UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934FORM 10-Q
| [X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 20042005
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
| [ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ____________ to _____________
COMMISSION FILE NUMBER 1-13792
Systemax Inc.
(Exact name of registrant as specified in its charter)
| Delaware (State or other jurisdiction of incorporation or organization) | 11-3262067 (I.R.S. Employer Identification No.) |
11 Harbor Park Drive
Port Washington, New York 11050
(Address of registrant'sregistrant’s principal executive offices)
(516) 608-7000
(Registrant'sRegistrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
[X]
Yes [ ] No [X]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange ActAct).
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2).12b-2 of the Exchange Act)
Yes [ ] No [X]
The number of shares outstanding of the registrant'sregistrant’s Common Stock as of November 5,July 31, 2006 was 35,021,391.
TABLE OF CONTENTS
| Explanatory Note | 3 | ||||||||
| Available Information | 3 | ||||||||
Part I | |||||||||
| Item 1. Financial Statements | 4 | ||||||||
| Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | 13 | ||||||||
| Item 3. Quantitative and Qualitative Disclosures About Market Risk | 19 | ||||||||
| Item 4. Controls and Procedures | 19 | ||||||||
Part II | |||||||||
| Item 1. Legal Proceedings | 22 | ||||||||
| Item 6. Exhibits | 22 | ||||||||
Signatures | 23 | ||||||||
Explanatory Note
The filing of this Quarterly Report on Form 10-Q was delayed because of the extensive additional work necessary to complete the previously-announced restatement of our Consolidated Financial Statements for the year ended December 31, 2004 was 34,405,080.and the need to engage a new independent registered public accounting firm as a result of the resignation of Deloitte & Touche LLP. The restatement is set forth in our amendment to our 2004 Annual Report on Form 10-K/A. The Condensed Consolidated Statement of Operations for the three and nine month periods ended September 30, 2004 and the Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2004 in this report are presented as restated. For information on the restatement and the impact of the restatement on our financial statements for the three and nine month periods ended September 30, 2004, we refer you to Item 8, “Financial Statements and Supplementary Data,” Note 2, “Restatement,” and Note 13, “Quarterly Financial Data,” in our amended 2004 Annual Report on Form 10-K/A.
Available Information
We maintain an internet web site atwww.systemax.com. We file reports with the Securities and Exchange Commission (“SEC”) and make available free of charge on or through this web site our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, including all amendments to those reports. These are available as soon as is reasonably practicable after they are filed with the SEC. All reports mentioned above are also available from the SEC’s web site(www.sec.gov). The information on our web site is not part of this or any other report we file with, or furnish to, the SEC.
Our Board of Directors has adopted the following corporate governance documents with respect to the Company (the “Corporate Governance Documents”):
In accordance with the corporate governance rules of the New York Stock Exchange, each of the Corporate Governance Documents is available on our Company web site (www.systemax.com) or can be obtained by writing to Systemax Inc., Attention: Board of Directors (Corporate Governance), 11 Harbor Park Drive, Port Washington, NY 11050.
PART I -— FINANCIAL INFORMATION
Item 1.Financial Statements
Systemax Inc.
Condensed Consolidated Balance Sheets
(In Thousands, except share data)
September 30, December 31, 2004 2003 ---- ---- (Unaudited) ASSETS: CURRENT ASSETS: Cash and cash equivalents $57,291 $38,702 Accounts receivable, net 153,811 152,435 Inventories 137,907 133,905 Prepaid expenses and other current assets 33,267 26,849 Deferred income tax assets 11,442 10,132 ------ ------ Total current assets 393,718 362,023 PROPERTY, PLANT AND EQUIPMENT, net 64,173 68,647 DEFERRED INCOME TAXES AND OTHER ASSETS 12,617 14,982 ------ ------ TOTAL ASSETS $470,508 $445,652 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY: CURRENT LIABILITIES: Short-term borrowings, including current portions of long-term debt $14,812 $20,814 Accounts payable 157,137 141,106 Accrued expenses and other current liabilities 60,119 51,037 ------ ------ Total current liabilities 232,068 212,957 ------- ------- LONG-TERM DEBT 17,116 18,353 ------ ------ OTHER LIABILITIES 1,648 1,768 ----- ----- SHAREHOLDERS' EQUITY: Preferred stock, par value $.01 per share, authorized 25 million shares, issued none Common stock, par value $.01 per share, authorized 150 million shares, issued 38,231,990 shares; outstanding 34,405,080 (2004) and 34,288,068 shares (2003) 382 382 Additional paid-in capital 175,180 175,343 Accumulated other comprehensive income, net 2,273 2,157 Retained earnings 86,797 81,022 ------ ------ 264,632 258,904 Less: common stock in treasury at cost - 3,826,910 (2004) and 3,943,922 (2003) shares 44,956 46,330 ------ ------ Total shareholders' equity 219,676 212,574 ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $470,508 $445,652 ======== ========
| September 30, 2005 (Unaudited) | December 31, 2004 | |||||||
|---|---|---|---|---|---|---|---|---|
| ASSETS: | ||||||||
| CURRENT ASSETS: | ||||||||
| Cash and cash equivalents | $ | 51,495 | $ | 36,257 | ||||
| Accounts receivable, net | 131,003 | 137,706 | ||||||
| Inventories, net | 174,459 | 192,774 | ||||||
| Prepaid expenses and other current assets | 19,501 | 22,096 | ||||||
| Deferred income tax assets, net | 9,149 | 9,594 | ||||||
| Total current assets | 385,607 | 398,427 | ||||||
| PROPERTY, PLANT AND EQUIPMENT, net | 58,965 | 65,563 | ||||||
| DEFERRED INCOME TAXES AND OTHER ASSETS, net | 25,437 | 19,206 | ||||||
| TOTAL ASSETS | $ | 470,009 | $ | 483,196 | ||||
| LIABILITIES AND SHAREHOLDERS' EQUITY: | ||||||||
| CURRENT LIABILITIES: | ||||||||
| Short-term borrowings, including current portions of long-term debt | $ | 26,091 | $ | 25,020 | ||||
| Accounts payable | 148,021 | 165,761 | ||||||
| Accrued expenses and other current liabilities | 55,546 | 59,639 | ||||||
| Total current liabilities | 229,658 | 250,420 | ||||||
| LONG-TERM DEBT | 8,174 | 8,639 | ||||||
| OTHER LIABILITIES | 2,439 | 1,505 | ||||||
| SHAREHOLDERS' EQUITY: | ||||||||
| Preferred stock, par value $.01 per share, authorized 25 million shares, issued | ||||||||
| none | ||||||||
| Common stock, par value $.01 per share, authorized 150 million shares, issued | ||||||||
| 38,231,990 shares; outstanding 34,712,560 (2005) and 34,432,799 shares (2004) | 382 | 382 | ||||||
| Additional paid-in capital | 178,032 | 180,640 | ||||||
| Accumulated other comprehensive income | 1,451 | 3,920 | ||||||
| Retained earnings | 95,521 | 87,486 | ||||||
| Common stock in treasury at cost - 3,519,430 (2005) and 3,799,191 (2004) shares | (41,343 | ) | (44,630 | ) | ||||
| Unearned restricted stock compensation | (4,305 | ) | (5,166 | ) | ||||
| Total shareholders' equity | 229,738 | 222,632 | ||||||
| TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | $ | 470,009 | $ | 483,196 | ||||
See notes to condensed consolidated financial statements.
Systemax Inc.
