10-Q 1 doc1.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended July 5, 2004 OR ( ) 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 0-20022 POMEROY IT SOLUTIONS, INC. -------------------------- (Exact name of registrant as specified in its charter) DELAWARE 31-1227808 -------- ---------- (State or other jurisdiction of incorporation (IRS Employer or organization) Identification No.) 1020 Petersburg Road, Hebron, KY 41048 -------------------------------------- (Address of principal executive offices) (859) 586-0600 -------------- (Registrant'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 requirements for the past 90 days. YES X NO --- --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES X NO --- --- The number of shares of common stock outstanding as of August 5, 2004 was 12,239,459 1

POMEROY IT SOLUTIONS, INC. TABLE OF CONTENTS Part I. Financial Information Item 1. Financial Statements: Page ---- Consolidated Balance Sheets as of July 3 5, 2004 (Unaudited) and January 5, 2004 Consolidated Statements of Income for 5 the Three Months Ended July 5, 2004 and 2003 (Unaudited) Consolidated Statements of Income for 6 the Six Months Ended July 5, 2004 and 2003 (Unaudited) Consolidated Statements of Cash Flows 7 for the Six Months Ended July 5, 2004 and 2003 (Unaudited) Notes to Consolidated Financial 8 Statements (Unaudited) Item 2. Management's Discussion and Analysis of 14 Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosure 19 about Market Risk Item 4. Controls and Procedures 19 Part II. Other Information 20 SIGNATURE 22

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POMEROY IT SOLUTIONS, INC. CONSOLIDATED BALANCE SHEETS (in thousands) July 5, January 5, 2004 2004 ------------ ----------- (unaudited) ASSETS Current Assets: Cash and cash equivalents . . . . . . . . . . . . . . $ 45,373 $ 40,200 ------------ ----------- Accounts receivable: Trade, less allowance of $2,556 at July 5, 2004 and January 5, 2004 . . . . . . . . . . . . . 111,779 111,324 Vendor receivables, less allowance of $100 at July 5, 2004 and January 5, 2004. . . . . . . 4,491 7,226 Net investment in leases. . . . . . . . . . . . . 4,427 2,056 Other . . . . . . . . . . . . . . . . . . . . . . 1,668 2,043 ------------ ----------- Total receivables . . . . . . . . . . . . . . 122,365 122,649 ------------ ----------- Inventories . . . . . . . . . . . . . . . . . . . . . 17,710 12,453 Other . . . . . . . . . . . . . . . . . . . . . . . . 5,655 5,193 ------------ ----------- Total current assets. . . . . . . . . . . . . 191,103 180,495 ------------ ----------- Equipment and leasehold improvements: Furniture, fixtures and equipment. . . . . . . . . 29,967 29,517 Leasehold Improvements . . . . . . . . . . . . . . 6,384 6,438 ------------ ----------- Total . . . . . . . . . . . . . . . . . . . . 36,351 35,955 Less accumulated depreciation. . . . . . . . . . . 20,467 19,696 ------------ ----------- Net equipment and leasehold improvements. . . 15,884 16,259 ------------ ----------- Net investment in leases, net of current portion. . . 2,292 2,935 Goodwill. . . . . . . . . . . . . . . . . . . . . . . 68,035 67,664 Intangible assets, net. . . . . . . . . . . . . . . . 457 436 Other assets. . . . . . . . . . . . . . . . . . . . . 1,757 1,410 ------------ ----------- Total assets. . . . . . . . . . . . . . . . . $ 279,528 $ 269,199 ============ ===========

See notes to consolidated financial statements. 3

POMEROY IT SOLUTIONS, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share data) July 5, January 5, 2004 2004 ------------ ----------- (unaudited) LIABILITIES AND EQUITY Current Liabilities: Current portion of notes payable . . . . . . . . . . . . . . . $ 912 $ 912 Accounts payable . . . . . . . . . . . . . . . . . . . . . . . 55,383 50,051 Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . 3,080 3,988 Other current liabilities. . . . . . . . . . . . . . . . . . . 9,703 8,758 ------------ ----------- Total current liabilities. . . . . . . . . . . . . . . . 69,078 63,709 ------------ ----------- Notes payable, less current portion. . . . . . . . . . . . . . 250 913 Deferred income taxes. . . . . . . . . . . . . . . . . . . . . 4,834 4,780 Commitments and contingencies Equity: Preferred stock, $.01 par value; authorized 2,000 shares, (no shares issued or outstanding). . . . . . . . . . . . - - Common stock, $.01 par value; authorized 20,000 shares, (13,017 and 12,943 shares issued at July 5, 2004 and January 5, 2004, respectively) . . . . . . . . . . . . . 130 130 Paid-in-capital . . . . . . . . . . . . . . . . . . . . . . 83,252 82,696 Retained earnings . . . . . . . . . . . . . . . . . . . . . 130,612 125,250 ------------ ----------- 213,994 208,076 Less treasury stock, at cost ( 768 and 738 shares at July 5, 2004 and January 5, 2004, respectively) . . . . . 8,628 8,279 ------------ ----------- Total equity. . . . . . . . . . . . . . . . . . . . . 205,366 199,797 Total liabilities and equity. . . . . . . . . . . . . $ 279,528 $ 269,199 ============ ===========

