Systemax Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1.
Basis of Presentation
The accompanying
condensed consolidated financial statements of the Company and its wholly-owned
subsidiaries are unaudited and have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim
financial information and the rules and regulations of the Securities and
Exchange Commission. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
of America are not required in these interim financial statements and have been
condensed or omitted. All significant intercompany accounts and transactions
have been eliminated in consolidation. Certain prior year amounts have been
reclassified to conform to current year presentation.
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, 2007 and the results of operations for the three and nine
month periods ended September 30, 2007 and 2006, cash flows for the nine month periods
ended September 30, 2007 and 2006 and changes in shareholders equity for the
nine month period ended September 30, 2007.
The December 31, 2006 condensed consolidated balance sheet has been
derived from the audited consolidated financial statements included in the
Companys Annual Report on Form 10-K for the year ended December 31, 2006.
These condensed consolidated financial statements
should be read in conjunction with the Companys audited consolidated financial
statements as of December 31, 2006 and for the year then ended included in the
Companys Annual Report on Form 10-K for the fiscal year ended December 31,
2006. The results for the three and nine
months ended September 30, 2007 are not necessarily indicative of the results
for an entire year.
Adoption of New Accounting Standard
Effective January 1, 2007
the Company adopted the provisions of FASB Interpretation 48, Accounting for
Uncertainty in Income Taxes (FIN 48).
FIN 48 clarifies the accounting and reporting for uncertainties in
income tax law. This interpretation
prescribes a comprehensive model for the financial statement recognition,
measurement, presentation and disclosure of uncertain tax positions taken or
expected to be taken in income tax returns. For those benefits to be
recognized, a tax position must be more-likely-than-not to be sustained upon
examination by taxing authorities. At January 1, 2007, the Company had a
liability for unrecognized tax benefits of $3,379,000 (including interest and
penalties of $731,000) of which $284,000 was charged to retained earnings at
January 1, 2007. Of this total, $2,586,000 (net of the federal benefit on state
issues) represents the amount of unrecognized tax benefits that, if recognized,
would favorably affect the effective income tax rate in any future periods.
The Company or one of its
subsidiaries file U.S. federal income tax returns and tax returns in various
state and foreign jurisdictions in Canada and Western Europe. The Companys U.S. federal income tax returns
have been examined by the Treasury Department through 2001. State and local tax returns have been
examined through various dates from 2001 to 2005 with ongoing tax examinations
pending in several states. Included in
the Companys FIN 48 liability is a current liability of $2,264,000 for the
expected taxes and interest and penalties relating to pending state tax
examinations involving disputed allocations of income; no issues have been
raised to date with respect to the other pending state tax examinations. The
Company has classified this as a current liability because payment of cash is
anticipated within one year. The income tax returns of the Companys principal
foreign subsidiaries have been audited by local taxing authorities for years
ended in 2001 through 2004.
With the exception of the
current liability of $2,264,000, the Companys remaining tax liabilities and
interest with respect to unrecognized tax benefits have been reclassified to
other non-current liabilities on the balance sheet because payment of cash is
not anticipated within one year. This
amount at January 1, 2007 aggregates to approximately $1,115,000, including
$305,000 for interest and penalties. The
Companys continuing practice is to record interest and penalties related to
tax positions in income tax expense in its consolidated statement of
operations.
During the nine months
ended September 30, 2007, the Company resolved a state tax increase issue by
paying an assessment of approximately $1,901,000 (including $169,000 in
interest) to a state taxing authority. As of September 30, 2007 the Companys
liability for unrecognized tax benefits was approximately $1,539,000 (including
interest and penalties of approximately $624,000).
8
The impact of FIN 48 on the results for the three
months ended September 30, 2007 was not material.
Other than the aforementioned FIN 48 adoption, since
the date of the Companys annual report on Form 10-K there have been no
material changes to the Companys significant accounting policies.
2. Stock-based Compensation Plans
Pre-tax stock-based employee compensation
expense for the nine months ended September 30, 2007 and 2006 was approximately
$2,353,000 and $1,228,000 respectively.
3.