Condensed Consolidated Statements of IncomeOperations (Unaudited)
(In Thousands, except per share amounts)
Nine Months Ended Three Months Ended September 30, September 30, -------------------------------- ------------------------------------ 2004 2003 2004 2003 --------------- --------------- ----------------- ----------------- Net sales $1,376,997 $1,220,270 $460,271 $405,011 Cost of sales 1,161,135 1,017,156 387,047 337,900 --------------- --------------- ----------------- ----------------- Gross profit 215,862 203,114 73,224 67,111 Selling, general and administrative expenses 196,092 190,305 66,416 64,822 Restructuring and other charges (reversals) 6,041 (1,160) 1,026 (1,272) Goodwill impairment 2,560 --------------- --------------- ----------------- ----------------- Income from operations 13,729 11,409 5,782 3,561 Interest and other expense, net 1,788 1,075 715 542 --------------- --------------- ----------------- ----------------- Income before income taxes 11,941 10,334 5,067 3,019 Provision for income taxes 6,166 5,256 2,375 1,112 --------------- --------------- ----------------- ----------------- Net income $5,775 $5,078 $2,692 $1,907 =============== =============== ================= ================= Net income per common share: Basic $.17 $.15 $.08 $.06 =============== =============== ================= ================= Diluted $.16 $.15 $.08 $.05 =============== =============== ================= ================= Weighted average common and common equivalent shares: Basic 34,358 34,124 34,399 34,159 =============== =============== ================= ================= Diluted 35,243 34,672 35,272 35,128 =============== =============== ================= =================
| Nine Months Ended September 30, | Three Months Ended September 30, | |||
|---|---|---|---|---|
| 2005 | 2004 | 2005 | 2004 | |
| Net sales | $1,532,552 | $1,375,758 | $488,502 | $457,984 |
| Cost of sales | 1,310,932 | 1,160,542 | 418,022 | 386,735 |
| Gross profit | 221,620 | 215,216 | 70,480 | 71,249 |
| Selling, general & administrative expenses | 201,806 | 196,092 | 62,025 | 66,416 |
| Restructuring and other charges | 3,494 | 6,041 | 442 | 1,026 |
| Income from operations | 16,320 | 13,083 | 8,013 | 3,807 |
| Interest and other expense, net | 2,352 | 1,788 | 1,276 | 715 |
| Income before income taxes | 13,968 | 11,295 | 6,737 | 3,092 |
| Provision for income taxes | 5,933 | 6,210 | 2,862 | 1,759 |
| Net income | $8,035 | $5,085 | $3,875 | $1,333 |
| Net income per common share: | ||||
| Basic | $.23 | $.15 | $.11 | $.04 |
| Diluted | $.22 | $.14 | $.11 | $.04 |
| Weighted average common and common equivalent shares: | ||||
| Basic | 34,619 | 34,358 | 34,695 | 34,399 |
| Diluted | 36,479 | 35,273 | 36,552 | 35,272 |
See notes to condensed consolidated financial statements.
Systemax Inc.
Condensed Consolidated Statement of Shareholders' Equity (Unaudited)
(In Thousands)
Common Stock Accumulated -------------------- Other Additional Comprehensive Treasury Comprehensive Number of Paid-in Retained Income, Stock, Income, Shares Amount Capital Earnings Net of Tax At Cost Net of Tax ---------- --------- ------------- ----------- ------------- ---------- --------------- Balances, January 1, 2004 34,288 $382 $175,343 $81,022 $2,157 $(46,330) Exercise of stock options 117 (963) 1,374 Change in cumulative translation adjustment, net 116 $116 Compensation expense related to stock option plans 800 Net income 5,775 5,775 ------ ----- -------- ------- ------ -------- ------ Total comprehensive income $5,891 ====== Balances, September 30, 2004 34,405 $382 $175,180 $86,797 $2,273 $(44,956) ====== ==== ======== ======= ====== =========
See notes to condensed consolidated financial statements.
Systemax Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited) (In Thousands) Nine Months Ended September 30, -------------------------------- 2004 2003 --------------- --------------- CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES: Net income $5,775 $5,078 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for deferred income taxes 358 (1,941) Depreciation and amortization 8,623 9,995 Provision for returns and doubtful accounts 2,069 3,627 Loss on dispositions and abandonment 525 132 Compensation expense related to stock option plans 800 Goodwill impairment 2,560 Changes in operating assets and liabilities: Accounts receivable (3,764) 764 Inventories (4,160) (10,509) Prepaid expenses and other current assets (5,803) 6,378 Accounts payable, accrued expenses and other current liabilities 25,027 (15,695) --------------- --------------- Net cash provided by operating activities 29,450 389 --------------- --------------- CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES: Investments in property, plant and equipment (5,528) (6,597) Proceeds from disposals of property, plant and equipment 978 90 Purchase of minority interest (2,560) --------------- --------------- Net cash used in investing activities (4,550) (9,067) --------------- --------------- CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES: Repayments of borrowings from banks (6,079) (6,263) Issuance of long-term borrowings and capital lease obligations 1,330 Repayments of long-term debt and capital lease obligations (1,322) (938) Exercise of stock options 412 1,318 --------------- --------------- Net cash used in financing activities (6,989) (4,553) --------------- --------------- EFFECTS OF EXCHANGE RATES ON CASH 678 (4,283) --------------- --------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 18,589 (17,514) CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 38,702 62,995 --------------- --------------- CASH AND CASH EQUIVALENTS - END OF PERIOD $57,291 $45,481 =============== ===============
| Common Stock | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Number of Shares Outstanding | Amount | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss), Net of Tax | Treasury Stock, At Cost | Unearned Restricted Stock Compensation | Comprehensive Income (Loss), Net of Tax | |||||||||||||||||||
| Balances, January 1, 2005 | 34,433 | $ | 382 | $ | 180,640 | $ | 87,486 | $ | 3,920 | $ | (44,630 | ) | $ | (5,166 | ) | |||||||||||
| Exercise of stock options | 280 | (2,619 | ) | 3,287 | ||||||||||||||||||||||
| Tax benefit of employee | ||||||||||||||||||||||||||
| stock plans | 11 | |||||||||||||||||||||||||
| Change in cumulative | ||||||||||||||||||||||||||
| translation adjustment, | ||||||||||||||||||||||||||
| net | (2,469 | ) | $ | (2,469 | ) | |||||||||||||||||||||
| Amortization of unearned | ||||||||||||||||||||||||||
| restricted stock | ||||||||||||||||||||||||||
| compensation | 861 | |||||||||||||||||||||||||
| Net income | 8,035 | 8,035 | ||||||||||||||||||||||||
| Total comprehensive income | $ | 5,566 | ||||||||||||||||||||||||
| Balances, Sept. 30, 2005 | 34,713 | $ | 382 | $ | 178,032 | $ | 95,521 | $ | 1,451 | $ | (41,343 | ) | $ | (4,305 | ) | |||||||||||
See notes to condensed consolidated financial statements.
Systemax Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In Thousands)
| Nine Months Ended September 30, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | |||||||
| CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES: | ||||||||
| Net income | $ | 8,035 | $ | 5,085 | ||||
| Adjustments to reconcile net income to net cash provided by (used in) | ||||||||
| operating activities: | ||||||||
| Depreciation and amortization | 8,017 | 8,623 | ||||||
| Provision (benefit) for deferred income taxes | (4,053 | ) | 446 | |||||
| Provision for returns and doubtful accounts | 4,531 | 2,069 | ||||||
| Compensation expense related to equity compensation plans | 861 | 800 | ||||||
| Loss on dispositions and abandonment | 736 | 525 | ||||||
| Tax benefit of employee stock plans | 11 | 134 | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | (6,442 | ) | (2,526 | ) | ||||
| Inventories | 15,170 | (3,061 | ) | |||||
| Prepaid expenses and other current assets | 882 | (5,799 | ) | |||||
| Accounts payable, accrued expenses and other current liabilities | (12,488 | ) | 23,457 | |||||
| Net cash provided by operating activities | 15,260 | 29,753 | ||||||
| CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES: | ||||||||
| Investments in property, plant and equipment | (4,450 | ) | (5,528 | ) | ||||
| Proceeds from disposals of property, plant and equipment | 253 | 978 | ||||||
| Net cash used in investing activities | (4,197 | ) | (4,550 | ) | ||||
| CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES: | ||||||||
| Proceeds (repayments) of borrowings from banks | 3,043 | (6,079 | ) | |||||
| Repayments of long-term debt and capital lease obligations | (454 | ) | (1,322 | ) | ||||
| Issuance of common stock | 668 | 278 | ||||||
| Net cash provided by (used in) financing activities | 3,257 | (7,123 | ) | |||||
| EFFECTS OF EXCHANGE RATES ON CASH | 918 | 512 | ||||||
| NET INCREASE IN CASH AND CASH EQUIVALENTS | 15,238 | 18,592 | ||||||
| CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD | 36,257 | 38,700 | ||||||
| CASH AND CASH EQUIVALENTS - END OF PERIOD | $ | 51,495 | $ | 57,292 | ||||
See notes to condensed consolidated financial statements.
