisitions completed in fiscal year 2000, products and leasing sales increased 19.6%. Service revenues increased $35.6 million, or 34.3%, to $139.4 million in fiscal 2000 from $103.8 million in fiscal 1999. Excluding acquisitions completed in fiscal year 2000, service revenues increased 32.9%.
Gross Profit. Gross profit margin was 13.3% in fiscal 2000 compared to 13.8% in fiscal 1999. The Company's decrease in its gross margin resulted primarily from the Company's decision to obtain new business and increase sales by aggressively pricing certain products and services. Services revenues increased to 15.1% of total net sales and revenues in fiscal 2000 compared to 13.7% of total net sales and revenues in fiscal 1999. Factors that may have an impact on gross margin in the future include the percentage of equipment sales with lower-margin customers and the ratio of service revenues to total net sales and revenues.
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 decreased to 6.6% in fiscal 2000 from 6.9% for fiscal 1999. This decrease is primarily due to the growth in net sales and revenues exceeding the growth in selling, general and administrative expenses. Total operating expenses expressed as a percentage of total net sales and revenues were 7.6% in fiscal 2000 and 7.8% in fiscal 1999.
Income from Operations. Income from operations increased $7.2 million, or 15.8%, to $52.7 million in fiscal 2000 from $45.5 million in fiscal 1999. The Company's operating margin decreased to 5.7% in fiscal 2000 from 6.0% in fiscal 1999 due to the decrease in gross profit.
Interest Expense. Total interest expense increased $0.5 million, or 12.8%, to $4.4 million in fiscal 2000 from $3.9 million in fiscal 1999. This increase is primarily related to higher average borrowings during fiscal 2000 as a result of higher working capital requirements.
Income Taxes. The Company's effective tax rate was 39.7% in fiscal 2000 compared to 40.4% in fiscal 1999. The decrease in the Company's effective tax rate results from a lower overall state income tax liability.
Net Income. Net income increased $4.6 million, or 18.5%, to $29.5 million in fiscal 2000 from $24.9 million in fiscal 1999. The increase was a result of the factors described above.
FISCAL YEAR 1999 COMPARED TO FISCAL YEAR 1998
Total Net Sales and Revenues. Total net sales and revenues increased $128.9 million, or 20.5%, to $756.8 million in fiscal 1999 from $627.9 million in fiscal 1998. This increase was attributable to an increase in sales to existing and new customers and to acquisitions completed in fiscal years 1999 and late 1998. This increase reflects an increase in sales volume; however, unit-selling prices have declined in fiscal 1999 as compared to fiscal 1998. Excluding acquisitions completed in fiscal years 1999 and late 1998, total net sales and revenues increased 12.8%.
Products and leasing sales increased $97.6 million, or 17.6%, to $653.0 million in fiscal 1999 from $555.4 million in fiscal 1998. Excluding acquisitions completed in fiscal years 1999 and late 1998, products and leasing sales increased 10.9%. Service revenues increased $31.3 million, or 43.2%, to $103.8 million in fiscal 1999 from $72.5 million in fiscal 1998. Excluding acquisitions completed in fiscal years 1999 and late 1998, service revenues increased 27.4%.
Gross Profit. Gross profit margin was 13.8% in fiscal 1999 compared to 13.4% in fiscal 1998. The Company improved its gross margin by increasing the volume of higher-margin service revenues that offset a decrease in products gross margins and the growth in product sales. Services revenues increased to 13.7% of total net sales and revenues in fiscal 1999 compared to 11.6% of total net sales and revenues in fiscal 1998. Factors that may have an impact on gross margin in the future include the percentage of equipment sales with lower-margin customers and the ratio of service revenues to total net sales and revenues.
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 decreased to 6.9% in fiscal 1999 from 7.0% for fiscal 1998. This decrease is primarily due to the growth in net sales and revenues exceeding the growth in selling, general and administrative expenses. Total operating expenses expressed as a percentage of total net sales and revenues were 7.8% in fiscal 1999 and 1998.
Income from Operations. Income from operations increased $10.4 million, or 29.6%, to $45.5 million in fiscal 1999 from $35.1 million in fiscal 1998. The Company's operating margin increased to 6.0% in fiscal 1999 from 5.6% in fiscal 1998 due to the increase in gross profit.
Interest Expense. Total interest expense increased $1.2 million, or 44.4%, to $3.9 million in fiscal 1999 from $2.7 million in fiscal 1998. This increase is primarily related to higher average borrowings during fiscal 1999 as a result of higher working capital requirements.