Net Income per Common Share
Net income per common share - basic was calculated
based upon the weighted average number of common shares outstanding during the
respective periods presented. Net income
per common share - diluted was calculated based upon the weighted average number
of common shares outstanding and included the equivalent shares for dilutive
options outstanding during the respective periods. The dilutive effect of
outstanding options issued by the Company is reflected in net income per share
- diluted using the treasury stock method. Under the treasury stock method,
options will only have a dilutive effect when the average market price of
common stock during the period exceeds the exercise price of the options. The
weighted average number of stock options outstanding excluded from the
computation of diluted earnings per share was 100,000 and 23,000 shares for the
three months ended September 30, 2007 and 2006 and zero and 53,000 shares for
the nine months ended September 30, 2007 and 2006, respectively, due to their antidilutive
effect.
4. Comprehensive Income
Comprehensive income consists of net income and
foreign currency translation adjustments, net of tax, and is included in the
Condensed Consolidated Statement of Shareholders Equity. For the three month
periods ended September 30, 2007 and 2006, comprehensive income was $20,847,000
and $12,218,000, respectively. For the nine month periods ended September 30,
2007 and 2006, comprehensive income was $50,831,000 and $41,351,000,
respectively.
5. Credit Facilities
The Company maintains a $120 million (which may be
increased by up to $30 million, subject to certain conditions) secured
revolving credit agreement with a group of financial institutions which
provides for borrowings in the United States and United Kingdom. The borrowings
are secured by all of the Companys domestic and United Kingdom accounts
receivable, the domestic inventories of the Company, general intangibles, the
Companys shares of stock in its domestic subsidiaries and the Companys United
Kingdom headquarters building. The credit facility expires and the outstanding
borrowings thereunder are due on October 26, 2010. The revolving credit
agreement contains certain financial and other covenants, including maintaining
a minimum level of availability and restrictions on capital expenditures and
payments of dividends. The Company was in compliance with all of the covenants
as of September 30, 2007. As of September 30, 2007, eligible collateral under
the agreement was $120 million and total availability was $110.2 million. There
were outstanding letters of credit of $9.8 million, and there were no
outstanding advances, as of September 30, 2007.
The Companys Netherlands
subsidiary maintains a 5.0 million ($7.1 million at the September 30, 2007
exchange rate) credit facility with a local financial institution. At September
30, 2007 there were no borrowings outstanding. Borrowings under the facility
are secured by the subsidiarys accounts receivable and are subject to a
borrowing base limitation of 85% of the eligible accounts. The facility expires
in September 2008.
9
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 years ended
December 31, 2005 and 2004, management approved and implemented restructuring
actions which included workforce reductions and facility consolidations.
The following
table summarizes the components of the accrued restructuring charges and the
movements within these components during the nine months ended September 30,
2007 (in thousands).
|
|
Nine months ended
September 30, 2007
|
|
Balance,
beginning of year
|
|
$
|
89
|
|
Amounts paid
|
|
(89
|
)
|
Balance, end of
period
|
|
$
|
|
|
7.
Product Warranties
Provisions for
estimated future expenses relating to product warranties for the Companys
assembled personal computers are recorded as cost of sales when revenue is
recognized. Liability estimates are determined based on management judgment
considering such factors as the number of units sold, historical and
anticipated rates of warranty claims and the likely current cost of corrective
action. The changes in accrued product
warranties were as follows (in thousands):
|
|
Nine months ended
September 30, 2007
|
|
Balance,
beginning of year
|
|
$
|
1,061
|
|
Charged to
expense
|
|
1,066
|
|
Deductions
|
|
(1,162
|
)
|
Balance, end of
period
|
|
$
|
965
|
|
8.
Segment Information
The Company operates and is internally managed in
three operating segments- Technology Products, Industrial Products and Hosted
Software. Our Technology Products segment sales include computer, computer
supplies and consumer electronics. We assemble PCs and sell them under the
trademarks
Systemax
and
Ultra
.
In addition, we market and sell computers, computer supplies and consumer
electronics manufactured by other leading companies. Our Industrial Products
segment sells a wide array of material handling equipment, storage equipment,
and consumable industrial products. Our Hosted Software segment participates in
the emerging market for on-demand, web-based business software applications
through the marketing of our PCS Profitability Suite
of hosted software.