Systemax Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)
| 1. | Basis of Presentation |
| The accompanying condensed consolidated financial statements of the Company, its wholly-owned subsidiaries |
| In the opinion of management, the accompanying condensed consolidated financial statements contain all normal and recurring adjustments necessary to present fairly the financial position of the Company as of September 30, |
| These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements as of December 31, |
| 2. | Stock-based Compensation |
| The Company has three stock-based compensation plans, two of which are for employees, consultants and advisors and the third of which is for non-employee |
Nine Months Ended Three Months Ended Sept. 30, Sept. 30, ----------------- ------------------ 2004 2003 2004 2003 ---- ---- ---- ---- Net income - as reported $5,775 $5,078 $2,692 $1,907 Stock-based employee compensation expense determined under fair value based method, net of related tax effects 308 387 94 129 --- --- -- --- Pro forma net income $5,467 $4,691 $2,598 $1,778 ====== ====== ====== ====== Net income per common share: Basic: Net income - as reported $.17 $.15 $.08 $.06 ==== ==== ==== ==== Net income - pro forma $.16 $.14 $.08 $.05 ==== ==== ==== ==== Diluted: Net income - as reported $.16 $.15 $.08 $.05 ==== ==== ==== ==== Net income - pro forma $.16 $.14 $.07 $.05 ==== ==== ==== ====
| Nine Months Ended September 30, | Three Months Ended September 30, | |||
|---|---|---|---|---|
| 2005 | 2004 | 2005 | 2004 | |
| Net income - as reported | $8,035 | $5,085 | $3,875 | $1,333 |
| Add: Stock-based compensation expense included in | ||||
| reported net income, net of related tax effects | 555 | 516 | 93 | |
| Deduct: Stock-based employee compensation expense | ||||
| determined under fair value based method, net of | ||||
| related tax effects | 892 | 824 | 194 | 94 |
| Pro forma net income (loss) | $7,698 | $4,777 | $3,774 | $1,239 |
| Net income per common share: | ||||
| Basic: | ||||
| Net income - as reported | $.23 | $.15 | $.11 | $.04 |
| Net income (loss) - pro forma | $.22 | $.14 | $.11 | $.04 |
| Diluted: | ||||
| Net income - as reported | $.22 | $.14 | $.11 | $.04 |
| Net income (loss) - pro forma | $.21 | $.14 | $.10 | $.04 |
| The fair value of options granted was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: |
2004 2003 ---- ---- Expected dividend yield 0% 0% Risk-free interest rate 5.0% 5.0% Expected volatility 50.0% 68.0% Expected life in years 2.29 2.42
| 2005 | 2004 | |
|---|---|---|
| Expected dividend yield | 0% | 0% |
| Risk-free interest rate | 5.5% | 5.9% |
| Expected volatility | 62.0% | 58.0% |
| Expected life in years | 2.41 | 2.40 |
| 3. | Net Income per Common Share |
| Net income per common share |
Nine Months Ended Sept. 30, Three Months Ended Sept. 30, --------------------------- ---------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- 601,000 702,000 553,000 683,000
| 4. | Comprehensive Income |
| Comprehensive income (loss) consists of net income (loss) and foreign currency translation adjustments, net of tax, and is included in the Condensed Consolidated Statement of Shareholders’ Equity. For the nine month periods ended September 30, comprehensive income was |
| 5. | Credit Facilities |
| The Company |
| Under the Company’s £15 million ($ |
| Under the Company’s €5 million ($ |
| 6. | Accrued Restructuring Costs |
| The Company periodically assesses its operations to ensure that they are efficient, aligned with market conditions and responsive to customer needs. During the nine |
| Nine months | Three months | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Periods ended September 30 | 2005 | 2004 | 2005 | 2004 | ||||||||||
| 2004 United States streamlining plan | $ | 122 | $ | 3,695 | ||||||||||
| 2003 United States warehouse consolidation plan | 602 | $ | 602 | |||||||||||
| Other severance and exit costs | 3,372 | 1,744 | $ | 442 | 424 | |||||||||
| Total restructuring and other charges | $ | 3,494 | $ | 6,041 | $ | 442 | $ | 1,026 | ||||||
| 2004 United States Streamlining Plan In the first quarter of 2004, the Company implemented a plan to streamline the back office and warehousing operations in its United States computer businesses. |
Severance and Asset Other Personnel Costs Write-downs Exit Costs Total --------------- ----------- ---------- ----- Charged to expense in 2004 $3,153 $483 $263 $3,899 Amounts utilized (2,292) (483) (42) (2,817) ------- ----- ---- ------- Accrued at September 30, 2004 $861 - $221 $1,082 ==== ===== ==== ======
| 2003 United States Warehouse Consolidation Plan In the fourth quarter of 2003, the Company implemented a plan to consolidate the warehousing facilities in its United States computer supplies business. |
| Other Severance and Exit Costs In the first quarter of 2005, the Company implemented plans to streamline operations in its European businesses. The Company recorded $3.4 million of costs related to these actions for severance and benefits for approximately 200 terminated employees during the first nine months of 2005. During the first nine months of 2004, the Company recorded |
Severance and Asset Other Personnel Costs Write-downs Exit Costs Total --------------- ----------- ---------- ----- Accrued at December 31, 2003 $ 63 $233 $417 $713 Charged to expense in 2004 97 302 399 Amounts utilized (63) (122) (392) (577) ---- ----- ----- ----- Accrued at September 30, 2004 - $208 $327 $535 ==== ===== ==== ====
Asset Other Write-downs Exit Costs Total ----------- ---------- ----- Accrued at December 31, 2003 $630 $1,682 $2,312 Charged to expense in 2004 181 181 Amounts utilized (630) (1,189) (1,819) ----- ------- ------- Accrued at September 30, 2004 - $674 $674 ===== ======= =======
| Severance and Personnel Costs | Other Exit Costs | Total | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Accrued at December 31, 2004 | $ | 633 | $ | 1,396 | $ | 2,029 | |||||
| Charged to expense in 2005 | 3,494 | 3,494 | |||||||||
| Amounts utilized | (3,749 | ) | (808 | ) | (4,557 | ) | |||||
| Accrued at September 30, 2005 | $ | 378 | $ | 588 | $ | 966 | |||||
| 7. | Segment Information |
| The Company operates in one primary business as a reseller of business products to commercial and consumer users. The Company operates and is |
| The Company’s chief operating decision-maker is the Company’s Chief Executive Officer. The Company evaluates segment performance based on income from operations before net interest, foreign exchange gains and losses, restructuring and other charges and income taxes. Corporate costs not identified with the disclosed segments and restructuring and other charges are grouped as “Corporate and other expenses.” The chief operating decision-maker reviews assets and makes capital expenditure decisions for the Company on a |
| Financial information relating to the |
| Nine Months Ended September 30, | Three Months Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | 2005 | 2004 | |||||||||||
| Net sales: | ||||||||||||||
| Computer products | $ | 1,401,446 | $ | 1,263,135 | $ | 442,709 | $ | 419,147 | ||||||
| Industrial products | 131,106 | 112,623 | 45,793 | 38,837 | ||||||||||
| Consolidated | $ | 1,532,552 | $ | 1,375,758 | $ | 488,502 | $ | 457,984 | ||||||
| Income (loss) from operations: | ||||||||||||||
| Computer products | $ | 23,340 | $ | 23,340 | $ | 8,951 | $ | 13,785 | ||||||
| Industrial products | 5,157 | 5,157 | 2,114 | 239 | ||||||||||
| Software application | (4,977 | ) | (3,731 | ) | (1,743 | ) | (1,386 | ) | ||||||
| Corporate and other expenses | (7,200 | ) | (11,683 | ) | (1,309 | ) | (8,831 | ) | ||||||
| Consolidated | $ | 16,320 | $ | 13,083 | $ | 8,013 | $ | 3,807 | ||||||
| Financial information relating to the Company’s operations by geographic area was as follows (in thousands): |
Nine Months Ended Three Months Ended Sept. 30, Sept. 30, ------------------------ ---------------------- 2004 2003 2004 2003 ---- ---- ---- ---- Net Sales: North America $871,990 $761,092 $301,007 $260,092 Europe 505,007 459,178 159,264 144,919 ------- ------- ------- ------- Consolidated $1,376,997 $1,220,270 $460,271 $405,011 ========== ========== ======== ======== Revenues are attributed to countries based on location of selling subsidiary.