Income Taxes. The Company's effective tax rate was 40.4% in fiscal 1999 compared to 38.1% in fiscal 1998. During fiscal 1998, the Company's effective tax rate was reduced due to the availability of the Kentucky Jobs Development Act ("KJDA") credit pertaining to the initial start-up cost component of the credit. For fiscal 1999, the Company's KJDA benefit was reduced to the annual eligible lease payments component of the credit plus any carryforward from prior years. In addition, this increase is the result of an increase in taxable income in states that have higher tax rates.
Net Income. Net income increased $4.7 million, or 23.3%, to $24.9 million in fiscal 1999 from $20.2 million in fiscal 1998. The increase was a result of the factors described above.
LIQUIDITY AND CAPITAL RESOURCES -------------------------------
Cash used in operating activities was $1.8 million in fiscal 2000. Cash used in investing activities was $20.9 million, which included $15.2 million for acquisitions, and $5.7 million for capital expenditures. Cash provided by financing activities was $22.1 million which included $23.6 million of net proceeds under notes payable, $11.6 million from the exercise of stock options and the related tax benefit, and $0.4 million proceeds from the employee stock purchase plan, offset by $13.5 million of net payments under bank notes payable.
A significant part of the Company's inventories is financed by floor plan arrangements with third parties. At January 5, 2001, these lines of credit totaled $72 million, including $60 million with Deutsche Financial Services ("DFS") and $12 million with IBM Credit Corporation ("ICC"). Borrowings under the DFS floor plan arrangements are made on thirty-day notes. Borrowings under the ICC floor plan arrangements are made on either thirty-day or sixty-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.
The Company's financing of receivables is provided through a portion of its credit facility with DFS. The credit facility provides a credit line of $80.0 million for accounts receivable financing. The accounts receivable portion of the credit facility carries a variable interest rate based on the prime rate less 125 basis points. At January 5, 2001, the amount outstanding was $55.5 million, including $9.2 million of overdrafts on the Company's books in accounts at a participant bank on the credit facility, which was at an interest rate of 7.75%. The overdrafts were subsequently funded through the normal course of business. The credit facility is collateralized by substantially all of the assets of the Company, except those assets that collateralize certain other financing arrangements. Under the terms of the credit facility, the Company is subject to various financial covenants.
The Company's credit facility extension agreement with DFS expired on January 12, 2001, and the Company signed an extension agreement with DFS under the same terms as the original credit facility. This extension will expire May 12, 2001. DFS approved, subject to execution of documentation, an increase in the total facility to $175 million during the extension period, which consists of $100 million working capital facility and $75 million inventory facility. The Company is currently negotiating with various financial institutions a new credit facility in order to increase its overall financing availability. Although there can be no assurances that the Company will be able to finalize a new credit facility, the Company currently anticipates that an agreement will be reached.
During fiscal 2000, the Company increased the leasing activity through its wholly owned leasing subsidiary, TIFS. This increased leasing activity for fiscal 2000 resulted in increased borrowings and resultant interest expense under the Company's credit facility with DFS. Further increases in leasing operations could impact one or more of total net sales and revenues, gross margin, operating income, net income, total debt and liquidity, depending on the amount of leasing activity and the types of leasing transactions. The funding of the Company's net investment in sales-type leases is provided by various financial institutions primarily on a nonrecourse basis.
The Company believes that the anticipated cash flow from operations and current financing arrangements will be sufficient to satisfy the Company's capital requirements for the next twelve months. Historically, the Company has financed acquisitions using a combination of cash, earn outs, shares of its Common Stock and seller financing. The Company anticipates that future acquisitions will be financed in a similar manner.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Registrant hereby incorporates the financial statements required by this item by reference to Item 14 hereof.
ITEM 9.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEMS 10-13.
The Registrant hereby incorporates the information required by Form 10-K, Items 10-13 by reference to the Company's definitive proxy statement for its 2001 Annual Meeting of shareholders which will be filed with the Commission prior to May 4, 2001. PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(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 Computer Resources, Inc.
By: /s/ David B. Pomeroy ---------------------------------- David B. Pomeroy Chairman of the Board and Chief Executive Officer
By: /s/ Stephen E. Pomeroy ---------------------------------- Stephen E. Pomeroy President and Chief Operating Officer
By: /s/ Dino M. Lucarelli ---------------------------------- Dino M. Lucarelli Chief Financial Officer and Chief Accounting Officer
Dated: April 5, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
Signature and Title Date - ------------------------------------- --------------
By: /s/ David B. Pomeroy April 5, 2001 - ------------------------------------- David B. Pomeroy, Director
By: /s/ Stephen E. Pomeroy April 5, 2001 - ------------------------------------- Stephen E. Pomeroy, Director
By: /s/ James H. Smith III April 5, 2001 - ------------------------------------- James H. Smith III, Director
By: /s/ Michael E. Rohrkemper April 5, 2001 - ------------------------------------- Michael E. Rohrkemper, Director
By: - ------------------------------------- William H. Lomicka, Director
By: - ------------------------------------- Vincent D. Rinaldi, Director
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders Pomeroy Computer Resources, Inc.