The Companys chief operating decision-maker is its
Chief Executive Officer. The Company evaluates segment performance based on
revenues, operating income 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 consolidated
basis only. The accounting policies of each of the segments are the same as
those of the Company.
10
Financial information relating to the Companys
operations by reportable segment was as follows (in thousands):
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
September
30
|
|
September
30
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Net sales:
|
|
|
|
|
|
|
|
|
|
Technology
products
|
|
$
|
625,683
|
|
$
|
522,661
|
|
$
|
1,840,922
|
|
$
|
1,550,096
|
|
Industrial
products
|
|
61,523
|
|
52,351
|
|
169,232
|
|
147,006
|
|
Hosted software
|
|
111
|
|
29
|
|
387
|
|
89
|
|
Consolidated
|
|
$
|
687,317
|
|
$
|
575,041
|
|
$
|
2,010,541
|
|
$
|
1,697,191
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
(loss):
|
|
|
|
|
|
|
|
|
|
Technology
products
|
|
$
|
23,731
|
|
$
|
17,281
|
|
$
|
63,629
|
|
$
|
48,145
|
|
Industrial
products
|
|
6,592
|
|
4,543
|
|
16,759
|
|
9,619
|
|
Hosted software
|
|
(5,308
|
)
|
(2,268
|
)
|
(10,983
|
)
|
(5,922
|
)
|
Corporate and
other expenses
|
|
791
|
|
(391
|
)
|
(1,993
|
)
|
(1,225
|
)
|
Consolidated
|
|
$
|
25,806
|
|
$
|
19,165
|
|
$
|
67,412
|
|
$
|
50,617
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial information relating to the Companys
operations by geographic area was as follows (in thousands):
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
September
30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Net sales:
|
|
|
|
|
|
|
|
|
|
United States:
|
|
|
|
|
|
|
|
|
|
Technology
products
|
|
$
|
356,642
|
|
$
|
309,773
|
|
$
|
1,045,283
|
|
$
|
920,845
|
|
Industrial
products
|
|
61,523
|
|
52,351
|
|
169,232
|
|
147,006
|
|
Hosted software
|
|
111
|
|
29
|
|
387
|
|
89
|
|
United States
total
|
|
418,276
|
|
362,153
|
|
1,214,902
|
|
1,067,940
|
|
Other North
America
|
|
41,191
|
|
33,388
|
|
116,033
|
|
94,373
|
|
North America
total
|
|
459,467
|
|
395,541
|
|
1,330,935
|
|
1,162,313
|
|
Europe
|
|
227,850
|
|
179,500
|
|
679,606
|
|
534,878
|
|
Consolidated
|
|
$
|
687,317
|
|
$
|
575,041
|
|
$
|
2,010,541
|
|
$
|
1,697,191
|
|
Revenues are attributed to countries based on the location of the
selling subsidiary.
9. Recent Accounting Pronouncements
In September 2006, the
Financial Accounting Standards Board (FASB) issued FASB Statement No. 157 Fair
Value Measurements which is effective for fiscal years beginning after
November 15, 2007.
This
statement was issued to increase consistency and comparability in fair value
measurements and for expanded disclosures about fair value measurements. The
Company is currently evaluating the potential impact, if any, of this pronouncement.
In February 2007, the
Financial Accounting Standards Board (FASB) issued FASB Statement No. 159 The
Fair Value Option for Financial Assets and Financial Liabilities (including an
amendment of FASB Statement No. 115) which is
effective for fiscal years beginning after November
15, 2007. This interpretation was issued to improve financial reporting by
providing entities with the opportunity to mitigate volatility in reported
earnings caused by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions. The Company is currently
evaluating the potential impact, if any, of this pronouncement.
11
Item 2.
Managements Discussion and Analysis of
Financial Condition and Results of Operations.
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 Companys
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 Companys
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. Statements in this report, particularly in Item
2. Managements Discussion and Analysis of Financial Condition and Results of
Operations and the Notes to Condensed Consolidated Financial Statements,
describe certain factors, 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.