| Nine Months Ended September 30, | Three Months Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | 2005 | 2004 | |||||||||||
| Net sales: | ||||||||||||||
| United States: | ||||||||||||||
| Industrial products | $ | 131,106 | $ | 112,623 | $ | 45,793 | $ | 38,837 | ||||||
| Computer products | 815,336 | 713,061 | 259,970 | 244,294 | ||||||||||
| United States total | 946,442 | 825,684 | 305,763 | 283,131 | ||||||||||
| Other North America | 68,233 | 45,313 | 21,510 | 15,855 | ||||||||||
| North America total | 1,014,675 | 870,997 | 327,273 | 298,986 | ||||||||||
| Europe | 517,877 | 504,761 | 161,229 | 158,998 | ||||||||||
| Consolidated | $ | 1,532,552 | $ | 1,375,758 | $ | 488,502 | $ | 457,984 | ||||||
| Revenues are attributed to countries based on the location of selling subsidiary. |
| 8. | Recent Accounting Pronouncements |
| In |
| In December 2004, the FASB issued SFAS 123 (revised 2004) (SFAS 123R), “Share-Based Payment.” SFAS 123R replaced SFAS 123, “Accounting for Stock-Based Compensation,” and superseded Accounting Principles Board Opinion 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires the recognition of compensation cost relating to share-based payment transactions, including employee stock options, in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS 123R provides alternative methods of adoption which include prospective application and a modified retroactive application. SFAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow as prescribed under current accounting rules. The Company is required to adopt the provisions of SFAS 123R effective as of the beginning of its first quarter in 2006. The Company is evaluating the available alternatives of adoption of SFAS 123R. The Company currently accounts for share-based payments using APB Opinion 25‘s intrinsic value method and recognizes no compensation expense for employee stock options as permitted under SFAS 123. See “Stock-based Compensation” above for the effect on reported net income if we had accounted for our stock-based compensation plans using the fair value recognition provisions of SFAS 123. The actual effects of adopting SFAS 123R will depend on numerous factors, including the amounts of share-based payments granted in the future, the valuation model we use and estimated forfeiture rates. The Company has not made any modifications to its stock-based compensation plans as a result of the issuance of SFAS 123R. The Company believes the adoption of SFAS 123R will not have a material effect on its consolidated financial statements. |
| In March 2005, the Securities and Exchange Commission released SEC Staff Accounting Bulletin (“SAB”) 107, “Share-Based Payment.” SAB 107 provides the SEC staff’s position regarding the application of SFAS No. 123R and certain SEC rules and regulations, and also provides the staff’s views regarding the valuation of share-based payments for public companies. The Company will adopt SAB 107 in connection with its adoption of SFAS 123R. The Company is currently reviewing the effects, if any, that the application of SAB 107 will have on the Company’s consolidated financial position and results of operations. |
| In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which replaces Accounting Principles Board Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements-An Amendment of APB Opinion No. 28.” SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition of a cumulative effect adjustment within net income of the period of the change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also applies to changes required by an accounting pronouncement in the rare case that the pronouncement does not contain specific transition provisions. This |
| In June 2005, the FASB issued FSP FAS 143-1, “Accounting for Electronic Equipment Waste Obligations” (“FSP FAS 143-1”), to address the accounting for obligations associated with a European Union’s Directive on Waste Electrical and Electronic Equipment (the “Directive”). The Directive, enacted in 2003, requires EU-member countries to adopt legislation to regulate the collection, treatment, recovery and environmentally sound disposal of electrical and electronic waste equipment. The Directive distinguishes between products put on the market after August 13, 2005 (“new waste”) and products put on the market on or before that date (“historical waste”). FSP FAS 143-1 addresses the accounting for historical waste only and will be applied the later of the first reporting period ending after June 8, 2005 or the date of the adoption of the law by the applicable EU-member country. The adoption of FSP FAS 143-1 did not have a material impact on the Company’s consolidated financial position or results of operations |
Item 2.Management's Discussion and Analysis of Financial Condition and Results of OperationsOperations..
Forward Looking Statements
This report contains forward looking statements within the meaning of that term in the Private Securities Litigation Reform Act of 1995 (Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). Additional written or oral forward looking statements may be made by the Company from time to time, in filings with the Securities and Exchange Commission or otherwise. Statements contained in this report that are not historical facts are forward looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward looking statements may include, but are not limited to, projections of revenue, income or loss and capital expenditures, statements regarding future operations, financing needs, compliance with financial covenants in loan agreements, plans for acquisition or sale of assets or businesses and consolidation of operations of newly acquired businesses, and plans relating to products or services of the Company, assessments of materiality, predictions of future events and the effects of pending and possible litigation, as well as assumptions relating to the foregoing. In addition, when used in this discussion, the words “anticipates”, “believes”, “estimates”, “expects”, “intends”, “plans” and variations thereof and similar expressions are intended to identify forward looking statements.
Forward-looking statements in this report are based on the Company’s beliefs and expectations as of the date of this report and are subject to risks and uncertainties which may have a significant impact on the Company’s business, operating results or financial condition. Investors are cautioned that these forward-looking statements are inherently uncertain. Should one or more of the risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described herein. ManyStatements in this report, particularly in “Item 2. Management’s Discussion and Analysis of these riskFinancial Condition and Results of Operations” and the Notes to Condensed Consolidated Financial Statements, describe certain factors, are discussed below in “Factors That May Affect Future Results and Financial Condition”.among others, that could contribute to or cause such differences.
Readers are cautioned not to place undue reliance on any forward looking statements contained in this report, which speak only as of the date of this report. We undertake no obligation to publicly release the result of any revisions to these forward looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unexpected events.
Overview
Systemax isWe are a direct marketer of brand name and private label products, includingproducts. Our operations are organized in two primary reportable segments – Computer Products and Industrial Products. Our Computer Products segment markets personal desktop computers, (PCs), notebook computers and computer related products and industrial products in North America and Europe. We market these products through an integrated system of distinctively branded, full-color direct mail catalogs, proprietary e-commerce internet sites and personalized relationship marketing. We assemble our own PCs and sell them under our own trademarks, which we believe gives us a competitive advantage. We also sell personal computers manufactured by other leading companies, such as IBMHewlett Packard, E-Machines and Hewlett Packard.Sony. Our Industrial Products segment markets material handling equipment, storage equipment and consumable industrial items in North America. We offer more than 100,000 products and continuously update our product offerings to address the needs of our customers, which include large, mid-sized and small businesses, educational and government entities as well as individual consumers. We reach customers by multiple channels, utilizing relationship marketers, e-commerce web sites, mailed catalogues and retail outlet stores. We also participate in the emerging market for on-demand, web-based software applications through the marketing of our PCS Profitability Suite™ of hosted software, which we began during 2004, and in which we have not yet recognized any revenues and have incurred considerable losses to date. Computers and computer related products account for more than 90%92% of our net sales, and, as a result, we are dependent on the general demand for information technology products.
The market for computer products is subject to intense price competition and is characterized by narrow gross profit margins. The North American industrial products market is highly fragmented and we compete against multiple distribution channels. Distribution of information technology and our industrial products is working capital intensive, requiring us to incur significant costs associated with the warehousing of many products, including the costs of leasing warehouse space, maintaining inventory and trackinginventory management systems, and employing personnel to perform the associated tasks. We supplement our on-hand product availability by maintaining relationships with major distributors and manufacturers, utilizing a combination of stocking and drop-shipment.drop-shipment fulfillment.
During fiscal 2002 and 2003, our performance and that of the industry as a whole was impacted negatively by a global economic downturn and cautious information technology spending. As it became evident that the industry was experiencing a prolonged economic downturn, we took measures to align our cost structure with lower revenues and decreasing gross margins. The primary component of our operating expenses historically has been employee related costs, which includes items such as wages, commissions, bonuses, and employee benefits. We have made substantial reductions in our workforce and closed or consolidated several facilities.facilities over the past several years. In response to poor economic conditions in the United States, we implemented a plan in the first quarter of 2004 we announced and began the implementation of a plan to streamline our United States computer business, consolidatingbusiness. This plan consolidated duplicative back office and warehouse operations. We have substantially completed this plan,operations, which resulted in annual savings of approximately $8 million excluding severance and other restructuring costs of approximately $3 million, which were recognized in fiscal 2004. With evidence of a prolonged economic downturn in Europe, we took measures to align our cost structure with expected potentially lower revenues and decreasing gross margins, initiating several cost reduction plans there during 2004 and 2005. Actions taken in 2005 to increase efficiency and profitability in our European operations resulted in the benefits evidenced by a continued declineelimination of approximately 240 positions, and are expected to result in selling, generalapproximately $6.0 million in future annual savings excluding the severance and administrative expense as a percentage of net sales.