We have audited the accompanying consolidated balance sheets of Pomeroy Computer Resources, Inc. as of January 5, 2000 and 2001, and the related consolidated statements of income, equity, and cash flows for each of the three years in the period ended January 5, 2001. 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 auditing standards generally accepted in the 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pomeroy Computer Resources, Inc. at January 5, 2000 and 2001, and the consolidated results of its operations and its consolidated cash flows for each of the three years in the period ended January 5, 2001 in conformity with accounting principles generally accepted in the United States.
Grant Thornton LLP
/s/ Grant Thornton LLP
Cincinnati, Ohio February 9, 2001
F - 1
See notes to consolidated financial statements
F - 3
See notes to consolidated financial statements
F - 4
See notes to consolidated financial statements
F - 5
See notes to consolidated financial statements
F - 6
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FISCAL YEARS ENDED JANUARY 5, 1999, JANUARY 5, 2000 AND JANUARY 5, 2001
1. COMPANY DESCRIPTION
Pomeroy Computer Resources, Inc. (the "Company") was organized in February 1992 to consolidate and reorganize predecessor companies. The Company has 20 million shares of $.01 par value common stock authorized, with 12.6 million shares outstanding. The Company is also authorized to issue 2 million shares of $.01 par value preferred stock. In fiscal 1995 the Company formed a wholly-owned subsidiary, Technology Integration Financial Services, Inc. ("TIFS") (f/k/a - Pomeroy Computer Leasing Company, Inc. ("PCL")), for the purpose of leasing computer equipment to the Company's customers. In fiscal 1997, the Company formed a wholly-owned subsidiary, Pomeroy Computer Resources of South Carolina, Inc. ("PCR-SC") for the purpose of acquiring The Computer Store ("TCS"), a computer reseller and service provider located in Columbia, South Carolina. In fiscal 1998, the Company formed a wholly-owned subsidiary, Pomeroy Select Integration Solutions, Inc. ("Pomeroy Select"), to which the Company transferred the assets, liabilities, business, operations and personnel comprising the Company's information technology ("IT") services business on January 6, 1999. In October 1999, the legal structure of the Company was changed for the purpose of increasing efficiencies. The Company formed the following wholly-owned subsidiaries: Pomeroy Computer Resources Holding Company, Inc. ("PCR Holding") and Pomeroy Computer Resources Sales Company, Inc. ("PCR Sales"). In addition, the Company formed Pomeroy Select Advisory Services, Inc. ("PSAS"), a wholly-owned subsidiary of Pomeroy Select, Acme Data Services, LLC ("Acme Data"), a wholly-owned subsidiary of PCR Sales, T.I.F.S. Advisory Services, Inc. ("TIFS Advisory"), a wholly-owned subsidiary of TIFS, and Pomeroy Computer Resources LLP ("PCR Ops"), a partnership between the Company and PCR Holding. PCR-SC and Global Combined Technologies, Inc. were merged into PCR Sales. In fiscal 2000, The Company and and its wholly owned subsidiary Pomeroy Select acquired The Linc Corporation ("The Linc"), a network design, consulting and systems engineering provider located in Birmingham, Alabama and Val Tech Computer Systems, Inc. ("Val Tech"), a leasing company also located in Birmingham, Alabama.
The Company sells, installs, services and leases microcomputers and microcomputer equipment primarily for commercial, health care, governmental, financial and educational customers. The Company also derives revenue as a service solution provider of Internet infrastructure services, network infrastructure services (LAN/WAN/MAN), and network integration services, e-business application development and desktop management services. The Company has thirty-one regional offices located in 16 states throughout the Southeast and Midwest United States. The Company grants credit to substantially all customers in these areas.
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 TIFS, Pomeroy Select, PCR Holding, PCR Sales, PSAS, Acme Data, TIFS Advisory, PCR Ops, The Linc and Val Tech. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the fiscal 1998 and 1999 financial statements included herein to conform with the presentation used in fiscal 2000.