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 Companys 2006 Annual Report on Form
10-K.
Critical accounting policies are those that are most important to the
presentation of our financial condition and results of operations, require
managements 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, accounts receivable and allowance for doubtful accounts,
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 Item 7 of the Companys Annual Report on Form 10-K
for the year ended December 31, 2006. There have been no significant changes in
the application of critical accounting policies or estimates during 2007, with
the exception of any tax estimates or adjustments related to the adoption of
FIN 48. 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 managements
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.
12
Overview
We are a direct marketer of brand name and private label products. Our
operations are organized in three primary reportable segments Technology
Products, Industrial Products and Hosted Software. Our Technology Products
segment markets personal desktop computers, notebook computers and computer
related products in North America and Europe.
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,
computer supplies and consumer electronics manufactured by other leading
companies. 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
sizable revenues and have incurred considerable losses to date. For the nine
months ended September 30, 2007, Technology Products account for 92% of our net
sales, and, as a result, we are dependent on the general demand for such
products. The Technology Products segment has historically experienced seasonal
fluctuations in sales, with the first and fourth calendar quarters experiencing
higher product demand than the second and third quarters.
The market for Technology 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 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 inventory 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 fulfillment.
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 over the past several
years. Our restructuring actions and other cost savings measures implemented
over the last several years resulted in reducing our consolidated selling,
general and administrative expenses. We will continue to monitor 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 financial statements, the factors that we believe may affect
our future results and financial condition as well as information about how
certain accounting principles and estimates affect the consolidated financial
statements. This discussion should be read in conjunction with the condensed
consolidated financial statements included herein.
13
Results of Operations
Three and Nine Months Ended September 30, 2007 compared to the Three
and Nine Months Ended September 30, 2006
Key Performance Indicators (in thousands):
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2007
|
|
2006
|
|
% Change
|
|
2007
|
|
2006
|
|
% Change
|
|
Net
sales by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Technology
products
|
|
$
|
625,683
|
|
$
|
522,661
|
|
19.7
|
%
|
$
|
1,840,922
|
|
$
|
1,550,096
|
|
18.8
|
%
|
Industrial
products
|
|
61,523
|
|
52,351
|
|
17.5
|
%
|
169,232
|
|
147,006
|
|
15.1
|
%
|
Hosted software
|
|
111
|
|
29
|
|
282.8
|
%
|
387
|
|
89
|
|
334.8
|
%
|
Total net sales
|
|
$
|
687,317
|
|
$
|
575,041
|
|
19.5
|
%
|
$
|
2,010,541
|
|
$
|
1,697,191
|
|
18.5
|
%
|
Net
sales by geography:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North America
|
|
$
|
459,467
|
|
$
|
395,541
|
|
16.2
|
%
|
$
|
1,330,935
|
|
$
|
1,162,313
|
|
14.5
|
%
|
Europe
|
|
227,850
|
|
179,500
|
|
26.9
|
%
|
679,606
|
|
534,878
|
|
27.1
|
%
|
Total net sales
|
|
$
|
687,317
|
|
$
|
575,041
|
|
19.5
|
%
|
$
|
2,010,541
|
|
$
|
1,697,191
|
|
18.5
|
%
|
Gross
margin
|
|
16.1
|
%
|
15.9
|
%
|
.2
|
%
|
15.3
|
%
|
15.3
|
%
|
|
%
|
Selling, general
and administrative costs
|
|
$
|
84,847
|
|
$
|
72,349
|
|
17.3
|
%
|
$
|
239,233
|
|
$
|
209,030
|
|
14.4
|
%
|
Selling, general
and administrative as a % of net sales
|
|
12.3
|
%
|
12.6
|
%
|
(.3
|
)%
|
11.9
|
%
|
12.3
|
%
|
(.4
|
)%
|
Operating income
|
|
$
|
25,806
|
|
$
|
19,165
|
|
34.7
|
%
|
$
|
67,412
|
|
$
|
50,617
|
|
33.2
|
%
|
Operating
margin
|
|
3.8
|
%
|
3.3
|
%
|
.5
|
%
|
3.4
|
%
|
3.0
|
%
|
.4
|
%
|
Effective income
tax rate
|
|
34.5
|
%
|
36.2
|
%
|
(1.7
|
)%
|
35.5
|
%
|
35.7
|
%
|
(.2
|
)%
|
Net income
|
|
$
|
17,644
|
|
$
|
12,451
|
|
41.7
|
%
|
$
|
45,301
|
|
$
|
37,114
|
|
22.1
|
%
|
Net
margin
|
|
2.6
|
%
|
2.2