Economic conditionsrestructuring costs to be recognized in North America have improved in 2004, with increased demand for both our computer products, particularly from our consumer customers, and industrial products.fiscal 2005. We will continue to focus on growthmonitor our costs and evaluate the need for additional actions.
The discussion of our results of operations and financial condition that follows will provide information that will assist in understanding our internet sales, which allows us to leveragefinancial statements, the factors that we believe may affect our advertising spendingfuture results and lower our order processing costs. We see unsettled economic conditions continuing to adverselyfinancial condition as well as information about how certain accounting principles and estimates affect several of the European markets we serve.consolidated financial statements. This discussion should be read in conjunction with the condensed consolidated financial statements included herein.
Results of Operations
Three Months Ended September 30, 20042005 Compared to Three Months Ended September 30, 20032004
Net sales for the three months ended September 30, 20042005 increased 13.6%6.7% to $460.3$488.5 million compared to $405.0$458.0 million in the year-ago quarter. Net sales in the third quarter of 2005 included approximately $147.6 million of internet-related sales, a 21.9% increase from $121.1 million of internet-related sales in the prior year’s third quarter. North American sales were $301.0$327.3 million, an increase of 15.7%9.5% from $260.1$299.0 million in the prior year. Sales increased in North America in both our computer and industrial products, led by increased e-commerce sales, which were up 17.5% from last year’s third quarter, reflecting strength in our consumer business. European sales increased 9.9%1.4%, to $159.3$161.2 million (representing 34.6%32.3% of worldwide sales) compared to $144.9$159.0 million (35.8%(34.7% of worldwide sales) in the year-ago quarter. Movements in foreign exchange rates unfavorably impacted the European sales comparison by approximately $0.5 million in the third quarter principally as a result of the impact of a weakening U.S. Dollar on the translation of our European financial statements.2005. Excluding the movements in foreign exchange rates, European sales would have been unchangedincreased 0.3% from the prior year. Sales as measured in local currencies, which had been declining in the first half of the year reflectingin each of the continuing difficult economic environmentEuropean markets we serve, began to show modest increases in certainsome of these markets in the third quarter. The increase in our North American sales resulted from sales growth in both our computer and industrial products groups. Sales of computer products were $281.5 million, an 8.2% increase from $260.1 million of sales in the prior year and was primarily a result of our European markets and its affect on demandsuccessful internet-based marketing focus. Sales of industrial products increased 17.9% to $45.8 million from corporate customers.$38.8 million in the prior year, continuing the trend in sales growth which began with the improved economic conditions in the United States last year.
Gross profit was $73.2$70.5 million compared to $67.1$71.2 million in the year-ago quarter, an increasea decrease of $6.1$0.8 million. The gross profit margin was 15.9%14.4% in the current quarter,period, compared to 16.6%15.6% in the year-ago quarter.period. The decline in the gross profit margin was due to competitive pricing pressures and lower unit selling prices, both in Europe and in North Americanthe computer products business and changes in the mix of products soldincreased warehouse costs for staff and supplies related to increased activity levels from a year ago.
Selling, general and administrative expenses for the quarter increased $1.6decreased $4.4 million, or 2.5%6.6%, to $66.4$62.0 million compared to $64.8$66.4 million in the third quarter of 2003.2004. This increasedecrease resulted primarily from increased dollar-denominated costsa $1.4 million decrease in Europe due to the impact of the weakening U.S. Dollar on the translation of our European financial statements. Savings resulting from previously completed workforce reductionsbad debt expense and a $2.0 million decrease in North America were offset by an unanticipated increase in professional fees and increased other operating expenses, including credit card fees related to increased sales volume.net advertising expense. Selling, general and administrative expenses as a percentage of net sales decreased to 14.4%12.7% compared to 16.0%14.5% in the year-ago quarter.
During the first quarter of 2005 we initiated plans to streamline and restructure the activities of our European computer businesses, resulting in the elimination of approximately 200 positions. We incurred $0.6 million of restructuring costs during the third quarter of 2004, we incurred $1.0 million of additional restructuring charges in the United States2005 associated with these actions for staff severance and Europe in connection with facility exit costs and workforce reductions.benefits for terminated employees.
As a result of the above factors, weWe had income from operations for the current quarter of $5.8$8.0 million compared to $3.6$3.8 million in the year-ago quarter. In North America, weWe had income from operations of $8.4$7.0 million in our North American operations in the current quarter compared to income from operations of $4.8$7.2 million last year. EuropeWe had a lossincome from operations in Europe of $2.6$1.0 million in the third quarter of 20042005, compared to a loss from operations of $1.2$3.4 million in the year-ago quarter.
Interest and other expense -— net consists principally of interest expense. Interest expense was $887,000$0.6 million in the third quarter of 20042005 and $638,000$0.9 million in 2003 as a result of higher average borrowings in Europe.2004. Interest income on invested funds increased slightly in 2004 because2005 as a result of more funds werecash available for investment.
Income tax expense was $2.4$2.9 million in the third quarter of 2004, an effective tax rate of 46.9%,2005 and $1.1$1.8 million in the year-ago quarter, anquarter. The effective tax rate of 36.8%. The effectiveincome tax rate for the third quarter of 20042005 was 42.5%, compared to 56.9% in the year ago period. The effective income tax rate was higher than the comparable periodin 2004 as a result of increases in the prior year due toprojected losses in tax jurisdictions for which no benefit is currently recognized, but was lower thanrecognized. Changes in the mix of U.S. and non-U.S. earnings over the balance of the year and changes in the valuation of deferred tax assets could have a significant impact on the effective tax rate for the first nine months of 2004 as it reflects a year-to-date adjustment to the rate used in the first half of the year.
As a result of the above, net income for the third quarter was $2.7$3.9 million, or $.08$.11 per basic and diluted share, compared to $1.9$1.3 million, or $.06$.04 per basic and $.05 per diluted share, in the third quarter of 2003.2004.
Nine Months Ended September 30, 20042005 Compared to Nine Months Ended September 30, 20032004
Net sales for the nine months ended September 30, 20042005 increased 12.8%11.4% to $1.38$1.53 billion compared to $1.22$1.38 billion in the year-ago period. North AmericanNet sales were $872.0 million, a 14.6% increase from last year’s $761.1 million. European sales increased 10.0% to $505 million forin the first nine months of 20042005 included approximately 446.5 million of internet-related sales, a 24.6% increase from $358.3 million of internet-related sales in the prior year. North American sales were $1.01 billion, an increase of 16.5% from $871.0 million in the prior year. European sales increased 2.6%, to $517.9 million (representing 36.7%33.8% of worldwide sales) compared to $459.2$504.8 million (representing 37.6%(36.7% of worldwide sales) in the year-ago nine-month period. The impact ofMovements in foreign exchange rates positively impacted the weakening U.S. Dollar on the translation of our European financial statements accounted for $53.3sales comparison by approximately $17.5 million of the increase.in 2005. Excluding the movements in foreign exchange rates, European sales would have decreased 1.6%3.5% from the prior year. The increaseSales as measured in North American sales resulted from increased saleslocal currencies in each of computer products to consumer customers, driven by increased internet purchases and increased salesthe European markets we serve decreased in our industrial products division. These were partially offset by2005 as a result of continuing weakness in demand for information technology products by corporatefrom business customers. EuropeanThe increase in our North American sales resulted from sales growth in both our computer and industrial products groups. Sales of computer products were lower$883.6 million, a 16.5% increase from $758.4 million of sales in local currencies asthe prior year and was primarily a result of continued weak marketour successful internet-based marketing focus. Sales of industrial products increased 16.4% to $131.1 million from $112.6 million in the prior year, continuing the trend in sales growth which began with the improved economic conditions in many of the local markets.United States last year.