Fiscal Year - The Company's fiscal year is a 12- month period ending January 5. References to fiscal 1998, 1999 and 2000 are for the fiscal years ended January 5, 1999, January 5, 2000 and January 5, 2001, respectively.
Goodwill and Other Intangible Assets - Goodwill is amortized using the straight-line method over periods of fifteen to twenty-five years. In accordance with SFAS No. 121, "Accounting for The Impairment of Long-Lived Assets", the Company evaluates its goodwill on an ongoing basis to determine potential impairment by comparing the carrying value to the undiscounted estimated expected future cash flows of the related assets. Other intangible assets are amortized using the straight-line method over periods up to ten 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. Depreciation on leasehold improvements is computed using the straight-line method over estimated useful lives or the term of the lease, whichever is less. During fiscal 2000 and 1999, depreciation expense associated with TIFS's operating leases is classified under cost of sales. Fiscal 1998 has not been reclassified due to immateriality. Expenditures for repairs and maintenance are charged to expense as incurred and additions and improvements that significantly extend the lives of assets are capitalized. 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.
F - 7
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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 Incentive Rebates - Certain vendors provide incentive rebates to perform product training, advertising and other sales and market development activities. The Company recognizes these rebates when it has completed its obligation to perform under the specific incentive arrangement. Incentive rebates are recorded as reductions of selling, general and administrative expense or, if volume based, cost of sales.
Inventories - Inventories are stated at the lower of cost or market. Cost is determined by the average cost method.
Revenue Recognition - The Company recognizes revenue on the sale of equipment and supplies or sales-type leases when the products are shipped. Service revenue is recognized when the applicable services are provided or for service contracts, ratably over the lives of the contracts. Leasing 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.
Stock-Based Compensation - The Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation", in the fall of 1995. The statement encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value beginning in fiscal 1996. The Company elected to account 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.
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 shares used in the basic EPS and diluted EPS computations:
F - 8
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Use of Estimates in Financial Statements - In preparing financial statements in conformity with generally accepted accounting principles, 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. Actual results could differ from those estimates.
Fair Value Disclosures - The fair value of financial instruments approximates carrying value.
Comprehensive Income - The Company does not have any comprehensive income items other than net income.
Derivative Instruments and Hedging Activities - The Company does not currently have any derivative instruments or hedging activities to report under this standard.
3. ACCOUNTS RECEIVABLE
The following table summarizes the activity in the allowance for doubtful accounts for fiscal years 1998, 1999 and 2000:
(in thousands) Trade Other ------- --------
Balance January 5, 1998 $ 355 $ 223 Provision 1998 193 1,100 Accounts written-off (444) (1,171) Recoveries 175 167 ------- -------- Balance January 5,1999 279 319 Provision 1999 346 2,142 Accounts written-off (876) (824) Recoveries 755 265 ------- -------- Balance January 5, 2000 504 1,902 Provision 2000 298 48 Accounts written-off (852) (58) Recoveries 636 - ------- -------- Balance January 5, 2001 $ 586 $ 1,892 ======= ========
4. NET INVESTMENT OF CAPITAL LEASES
The Company's capital lease portfolio includes direct financing and operating leases. 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 financings for end users.
Direct financing and operating leases consist principally of notebook and desktop personal computers, communication products and high-powered servers with terms generally from two to three years. The components of the net investment in direct financing leases as of end of fiscal years 1999 and 2000:
(in thousands) 1999 2000 -------- -------- Minimum Lease Payments Receivable $23,823 $58,681 Estimated Residual Value 818 4,049 Initial Direct Costs 425 622 Unearned Income (2,430) (5,445) -------- -------- Total $22,636 $57,907 ======== ========
F - 9
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
5. INVENTORIES
Inventories consist of items held for resale and are comprised of the following components as of the end of fiscal:
(in thousands) 1999 2000 ------- ------- Equipment and supplies $35,077 $25,910 Service parts 3,781 3,436 ------- ------- Total $38,858 $29,346 ======= =======
6. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets consist of the following as of the end of the fiscal year, net of accumulated amortization of $6,181 thousand (1999) and $9,818 thousand (2000), respectively:
(in thousands) 1999 2000 ------- ------- Goodwill $38,404 $51,862 Covenants not to compete 557 702 Customer lists 383 312 Intangibles - 582 ------- ------- $39,344 $53,458 ======= =======
In fiscal 1999, the Company acquired certain assets of Systems Atlanta Commercial Systems, Inc., a privately held systems integrator and provider of technology staffing in Atlanta, Georgia. In addition, the Company acquired through a stock purchase Acme Data Systems ("ADS"), a privately held computer network integrator and services provider in Columbus, Ohio. The Company recorded $0.8 million and $4.6 million of goodwill in connection with those acquisitions, respectively.