|
%
|
.4
|
%
|
2.3
|
%
|
2.2
|
%
|
.1
|
%
|
The
Technology Products sales increase was driven by increased internet and retail
store sales, private label product sales and expanded product offerings. The
Industrial Products sales increase resulted from the Company increasing its
market share through competitive pricing advantages and increased internet
sales. Both North America sales and Europe sales increased in the third quarter
and for the first nine months as compared to the same periods in the prior
year. European sales increased primarily as a result of growth in business to
business sales. Movements in foreign exchange rates positively impacted the
European sales comparison by approximately $15 million in the third quarter and
$57 million for the first nine months of 2007. Excluding the movements in
foreign exchange rates, European sales would have increased 19% from the prior
quarter and 16% from the prior year. Sales as measured in local currencies
increased in all of the European markets we serve for the first nine months of
2007. The increase in our North American sales resulted from sales growth in
both our Technology Products and Industrial Products groups. This increase was
primarily a result of our continuing internet initiatives and expansion of our
product offerings. Consolidated gross margin increased slightly due to
decreased competitive pricing pressures. Third quarter gross margin improved by
over 180 basis points as compared to the first quarter of 2007 due primarily to
less price discounting for technology products.
Gross margin is dependent on variables such as product mix, vendor price
protection and other sales incentives, competition, pricing strategy,
cooperative advertising funds required to be classified as a reduction to cost
of sales and other variables, any or all of which may result in fluctuations in
gross margin.
Selling, general and administrative expenses for the third quarter of
2007 increased 17.3% from the same period in 2006, primarily the result of $7.0
million of increased salaries and $6.4 million of increased advertising costs.
For the first nine months of 2007 selling, general and administrative expenses
increased by 14.4% compared to the same period in 2006, primarily the result of
$18.0 million of increased salaries and $17.3 million of increased advertising
costs offset by settlement proceeds of approximately $2.4 million from a
lawsuit that was settled favorably in the first quarter of 2007.
During the first quarter of 2006 we sold a warehouse facility and
recognized a gain of approximately $6.7 million net of a prepayment penalty incurred
upon the repayment of the underlying mortgage loan, which is included in Interest
and other
14
income, net. The facility was replaced by a larger, leased building.
The Companys estimated effective tax rate for the third quarter of
2007 was 34.5% compared to 36.2% in 2006. The reduction in the rate for third
quarter of 2007 was primarily attributable to higher income in locations with
lower effective tax rates. For the first nine months of 2007 the Companys
effective tax rate was 35.5% down slightly from 35.7% in 2006.
Financial Condition, Liquidity
and Capital Resources
Our primary liquidity needs are to support working capital requirements
in our business, to fund capital expenditures, and to fund minimal
acquisitions. 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
as well as any interest and debt repayments in the next twelve months and
thereafter.
Selected liquidity data (in thousands):
|
|
September 30,
|
|
December 31,
|
|
|
|
|
|
2007
|
|
2006
|
|
$ Change
|
|
Cash and cash
equivalents
|
|
$
|
97,784
|
|
$
|
86,964
|
|
$
|
10,820
|
|
Accounts
receivable, net
|
|
$
|
181,259
|
|
$
|
164,615
|
|
$
|
16,644
|
|
Inventories, net
|
|
$
|
234,877
|
|
$
|
233,136
|
|
$
|
1,741
|
|
Prepaid expenses
and other current
|
|
$
|
26,952
|
|
$
|
26,919
|
|
$
|
33
|
|
Accounts payable
|
|
$
|
220,977
|
|
$
|
201,486
|
|
$
|
19,491
|
|
Accrued expenses
|
|
$
|
74,271
|
|
$
|
75,688
|
|
$
|
(1,417
|
)
|
Short term debt
|
|
$
|
494
|
|
$
|
12,788
|
|
$
|
(12,294
|
)
|
Working capital
|
|
$
|
252,909
|
|
$
|
229,399
|
|
$
|
23,510
|
|
Our working capital increased in the first nine months of 2007,
primarily the result of an increase in accounts receivable and inventory in
Europe and an increase in accounts payable, offset by a reduction in short term
debt in Europe and a decrease in accrued expenses. Our inventory turnover
decreased from 10 to 9 times on an annual basis. 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.