Gross profit was $215.9$221.6 million or 15.7% of net sales, compared to $203.1$215.2 million or 16.6% of net sales, in the year-ago nine month period, an increase of $12.7$6.4 million. The gross profit margin was 14.5% in the current year, compared to 15.6% in the year-ago period. The decline in the gross profit margin was due to continued pricing pressure, increased customer discounting and a changepressures in the mix ofcomputer products sold.business and increased warehouse costs for staff and supplies related to increased activity levels from a year ago.
Selling, general and administrative expenses for the nine months increased $5.8$5.7 million, or 3.0%2.9%, to $201.8 million compared to $196.1 million for the first nine months of 2004. This increase resulted primarily from more than $2.8 million of increased costs in Europe due to the effects of changes in foreign exchange rates and $2.8 million of higher credit card processing fees related to the higher sales volume in 2005. We also had increased consulting fees related to the restatement of our 2004 results which were offset by reductions in other operating expenses. Selling, general and administrative expenses as a percentage of net sales, however, decreased to 13.2% compared to $190.314.3% in the year-ago period.
During the first quarter of 2005 we initiated plans to streamline and restructure the activities of our European computer businesses. We incurred $3.5 million of restructuring costs associated with these actions in the first nine months of 2003. This increase resulted from the impact of the weakening U.S. Dollar on the translation of our European costs. Decreases in selling, general and administrative expenses resulting from workforce reductions in the U. S. associated with the first quarter 2004 computer business streamlining plan described below were offset by an unanticipated increase in professional fees and increased other operating expenses, including credit card fees related to increased sales volume. As a percentage of sales, these expenses were 14.2% compared to 15.6% in the year-ago period.
In the first quarter of 2004 we implemented a plan to streamline the activities of our United States computer businesses’ back office and warehouse operations, resulting in the elimination of approximately 200 jobs. We incurred $3.7 million of restructuring costs associated with this plan, including $3.2 million2005 for staff severance and benefits for terminated employees and $0.5 million of non-cash costs for impairment of the carrying value of fixed assets. During the third quarter of 2004 we recorded $600,000 of additional costs related to facility exit costs for previously implemented plans to consolidate warehouse locations. We incurred $1.7 million of restructuring charges in Europe in connection with facility exit costs and workforce reductions during the first nine months of 2004, including a consolidation of United Kingdom sales offices in the first quarter of 2004, resulting in the elimination of 50 jobs.employees.
During the second quarter of 2003, we purchased the minority ownership of our Netherlands subsidiary pursuant to the terms of the original purchase agreement for $2.6 million. All of the purchase price was attributable to goodwill and, as a result of an impairment analysis, was written off in accordance with SFAS 142.
The CompanyWe had income from operations for the currentfirst nine month periodmonths of $13.72005 of $16.3 million compared to $11.4$13.1 million in the year-ago nine month period. The CompanyWe had income from operations of $15.4$22.8 million in itsour North American operations in the current nine month periodyear compared to $11.9income from operations of $16.9 million last year. We had a loss from operations in Europe of $1.7$6.5 million in the first nine months of 2005, compared to a loss from operations of $0.5$3.8 million in the year-ago period.
Interest and other expense -— net consists principally of interest expense. Interest expense was $2.3$1.4 million in the first nine months of 2004 and $1.7 million in 2003 as a result of higher average borrowings in Europe.2005, which was unchanged from 2004. Interest income on invested funds increased slightly in 2005 as a result of less funds available for investment.
Income tax expense was $0.5 million in both years.
The income tax provision was $6.2$5.9 million for the first nine months of 2004, an2005 and $6.2 million in the year-ago period. The effective income tax rate of 51.6%for 2005 was 42.5%, compared to a $5.3 million tax provision, an55.0% in the year ago period. The effective income tax rate of 50.9%, for the comparable period in 2003. The high effective tax ratewas higher in 2004 was due toas a result of increases in the projected losses in tax jurisdictions for which no benefit is currently recognized. TheChanges in the mix of U.S. and non-U.S. earnings over the balance of the year and changes in the valuation of deferred tax assets could have a significant impact on the effective tax rate in 2003 was affected by non-deductible costs incurred and losses in tax jurisdictions for which no benefit is recognized.the year.
As a result of the above, net income for the first nine months of 20042005 was $5.8$8.0 million, or $.17$.23 per basic and $.16$.22 per diluted share, compared to $5.1 million, or $.15 per basic and $.14 per diluted share, in the year ago period.first nine months of 2004.
Liquidity and Capital Resources
Our primary liquidity needs are to support working capital requirements in our business and to fund capital expenditures. We rely principally upon operating cash flow and borrowings under our credit facilities to meet these needs. We believe that cash flow available from these sources will be sufficient to meet our working capital requirements, projected capital expenditures and interest and debt repayments in the foreseeable future.
Our cash balance increased to $57.3working capital was $155.9 million during the nine months endedat September 30, 20042005, an increase of $7.9 million from $38.7$148.0 million at the end of 2003. Net cash provided by operating activities was $29.5 million in 2004, compared with $0.4 million in 2003. The increase in cash provided by operations in 2004 resulted from changes in our working capital accounts, which provided $11.3 million in cash compared to using $19.1 million of cash in 2003. The improvement resulted primarily from a $25.0 million increase in accounts payable, accrued expenses and other current liabilities in the first nine months of 2004, compared to a $15.7 million decrease for the same period of the prior year. Cash generated from net income adjusted by other non-cash items provided $18.2 million in 2004, compared to $19.5 million provided by these items in 2003.
Our working capital was $162 million at September 30, 2004, an increase of $13 million from $149 million at the end of 2003.2004. This was due principally to a $19$15.2 million increase in cash and a $1$21.8 million increasedecrease in accounts payable and accrued expenses, offset by a $6.7 million decrease in accounts receivable, a $4an $18.3 million increasedecrease in inventories, an $8a $3.0 million increasedecrease in prepaid expenses and other current assets and a $6 million decrease in short-term debt, offset by a $16$1.1 million increase in accounts payable and a $9 million increase in accrued expenses and other current liabilities.short-term borrowings. Our inventories increased in anticipationslightly from the end of traditionally strong fourththe prior quarter, sales, which are heavily influenced by individual consumer purchases.but were still considerably lower than at the beginning of the year. Inventory turnover decreased slightly from 10 to 9.7. Future accounts receivable and inventory balances will continue to fluctuate with changes in sales volume and the mix of our net sales between consumer and business customers.
Our cash balance increased to $51.5 million during the nine months ended September 30, 2005 from $36.3 million at the end of 2004. Net cash provided by operating activities was $15.3 million for the first nine months of 2005, compared to $29.8 million in the same period of 2004. The decrease in cash provided by operations in 2005 resulted from changes in our working capital accounts, which used $2.9 million in cash compared to providing $12.1 million of cash in 2004. The improvement resulted primarily from a $12.5 million decrease in accounts payable, accrued expenses and other current liabilities in the first nine months of 2005, compared to a $23.5 million increase for the same period of the prior year. Cash generated from net income adjusted by other non-cash items provided $18.1 million in 2005, compared to $17.7 million provided by these items in 2004.
We maintain our cash and cash equivalents primarily in money market funds or their equivalent. As of SeptemberJune 30, 2004,2005, all of our investments mature in less than three months. Accordingly, we do not believe that our investments have significant exposure to interest rate risk.
In 2004 $4.6We used $4.2 million of cash was usedin 2005 and $4.6 million in 2004 in investing activities, principally for the purchase of property, plant and equipment. Capital expenditures in 2004both periods consisted primarily of upgrades and enhancements to our information and communications systems hardware and facilities costs for the opening of several new retail outlet stores. Cash of $9.1 million was used in investing activities in 2003, including $6.5 million for capital expenditures and $2.6 million for the acquisition of the minority interest in our Netherlands subsidiary.
Net cash of $7.0$3.3 million was used inprovided by financing activities in 2004.2005. Cash of $6.1$3.0 million was used to repayprovided by short-term borrowings under our European credit facilities. We used cash of $1.3$0.5 million for payments under long-term borrowing and capital lease agreements. Exercises of stock options provided $412,000$0.7 million of cash in 2004.2005. Cash of $4.6$7.1 million was used byin financing activities in 2003,2004, including $7.2$6.1 million used to repay short and long-term obligations, $1.3 million provided by the issuanceborrowings under our European lines of a capital leasecredit and $1.3 million to repay long-term obligations. This was offset by $0.3 provided by the exerciseexercises of stock options.