In fiscal 2000, the Company acquired certain assets of Data Source - Hagen, a Minneapolis, Minnesota-based network integrator. In addition, the Company acquired Datanet, Inc., a Raleigh, North Carolina-based Information Technology Company and The Linc, a Birmingham Alabama-based Cisco Silver Partner whose primary focus is on network design, consulting, systems engineering and maintenance in connection with Cisco products and Val Tech, a Birmingham, Alabama leasing company. The Company recorded $1.2 million, $8.9 million, and $4.0 million of goodwill in connection with those acquisitions, respectively.
7. BORROWING ARRANGEMENTS
Bank Notes Payable - The Company has available a $140 million credit facility with Deutsche Financial Services Corp. ("DFS"). This credit facility provides a credit line of $60 million for inventory financing and $80 million for accounts receivable financing. The inventory financing portion of the credit facility utilizes thirty day notes and provides interest free financing due to subsidies by manufacturers. The credit facility can be amended, with proper notification, if the thirty day interest free subsidies provided by manufacturers are revised. At January 5, 2001, bank notes payable includes $9.2 million of overdrafts in accounts with a participant bank to this credit facility. These amounts were subsequently funded through the normal course of business. The accounts receivable portion of the credit facility carries a variable interest rate based on the prime rate less 125 basis points. The interest rate charged was 7.75% at January 5, 2001. The credit facility is collateralized by substantially all of the assets of the Company, except those assets that collateralize certain other financing arrangements. Under the terms of the credit facility, the Company is subject to various financial covenants. The weighted average interest rate on the bank revolving credit agreements was 7.6%, 7.0%, and 8.0% in fiscal 1998, 1999 and 2000, respectively.
F - 10
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Company's credit facility extension agreement with DFS expired on January 12, 2001, and the company signed an extension agreement with DFS under the same terms as the original credit facility. This extension will expire May 12, 2001.
Floor plan arrangements - The Company finances inventory through floor plan arrangements with two finance companies. As of January 5, 2001, the floor plan lines of credit were $60 million with DFS and $12 million with IBM Credit Corporation ("ICC"). Borrowings under the ICC floor plan arrangement are made on either thirty-day or sixty-day notes, with one-half of the note amount due in thirty days on the sixty-day notes. Borrowings under the DFS floor plan arrangement are made on thirty-day notes. Financing on many of the arrangements, which are subsidized by manufacturers, is interest free. The average rate on the plans overall is less than 1.0%.
Notes payable - Notes payable consist of the following:
Payments on long-term debt and capital lease obligations are due as follows:
(in thousands)
Fiscal Year ----------------------- 2001 $25,617 2002 19,179 2003 4,124 ------- $48,920 =======
F - 11
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
8. INCOME TAXES
The provision for income taxes consists of the following:
(in thousands) Fiscal Years --------------------------- 1998 1999 2000 -------- -------- ------- Current: Federal $11,430 $14,275 $16,060 State 1,310 3,304 2,614 -------- -------- ------- Total current 12,740 17,579 18,674 -------- -------- -------
Deferred: Federal (311) (618) 650 State (20) (97) 82 -------- -------- ------- Total deferred (331) (715) 732 -------- -------- ------- Total income tax provision $12,409 $16,864 $19,406 ======== ======== =======
The approximate tax effect of the temporary differences giving rise to the Company's deferred income tax assets (liabilities) are:
(in thousands) Fiscal Years ------------------ 1999 2000 -------- -------- Deferred Tax Assets: Bad debt provision $ 444 $ 246 Depreciation 890 895 Leases 864 1,614 Deferred compensation 627 622 Other 18 72 -------- -------- Total deferred tax assets 2,843 3,449 -------- --------
Deferred Tax Liabilities: Acquisition of lease residuals (580) (278) Accounts Receivable (279) (664) Intangibles (1,161) (1,611) Other - (805) -------- -------- Total deferred tax liabilities (2,020) (3,358) -------- -------- Net deferred tax assets $ 823 $ 91 ======== ========
The Company's net long term deferred tax assets are included in long term other assets. The Company's net short-term deferred liabilities are included in miscellaneous liabilities.