The increase in cash provided by operations in 2007 resulted from
changes in our working capital accounts, which provided $5.1 million in cash
compared to $45.9 million of cash used in 2006, primarily the result of an
increase in accounts payable and accrued expenses and a decrease in inventories
and prepaids and other current assets. Cash generated from net income adjusted by
other non-cash items provided $58.3 million for the nine months ended September
30, 2007 compared to $42.2 million provided by these items, excluding a gain on
the sale of a warehouse facility in 2006, for the nine months ended September
30, 2006.
Cash flows from investing activities provided cash of $14.5 million in
2006, primarily the result of $18.6 million of proceeds from the sale of a
warehouse facility. Capital expenditures in 2007 and 2006 consisted primarily
of upgrades and enhancements to our information and communications systems
hardware and facilities costs for the opening of new retail outlet stores.
Net cash of $46.8 million was used in financing activities for the nine months ended September 30, 2007. We repaid $12.5 million in short-term loans in Europe and we paid $36.6 million for a special dividend. Proceeds and excess tax benefits from stock option exercises provided approximately $4.5 million of cash. In the first nine months of 2006, we used cash of $12.4 million to repay long-term debt obligations, primarily for the mortgage on a warehouse facility, we used $8.1 million to repay short-term borrowings in Europe and we received $1.0 million of proceeds from stock option exercises and excess tax benefits.
Under our $120 million (which may be increased by up to $30 million, subject to certain conditions) secured revolving credit agreement for borrowings in the United States and United Kingdom, as of September 30, 2007, eligible collateral was $120 million and total availability was $110.2 million. There were outstanding letters of credit of $9.8 million and there were no
15
outstanding advances as of September 30, 2007. The borrowings are secured by all of the domestic and United Kingdom accounts receivable, the domestic inventories of the Company, general intangibles, the Companys shares of stock in its domestic subsidiaries and the Companys United Kingdom headquarters building. The credit facility expires and the outstanding borrowings thereunder are due on October 26, 2010. The revolving credit agreement contains certain financial and other covenants, including maintaining a minimum level of availability and restrictions on capital expenditures and payments of dividends. We were in compliance with all of the covenants under this facility as of September 30, 2007.
Under our Netherlands 5 million ($7.1 million at the September 30,
2007 exchange rate) credit facility, at September 30, 2007 there were no
borrowings outstanding under this line. This facility expires in September
2008.
We also have certain obligations with various parties that include
commitments to make future payments. Our principal commitments at September 30,
2007 consisted of repayments of borrowings under our credit agreements,
payments under operating leases for certain of our real property and equipment
and payments under employment and other service agreements. In connection with
the adoption of FIN 48, as of September 30, 2007 the Company had a $1.5 million
liability related to uncertain tax positions. During the second quarter of 2007
the Company paid approximately $1.9 million to a state taxing authority related
to the settlement of a previously uncertain tax position. No other material
changes occurred in the Companys contractual obligations during the nine
months ended September 30, 2007.
Our current and anticipated needs for cash include funding growth in
working capital and capital expenditures necessary for future growth in sales
and potential expansion through acquisitions. We believe that our cash balances
and our availability under credit facilities will be sufficient to fund our
working capital and other cash requirements for the next twelve months.
We maintain our cash and cash equivalents primarily in money market
funds or their equivalent. As of September 30, 2007, all of our investments had
maturities of less than three months.
Accordingly, we do not believe that our investments have significant
exposure to interest rate risk.