Under our $70 million United States secured revolving credit agreement, which expiresthen was $70 million and expired on March 31, 2005,September 30, 2006, availability as of September 30, 20042005 was $60.4$62.8 million. There were outstanding letters of credit of $10.1$7.7 million and there were no outstanding advances as of SeptemberJune 30, 2004.2005. The agreement was amended in October 2005 to increase the amount available to $120 million, extend the maturity date to October 2010 and provide for United States and United Kingdom borrowings. Under our £15 million ($27.126.5 million at the September 30, 20042005 exchange rate) multi-currency United Kingdom credit facility, which iswas available to our United Kingdom subsidiaries, at September 30, 20042005 there were £4.4£8.1 million ($8.014.3 million) of borrowings outstanding with interest payable at a rate of 5.87%. The facility doesdid not have a termination date, but may be canceledwas cancelable by either party on six months notice. Borrowings under the facility arewere secured by certain assets of our United Kingdom subsidiaries. The United Kingdom facility was terminated in October 2005 and replaced by expanding the United States credit facility to $120 million.
Under our Netherlands €5 million ($6.26.0 million at the September 30, 20042005 exchange rate) credit facility, at September 30, 20042005 there were €4.1€2.5 million ($5.13.0 million) of borrowings outstanding under this line with interest payable at a rate of 5.0%. per annum. This facility expires in November 2005.
We have begun discussions with our lenders to replace the current United States and United Kingdom credit facilities with a single multi-currency borrowing facility. We expect that a new agreement will be completed in the next three months.2006.
We also have certain obligations with various parties that include commitments to make future payments. Our principal commitments at September 30, 20042005 consisted of repayments of borrowings under our credit agreements and long-term borrowings and payments under operating leases for certain of our real property and equipment.
Off-balance Sheet Arrangements
The Company has not created, and is not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating the Company’s business. The Company does not have any arrangements or relationships with entities that are not consolidated into the financial statements that are reasonably likely to materially affect the Company’s liquidity or the availability of capital resources.
Factors That May Affect Future Results and Financial Condition
There are a number of factors and variables that affect our results of operations and financial condition. Following is a description of some of the important factors that may affect future results.
Other factors that could contribute to or cause such differences include, but are not limited to, unanticipated developments in any one or more of the following areas: (i) the effect on us of volatility in the price of paper and periodic increases in postage rates, (ii) the operation of our management information systems, (iii) significant changes in the computer products retail industry, especially relating to the distribution and sale of such products, (iv) timely availability of existing and new products, (v) risks involved with e-commerce, including possible loss of business and customer dissatisfaction if outages or other computer-related problems should preclude customer access to us, (vi) risks associated with delivery of merchandise to customers by utilizing common delivery services such as the United States Postal Service and United Parcel Service, including possible strikes and contamination, (vii) borrowing costs or availability, (viii) pending or threatened litigation and investigations and (ix) the availability of key personnel, as well as other risk factors which may be detailed from time to time in our Securities and Exchange Commission filings.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and revenues and expenses during the period. Significant accounting policies employed by the Company, including the use of estimates, were presented in the Notes to Consolidated Financial Statements of the Company's 2003Company’s amended 2004 Annual Report on Form 10-K.10-K/A.
Critical accounting policies are those that are most important to the presentation of our financial condition and results of operations, require management'smanagement’s most difficult, subjective and complex judgments, and involve uncertainties. The accounting policies that have been identified as critical to our business operations and understanding the results of operations pertain to revenue recognition, net accounts receivable, inventories, long-lived assets, income taxes and restructuring charges and accruals. The application of each of these critical accounting policies and estimates was discussed in the Company'sCompany’s amended Annual Report on Form 10-K10-K/A for the year ended December 31, 2003.2004. There have been no significant changes in the application of critical accounting policies or estimates during 2004.2005. Management believes that full consideration has been given to all relevant circumstances that we may be subject to, and the condensed consolidated financial statements of the Company accurately reflect management’s best estimate of the consolidated results of operations, financial position and cash flows of the Company for the periods presented. Because of the uncertainty in these estimates, actual results could differ from estimates used in applying the critical accounting policies. We are not aware of any reasonably likely events or circumstances which would result in different amounts being reported that would materially affect its financial condition or results of operations.
Recent Accounting Developments
In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.” SFAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. SFAS 151 also requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facility. The provisions of SFAS 151 will be effective for fiscal years beginning after June 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal 2006. The Company does not expect that the adoption will have a material impact on the Company’s consolidated financial position or results of operations.
In December 2004, the FASB issued SFAS 123 (revised 2004) (SFAS 123R), “Share-Based Payment.” SFAS 123R replaced SFAS 123, Accounting for Stock-Based Compensation, and superseded Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees. SFAS 123R requires the recognition of compensation cost relating to share-based payment transactions, including employee stock options, in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS 123R provides alternative methods of adoption which include prospective application and a modified retroactive application. SFAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow as prescribed under current accounting rules. The Company is required to adopt the provisions of SFAS 123R effective as of the beginning of its first quarter in 2006. The Company is evaluating the available alternatives of adoption of SFAS 123R. The Company currently accounts for share-based payments using APB Opinion 25‘s intrinsic value method and recognizes no compensation expense for employee stock options as permitted under SFAS 123. See “Stock-based Compensation” above for the effect on reported net income if we had accounted for our stock-based compensation plans using the fair value recognition provisions of SFAS 123. The actual effects of adopting SFAS 123R will depend on numerous factors, including the amounts of share-based payments granted in the future, the valuation model we use and estimated forfeiture rates. The Company has not made any modifications to its stock-based compensation plans as a result of the issuance of SFAS 123R. The Company believes the adoption of SFAS 123R will not have a material effect on its consolidated financial statements.
In March 2005, the Securities and Exchange Commission (“SEC”) released SEC Staff Accounting Bulletin (“SAB”) 107, “Share-Based Payment.” SAB 107 provides the SEC staff’s position regarding the application of SFAS No. 123R and certain SEC rules and regulations, and also provides the staff’s views regarding the valuation of share-based payments for public companies. The Company will adopt SAB 107 in connection with its adoption of SFAS 123R. The Company is currently reviewing the effects, if any, that the application of SAB 107 will have on the Company’s consolidated financial position and results of operations.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which replaces Accounting Principles Board Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements-An Amendment of APB Opinion No. 28.” SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition of a cumulative effect adjustment within net income of the period of the change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also applies to changes required by an accounting pronouncement in the rare case that the pronouncement does not contain specific transition provisions. This statement also carries forward the guidance from APB No. 20 regarding the correction of an error and changes in accounting estimates. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not believe the adoption of SFAS 154 will have a material effect on its consolidated financial position, results of operations or cash flows.
In June 2005, the FASB issued FSP FAS 143-1, “Accounting for Electronic Equipment Waste Obligations” (“FSP FAS 143-1”), to address the accounting for obligations associated with a European Union’s Directive on Waste Electrical and Electronic Equipment (the “Directive”). The Directive, enacted in 2003, requires EU-member countries to adopt legislation to regulate the collection, treatment, recovery and environmentally sound disposal of electrical and electronic waste equipment. The Directive distinguishes between products put on the market after August 13, 2005 (“new waste”) and products put on the market on or before that date (“historical waste”). FSP FAS 143-1 addresses the accounting for historical waste only and will be applied the later of the first reporting period ending after June 8, 2005 or the date of the adoption of the law by the applicable EU-member country. The adoption of FSP FAS 143-1 did not have a material impact on the Company’s consolidated financial position or results of operations for the EU-member countries which have adopted the law.
In October 2005, the FASB issued FSP FAS 13-1, “Accounting for Rental Costs Incurred During a Construction Period” (“FSP FAS 13-1”), which requires the expensing of rental costs associated with ground or building operating leases that are incurred during the construction period. FSP FAS 13-1 is effective in the first reporting period beginning after December 15, 2005. The Company does not expect that this pronouncement will have a material effect on its financial position or results of operations.
Item 3.Quantitative and Qualitative Disclosure About Market RiskRisk..
We are exposed to market risks, which include changes in U.S. and international interest rates as well as changes in currency exchange rates (principally Pounds Sterling, Euros and Canadian dollars) as measured against the U.S. dollar and each other.