F - 12
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Company's effective income tax rate differs from the Federal statutory rate as follows:
Fiscal Years ------------------- 1998 1999 2000 ----- ----- ----- Tax at Federal statutory rate 35.0 35.0 35.0 State taxes 4.4 5.9 3.7 Kentucky Relocation Credits (1.9) (0.9) (0.1) Other 0.6 0.4 1.1 ----- ----- ----- Effective tax rate 38.1 40.4 39.7 ===== ===== =====
9. OPERATING LEASES
The Company leases office and warehouse space, vehicles and certain office equipment from various lessors including a related party. 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, 2001 are as follows:
(in thousands)
Fiscal Year ----------------------------- 2001 $ 5,503 2002 4,013 2003 3,239 2004 1,983 2005 1,885 Thereafter 566 -------- Total minimum lease payments $17,189 ========
10. EMPLOYEE BENEFIT PLANS
The Company has a savings plan intended to qualify under sections 401(a) and 401(k) of the Internal Revenue Code. The plan covers substantially all employees of the Company. Beginning January 6, 1998, the Company made contributions to the plan based on a participant's annual pay. Contributions made by the Company for fiscal 1999 and 2000 were approximately $263 thousand and $317 thousand, respectively. During fiscal 1998, the distribution of assets from an Employee Stock Ownership Plan was completed.
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 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). 100,000 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.
F - 13
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
11. INVESTMENT IN LEASE RESIDUALS
The Company participates in a Remarketing and Agency Agreement ("Agreement") with Information Leasing Corporation ("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 1998, 1999 and 2000 the Company sold equipment and related support services to ILC, for lease to ILC's customers, in amounts of $2.8 million, $0.6 million, and $2.8 million, respectively. The Company also obtained rights to lease residuals from ILC in the amount of $250 thousand in 1998. Such amounts are recorded as a reduction of the related cost of sales. Residuals acquired in this manner are recorded at the estimated present value of the interest retained.
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 carrying value of investments in lease residuals is $2.6 million and $2.3 million as of January 5, 2000 and 2001, respectively 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.
12. MAJOR CUSTOMERS
There were no sales to a major customer for fiscal 1998, 1999 and 2000.
13. ACQUISITIONS
During fiscal 1998, the Company completed several acquisitions. The total consideration given consisted of $21.2 million in cash, subordinated notes of $3.3 million and 39 thousand unregistered shares of the Company's stock with an approximate value of $0.8 million. Interest on the subordinated notes is payable quarterly. Principal is payable in equal annual installments. The acquisitions were accounted for as purchases, accordingly the purchase price was allocated to assets and liabilities based on their estimated value as of the dates of acquisition. The results of operations of the acquisitions are included in the consolidated statement of income from the dates of acquisition. If the 1998 acquisitions had occurred on January 6, 1998, the pro forma operations of the Company would not have been materially different than that reported in the accompanying consolidated statements of income.
During fiscal 1999, the Company completed two acquisitions. The total consideration given consisted of $4.2 million in cash, subordinated notes of $2.6 million and 39 thousand unregistered shares of the Company's stock with an approximate value of $0.6 million. Interest on the subordinated notes is payable quarterly. Principal in the amount of $0.6 million is payable in full on the anniversary date of closing and the $2.0 million of principal is payable in equal annual installments. The acquisitions were accounted for as purchases, accordingly the purchase price was allocated to assets and liabilities based on their estimated value as of the dates of acquisition. The results of operations of the acquisitions are included in the consolidated statement of income from the dates of acquisition. If the 1999 acquisitions had occurred on January 6, 1999, the pro forma operations of the Company would not have been materially different than that reported in the accompanying consolidated statements of income.
During fiscal 2000, the Company completed four acquisitions. The total consideration given consisted of $15.2 million in cash, subordinated notes of $4.8 million. Interest on the subordinated notes is payable quarterly. Principal in the amount of $0.2 million was a 90 day note paid in full in 2000, and the $4.6 million of principal is payable in equal annual installments commencing on the first anniversary of closing. The acquisitions were accounted for as purchases, accordingly the purchase price was allocated to assets and liabilities based on their estimated value as of the dates of acquisition. The results of operations of the acquisitions are included in the consolidated statement of income from the dates of acquisition. If the 2000 acquisitions had occurred on January 6, 2000, the pro forma operations of the Company would not have been materially different than that reported in the accompanying consolidated statements of income.
F - 14
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
14. RELATED PARTIES
The Company leases its headquarters, distribution facility and the national training center from a company that is controlled by the Chief Executive Officer of the Company. It is a triple net lease agreement, which expires in the year 2010. Base rental for fiscal 1999 and fiscal 2000 was $863 thousand and $1,068 thousand, respectively. The annual rental for these properties was determined on the basis of a fair market value rental opinion provided by an independent real estate company, which was updated in 2000. In addition, the Company pays for the business use of real estate that is owned by the Chief Executive Officer of the Company. During fiscal years 1998, 1999 and 2000, the Company paid $60 thousand, $95 thousand and $95 thousand, respectively in connection with this real estate.