Off-balance Sheet Arrangements
The Company currently leases its facility in Port Washington, NY from Addwin
Realty Associates, an entity owned by Richard Leeds, Bruce Leeds, and Robert
Leeds, Directors of the Company and the Companys three senior executive
officers and principal stockholders.
The Company has not created, and is not party to, except as described
above, any special-purpose or off-balance sheet entities for the purpose of
raising capital, incurring debt or operating the Companys 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 Companys liquidity or the availability of capital
resources.
Item 3.
Quantitative and Qualitative Disclosure About
Market Risk.
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.
The translation of
the financial 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, 2007 we had no outstanding
forward exchange contracts.
Our exposure to
market risk for changes in interest rates relates primarily to our variable
rate debt. Our variable rate debt includes short-term borrowings in Europe
under our credit facilities. As of September 30, 2007, we did not have any
balance
16
outstanding on our
variable rate debt. Based on our market sensitive instruments as of September
30, 2007, a hypothetical change in average interest rates of one percentage
point is not expected to have a material effect on our financial position,
results of operations or cash flows for the fiscal year.
Item 4.
Controls and Procedures
The Company
establishes and maintains disclosure controls and procedures that are intended
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 SECs rules and forms. Disclosure controls are also intended
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 Chief Executive Officer and Chief Financial Officer, 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 Chief
Executive Officer and the Chief Financial Officer, of the effectiveness of the
design and the operation of our disclosure controls and procedures pursuant to Exchange
Act Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934. As part of
this evaluation we identified certain significant deficiencies, as previously
defined under Auditing Standard No. 2: An Audit of Internal Control Over
Financial Reporting Performed in Conjunction With an Audit of Financial
Statements, in our internal controls over financial reporting as of September
30, 2007. These significant deficiencies are:
The Company has internal control deficiencies in its
information technology area including the lack of adequate general controls.
The Company lacks program change and project management controls, has
inadequate segregation of duties between information technology department
development and production functions, needs formal information technology
strategic planning, needs formal documentation of information security
procedures, needs security around user rights to certain application systems
and needs to implement formal help desk procedures.
The Company has disparate operating and financial
information systems at certain of the Companys locations that have inherent
limitations resulting in a control environment heavily reliant upon manual
review procedures and adjustments. These deficiencies include inadequate or
lack of systems interfaces and the preparation of numerous manual journal
entries. In addition, there are additional adjustments entered into the general
ledger from subsidiaries after submission by the subsidiary.
These significant deficiencies do not, in our
judgment, rise to the level of a material weakness in internal controls over
financial reporting. The Chief Executive Officer and the Chief Financial
Officer have concluded, based on our evaluation as of September 30, 2007, that
our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended) were
effective.
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
17
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.
Section 404 of the Sarbanes-Oxley
Act
For the year ended December 31, 2006 and the period ended September 30,
2007, we were not subject to the internal controls certification and
attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002
because we were not an accelerated filer as defined by the SEC. For the year
ending December 31, 2007, as an accelerated filer we will be subject to the
requirements of Section 404 that management provide an assessment of the
effectiveness of the Companys internal control over financial reporting and
the Companys independent registered public accounting firm will be required to
audit that assessment.
We are working to achieve compliance with the
requirements of Section 404. We are dedicating substantial time and resources
to documentation and testing of our internal controls and have engaged outside
consultants to assist us. We have increased headcount of qualified financial
personnel. We have made substantive (though not material) changes to our
internal controls, including developing estimation processes to appropriately
calculate fairly stated inventory in transit, vendor drop shipments, sales
returns and allowances, cooperative advertising and customer rebate reserves,
and other vendor and employee related costs. We continue to perform and put in
place extensive detect controls in areas where we have had significant
deficiencies.We have formed a disclosure committee for purposes of ensuring
that disclosures made by the Company in its filings with the SEC or to its
security holders or the investment community are accurate and complete.
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 weakness or weaknesses exist. As a result,
management may not be able to issue an unqualified opinion on the effectiveness
of the Companys internal control over financial reporting as of December 31,
2007.
Changes in Internal Control Over
Financial Reporting
There have been no changes in the Companys internal controls over
financial reporting during the quarterly period ended September 30, 2007 that
have materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting.
18