We have limited involvement with derivativeThe translation of the financial instruments and do not use them for trading purposes.statements of our operations outside of the United States is impacted by movements in foreign currency exchange rates. Changes in currency exchange rates as measured against the U.S. dollar may positively or negatively affect sales, gross margins, operating expenses and retained earnings as expressed in U.S. dollars. We have limited involvement with derivative financial instruments and do not use them for trading purposes. We may enter into foreign currency options or forward exchange contracts aimed at limiting in part the impact of certain currency fluctuations, but as of September 30, 20042005 we had no outstanding forward exchange contracts.
Our exposure to market risk for changes in interest rates relates primarily to our variable rate debt. In connection withOur variable rate debt includes short-term borrowings under our European credit facilities and our United Kingdom term loan agreement, effective April 30, 2002 we entered into an interest rate collar agreement to reduce our exposure to market rate fluctuations. Atloan. As of September 30, 20042005, the notional amountbalance outstanding on our variable rate debt was approximately $25.5 million. Based on our market sensitive instruments as of the interest rate collar was £5.3million ($9.5 million at the September 30, 2004 exchange rate) with an2005, a hypothetical change in average interest rate caprates of 6.0% andone percentage point is not expected to have a floormaterial effect on our financial position, results of 4.5%. The interest rate collar expires on April 30, 2005.operations or cash flows for the fiscal year.
Item 4.Controls and Procedures
Disclosure Controls and Procedures
The Company hasestablishes and maintains disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed by the Company in the reports it files under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls are also designed to provide reasonable assurance that such information is accumulated and reported to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosure.
Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in control systems, misstatements due to error or fraud may occur and not be detected. These limitations include the circumstances that breakdowns can occur as a result of error or mistake, the exercise of judgment by individuals or that controls can be circumvented by acts of misconduct. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including the Chairman and Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and the operation of the Company’sour disclosure controls and procedures. procedures pursuant to Exchange Act Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934.
Based on thattheir evaluation, as of September 30, 2005, the Company’s Chairman and Chief Executive Officer and the Chief Financial Officer have concluded that as of September 30, 2004, the Company’sour disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company(as defined in the reports filed or submitted by itRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, isamended) were not effective to ensure that the information required to be disclosed by us in this quarterly report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and formsforms. This conclusion is based on our identification of three material weaknesses in our internal controls over financial reporting as of September 30, 2005. The material weaknesses are:
As a result of this determination and as part of the work undertaken in connection with this report, we have applied compensating procedures and processes as necessary to ensure the reliability of our financial reporting. Accordingly, management believes, based on its knowledge, that (i) this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading with respect to the period covered by this report and (ii) the financial statements, and other financial information included in this report, fairly reflect the form and substance of transactions and fairly present in all material respects our financial condition, results of operations and cash flows as at, and for, the periods presented in this report.
Material Weaknesses Reported for the Years Ended December 31, 2004 and December 31, 2003
As reported in our amended Annual Reports on Form 10-K/A for the years ended December 31, 2004 and December 31, 2003, management was unable to conclude that the Company’s internal controls over financial reporting were then effective, as a result of material weaknesses resulting from the ineffectiveness of internal controls over inventory in our United Kingdom and Tiger Direct subsidiaries. We are continuing to evaluate and test the steps taken to improve the effectiveness of our internal controls over financial reporting and we implemented the following changes to further address our material weaknesses:
During 2005, beginning in the first quarter, we implemented a number of remediation measures to address the material weakness related to inventory at our United Kingdom subsidiary. These measures included:
During 2005, beginning in the third quarter, we also implemented remediation measures to address the material weakness related to inventory at our Tiger Direct subsidiary. These measures included:
While progress is being made to remediate the material weaknesses identified, we are continuing to monitor these processes to further improve our procedures as may be necessary.
Deloitte & Touche LLP, our former independent registered public accounting firm, issued a material weakness letter to the Company which addressed both the weaknesses at the Company’s United Kingdom subsidiary and inadequate oversight and control activities on the part of senior management of the Company over its remote subsidiaries. These matters were discussed in such reports is assembleddetail among management, the audit committee and reportedDeloitte & Touche.
Section 404 of the Sarbanes-Oxley Act
We are not yet subject to the Company’s management, includinginternal controls certification and attestation requirements of Section 404 of the Chairman and Chief Executive Officer and the Chief Financial Officer,Sarbanes-Oxley Act of 2002 because we are not an accelerated filer. Based on SEC implementing regulations in effect as appropriate to allow timely decisions regarding required disclosures.
The Company previously disclosed in its Form 10-Q for the quarter endedof June 30, 20042006, at the end of fiscal year 2007 Section 404 of the Sarbanes-Oxley Act of 2002 will require that management identified and reported toprovide an assessment of the Audit Committeeeffectiveness of the Company’s Board of Directors certain matters involving internal control deficiencies. These includedover financial reporting and that the Company’s independent registered public accounting firm will be required to audit that assessment.
We are continuing to work to achieve compliance with the requirements of Section 404. We have dedicated substantial time and resources to documentation and review of our procedures, including the hiring of additional internal audit staff in both the United States and in Europe. We will also evaluate the need to engage outside consultants to assist us. We have not completed this process or its assessment, due to the complexities of our decentralized structure and the number of accounting systems in use. We have not completed our assessment of our internal control deficiencies arising fromover financial reporting. In addition to the consolidationtwo material weaknesses as of its U.S. computer businesses with separate accounting systems toMarch 31, 2005 discussed under the caption “Disclosure Controls and Procedures,” we have identified a single accounting system. Thesenumber of internal control significant deficiencies, affectedincluding controls in the information technology area, that may affect the timeliness and accuracy of recording certain transactions and included the lack of formal procedures to reconcile intercompany accounts and transactions. We have addressed these deficiencies with the hiring and training of additional accounting staff.
We also identified deficiencies related to policies and procedures and systems interfaces and are undertaking measures to remediate them. Management and the Audit Committee believe that those internal control deficiencies, as mitigated by substantial manual procedures and account reconciliations,which, individually or in the aggregate, didcould become material weaknesses in future periods if not remediated. While the Company does not believe that the following are currently material weaknesses, they are designated as significant deficiencies as of September 30, 2005:
We have a significant amount of work to do to remediate the items we have identified. In the course of completing our evaluation and testing we may identify further deficiencies and weaknesses that will need to be addressed and will require remediation. We may not be able to correct all such internal control deficiencies in a timely manner and may find that a material effectweakness or weaknesses continues to exist. As a result, management may not be able to issue an unqualified opinion on the financial statementseffectiveness of the Company for the period ended September 30, 2004.Company’s internal control over financial reporting as of December 31, 2007, if required.
Other than arising from the review described above, there have been noChanges in Internal Controls Over Financial Reporting
Our management is not aware of any changes in internal control over financial reporting other than those described above that occurred during the period covered by this reportquarter ended September 30, 2005 that have materially affected, or arewere reasonably likely to materially affect, the Company’sour internal control over financial reporting.
PART II -— OTHER INFORMATION
Item 6.1.Exhibits and Reports on Form 8-KLegal Proceedings
| Beginning on May 24, 2005, three shareholder derivative lawsuits were filed, one in the United States District Court for the Eastern District of New York and two in the Supreme Court of New York, County of Nassau, against various officers and directors of the Company and naming the Company as a nominal defendant in connection with the Company’s restatements of its fiscal year 2003 and 2004 financial statements. The defendants and the Company denied all of the allegations of wrongdoing contained in the complaints. On May 16, 2006, the parties entered into a stipulation of settlement of this case. By order dated July 6, 2006 the United States District Court for the Eastern District of New York approved the settlement and dismissed the federal complaint with prejudice. Pursuant to the settlement the defendants are released from liability and the Company will adopt certain corporate governance principles including the appointment of a lead independent director to, among other things, assist the Board of Directors in assuring compliance with and implementation of the Company's corporate governance jpolicies and pay $300,000 of the legal fees of the plaintiffs. The plaintiffs were directed by the U.S. District Court to move to dismiss the state court actions. |
(a) Exhibits.Item 6.Exhibits
| 31 | Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32 | Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
(b) Reports on Form 8-K.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: August 29, 2006 | SYSTEMAX INC. |
By:/s/ RICHARD LEEDS Richard Leeds Chairman and Chief Executive Officer By:/s/ STEVEN GOLDSCHEIN Steven Goldschein Senior Vice President and Chief Financial Officer |