A director of the Company is President of Information Leasing Corporation ("ILC"). In the first quarter of fiscal 2000, the Company sold certain leases to ILC for $5.0 million.
15. SUPPLEMENTAL CASH FLOW DISCLOSURES
Supplemental disclosures with respect to cash flow information and non-cash investing and financing activities are as follows:
(in thousands) Fiscal Years ----------------------------- 1998 1999 2000 --------- -------- -------- Interest paid $ 2,463 $ 3,704 $ 4,341 ========= ======== ======== Income taxes paid $ 17,432 $17,799 $20,206 ========= ======== ======== Additions to goodwill for adjustments to acquisition assets $ - $ 3,147 $ 1,119 ========= ======== ========
Business combinations accounted for as purchases: Assets acquired $ 50,228 $10,497 $28,602 Liabilities assumed (25,015) (3,166) (8,581) Notes payable (3,250) (2,553) (4,795) Stock issued (750) (556) - --------- -------- -------- Net cash paid $ 21,213 $ 4,222 $15,226 ========= ======== ========
16. STOCKHOLDERS' EQUITY AND STOCK OPTION PLANS
The Company's 1992 Non-Qualified and Incentive Stock Option 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. 3,500,000 shares of the common stock of the Company are reserved for issuance under the plan. The plan will terminate ten years from the date of adoption. 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.
The Company's 1992 Outside Directors' Stock Option Plan 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. 262,500 shares of common stock of the Company are reserved for issuance under the plan. The plan will terminate ten years from the date of adoption. Pursuant to the plan, an option to purchase 10,000 shares of common stock automatically will be granted on the first day of the initial term of a director. An additional 2,500 shares of common stock automatically will be granted to an eligible director upon the first day of
F - 15
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
each consecutive year of service on the board. Options may be exercised after one year from the date of grant for not more than one-third of the shares subject to the option and an additional one-third of the shares subject to the option may be exercised for each of the next two years thereafter. To the extent not exercised, options will expire five years after the date of grant.
The following summarizes the stock option transactions under the plans for the three fiscal years ended January 5, 2001:
Weighted Average Shares Exercise price ----------- ----------------- Options outstanding January 5, 1998 636,297 $ 12.01 Granted 278,953 17.75 Exercised (264,990) 8.98 Forfeitures (7,175) 10.24 Other (54,826) 6.16 ---------- Options outstanding January 5, 1999 588,259 13.97 Granted 811,852 16.02 Exercised (68,961) 7.98 Forfeitures (189,677) 17.74 ---------- Options outstanding January 5, 2000 1,141,473 15.14 Granted 1,580,360 15.01 Exercised (726,867) 13.20 Forfeitures (359,572) 18.40 ---------- Options outstanding January 5, 2001 1,635,394 $ 15.16 ==========
The following summarizes options outstanding and exercisable at January 5, 2001:
The weighted average fair value at date of grant for options granted during fiscal 1998, 1999 and 2000 was $7.00, $5.79 and $7.48, respectively. The fair value of options at the date of grant was estimated using the Black-Scholes model with the following weighted average assumptions:
F - 16
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Fiscal 1998 Fiscal 1999 Fiscal 2000 ------------ ------------ ------------ Expected life (years) 2.0 2.0 3.7 Interest rate 5.3% 6.4% 4.7% Volatility 69% 60% 62% Dividend yield 0% 0% 0%
Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards in fiscal 1998, 1999 and 2000 consistent with the provisions of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
17. LITIGATION
There are various legal actions arising in the normal course of business that have been brought against the Company. Management believes these matters will not have a material adverse effect on the Company's consolidated financial position or results of operations.
18. SEGMENT INFORMATION AND CONCENTRATIONS
Segment Information - The Company operates in three industry segments: products, services and leasing. The products segment is primarily engaged in the sale and distribution of computers, hardware, software and related products. The Company offers products from an array of manufacturers including Cisco, Computer Associates, Sun, Oracle, EMC, Compaq, Hewlett-Packard, IBM, Microsoft, Nortel Networks, Novell and Palm Computing. As a service solution provider, the Company offers five categories of service: internet infrastructure services, network infrastructure services(LAN/WAN/MAN), network integration services, e-business application development and desktop management services. Internet infrastructure solutions include services to assist customers in implementing network and server infrastructure components, enterprise management services that monitor the network buildup and broadband implementation services. Network infrastructure services include LAN/WAN/MAN implementation services. These services assist the customer in installing and implementing an internal network infrastructure that includes cabling, network equipment consulting, implementation and support; IP telephony services for maximizing voice/data circuits, wireless LAN implementation and storage services that provide consulting, design, implementation and support on storage area networks and network attached storage implementations. Network integration solutions provide services to assist customers in implementing thin client/server based computing, groupware implementation and System/Application enablement. E-business application development includes the infrastructure platform consulting, design and implementation. Desktop management services include assisting customers in project roll-outs, installation of personal computer systems, peripherals and accessories; warranty and non-warranty repair and maintenance, redeployment and end-of-life services. The Company has achieved Gold Authorization from Cisco. The Company has also been awarded 2 specialization's from Cisco; Voice Access and IP Telephony, which gives customers access to specialized knowledge and expertise to consult, design and implement converged voice and data telephony circuits and wireless LAN implementations. The leasing segment primarily
F - 17
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
provides in-house leasing services to the Company's products and services customers. The Company leases many types of equipment with the predominant focus on notebook and desktop personal computers, communication products and high-powered servers. The Company provides products and services primarily to large and medium sized corporate, health care, governmental, financial and educational customers. The Company has no 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.
Summarized financial information concerning the Company's reportable segments is shown in the following table. (in thousands)
Fiscal 1998 -------------------------------------------- Products Services Leasing Consolidated --------- --------- -------- ------------ Revenue $ 554,012 $ 72,495 $ 1,421 $ 627,928 Income from operations $ 23,101 $ 11,980 $ 17 $ 35,098 Total assets $ 189,438 $ 42,199 $ 22,589 $ 254,226 Capital expenditures $ 766 $ 374 $ 2,041 $ 3,181 Depreciation and amortization $ 4,142 $ 995 $ 240 $ 5,377
Fiscal 1999 -------------------------------------------- Products Services Leasing Consolidated --------- --------- -------- ------------ Revenue $ 648,924 $ 103,821 $ 4,012 $ 756,757 Income from operations $ 22,954 $ 21,111 $ 1,446 $ 45,511 Total assets $ 229,903 $ 55,043 $ 48,195 $ 333,141 Capital expenditures $ 3,435 $ 492 $ 722 $ 4,649 Depreciation and amortization $ 4,986 $ 1,342 $ 1,185 $ 7,513
Fiscal 2000 -------------------------------------------- Products Services Leasing Consolidated --------- --------- -------- ------------ Revenue $ 775,299 $ 139,444 $ 10,395 $ 925,138 Income from operations $ 22,742 $ 26,622 $ 3,335 $ 52,699 Total assets $ 222,984 $ 69,652 $ 75,197 $ 367,833 Capital expenditures $ 3,967 $ 729 $ 953 $ 5,649 Depreciation and amortization $ 7,310 $ 1,749 $ 1,285 $ 10,344
Concentrations - During fiscal 1998, 1999 and 2000, approximately 30.2%, 32.2% and 29.6% respectively, of the Company's total net sales and revenues were derived from its top ten customers.
Due to the demand for the products sold by the Company, significant product shortages occur from time to time because manufacturers are unable to produce certain products to meet increased demand. Failure to obtain adequate product shipments could have a material adverse effect on the Company's operations and financial results.
The Company is required to have authorizations from manufacturers in order to sell their products. The loss of a significant vendor's authorization could have a material adverse effect on the Company's business.
F - 18
POMEROY COMPUTER RESOURCES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
19. SUBSEQUENT EVENTS
The Company's credit facility extension agreement with DFS expired on January 12, 2001, and the Company signed an extension agreement with DFS under the same terms as the original credit facility. This extension will expire May 12, 2001. DFS approved, subject to execution of documentation, an increase in the total facility to $175 million during the extension period, which consists of $100 million working capital facility and $75 million inventory facility. The Company is currently negotiating with various financial institutions a new credit facility in order to increase its overall financing availability. Although there can be no assurances that the Company will be able to finalize a new credit facility, the Company currently anticipates that an agreement will be reached.
On January 11, 2001, the Company announced it had entered into a letter of intent to purchase certain operating assets and the systems integration and consulting business of Osage Systems Group, Inc. ("Osage"). The transaction is subject to a number of consents. It is contemplated that the transaction will also be effected through the provisions of the U.S. Bankruptcy Code and will, accordingly, be subject to court approval. If the sale is completed, the Company anticipates that the systems integration and consulting business of Osage will operate as additional branch offices of the Company and the results of operations from the acquisition will be included in the consolidated statement of income from the date of acquisition.
F - 19