See notes to consolidated financial statements. 4

POMEROY IT SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data) Three Months Ended -------------------------- July 5, July 5, 2004 2003 ------------ ------------ (unaudited) (unaudited) Net sales and revenues: Sales-equipment, supplies and leasing. $ 143,722 $ 116,195 Service. . . . . . . . . . . . . . . . 34,433 31,157 ------------ ------------ Total net sales and revenues. . . . 178,155 147,352 ------------ ------------ Cost of sales and service: Sales-equipment, supplies and leasing. 133,444 107,291 Service. . . . . . . . . . . . . . . . 24,980 22,744 ------------ ------------ Total cost of sales and service . . 158,424 130,035 ------------ ------------ Gross profit . . . . . . . . . 19,731 17,317 ------------ ------------ Operating expenses: Selling, general and administrative. 12,785 11,958 Rent expense . . . . . . . . . . . . 777 809 Depreciation . . . . . . . . . . . . 1,027 1,250 Amortization . . . . . . . . . . . . 39 73 ------------ ------------ Total operating expenses . . . 14,628 14,090 ------------ ------------ Income from operations. . . . . . . . . 5,103 3,227 ------------ ------------ Other expense (income): Interest, net. . . . . . . . . . . . (19) (81) Other. . . . . . . . . . . . . . . . 21 8 ------------ ------------ Total other expense (income) . 2 (73) ------------ ------------ Income before income tax . . . . . . . 5,101 3,300 Income tax expense. . . . . . . . . . . 2,015 1,287 ------------ ------------ Net income . . . . . . . . . . . . . $ 3,086 $ 2,013 ============ ============ Weighted average shares outstanding: Basic. . . . . . . . . . . . . . . . 12,258 12,346 ============ ============ Diluted. . . . . . . . . . . . . . . 12,401 12,379 ============ ============ Earnings per common share: Basic. . . . . . . . . . . . . . . . $ 0.25 $ 0.16 ============ ============ Diluted. . . . . . . . . . . . . . . $ 0.25 $ 0.16 ============ ============

See notes to consolidated financial statements. 5

POMEROY IT SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data) Six Months Ended -------------------------- July 5, July 5, 2004 2003 ------------ ------------ (unaudited) (unaudited) Net sales and revenues: Sales-equipment, supplies and leasing. $ 268,321 $ 216,181 Service. . . . . . . . . . . . . . . . 65,048 61,149 ------------ ------------ Total net sales and revenues. . . . 333,369 277,330 ------------ ------------ Cost of sales and service: Sales-equipment, supplies and leasing. 248,017 199,361 Service. . . . . . . . . . . . . . . . 47,252 44,275 ------------ ------------ Total cost of sales and service . . 295,269 243,636 ------------ ------------ ------------ ------------ Gross profit . . . . . . . . . 38,100 33,694 ------------ ------------ Operating expenses: Selling, general and administrative. 25,752 23,448 Rent expense . . . . . . . . . . . . 1,545 1,595 Depreciation . . . . . . . . . . . . 1,916 2,414 Amortization . . . . . . . . . . . . 79 296 Provision for doubtful accounts. . . - 200 ------------ ------------ Total operating expenses . . . 29,292 27,953 ------------ ------------ Income from operations. . . . . . . . . 8,808 5,741 ------------ ------------ Other expense (income): Interest . . . . . . . . . . . . . . (31) (15) Miscellaneous. . . . . . . . . . . . 23 (14) ------------ ------------ Net other expense (income) . . (8) (29) ------------ ------------ Income before income tax . . . . . . . 8,816 5,770 Income tax expense. . . . . . . . . . . 3,454 2,250 ------------ ------------ Net income . . . . . . . . . . . . . $ 5,362 $ 3,520 ============ ============ Weighted average shares outstanding: Basic. . . . . . . . . . . . . . . . 12,245 12,399 ============ ============ Diluted. . . . . . . . . . . . . . . 12,362 12,422 ============ ============ Earnings per common share: Basic. . . . . . . . . . . . . . . . $ 0.44 $ 0.28 ============ ============ Diluted. . . . . . . . . . . . . . . $ 0.43 $ 0.28 ============ ============

See notes to consolidated financial statements 6

POMEROY IT SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Six Months Ended -------------------------- July 5, July 5, 2004 2003 ------------ ------------ (unaudited) (unaudited) Cash flows from operating activities: Net income . . . . . . . . . . . . . . . . . . . $ 5,362 $ 3,520 Adjustments to reconcile net income to net cash from operating activities: Depreciation . . . . . . . . . . . . . . . . . . 1,916 2,414 Amortization . . . . . . . . . . . . . . . . . . 79 296 Deferred income taxes. . . . . . . . . . . . . . (395) 1,617 Loss on sale of fixed assets . . . . . . . . . . 22 19 Changes in working capital accounts, net of effects of acquisitions: Accounts receivable . . . . . . . . . . . . . 668 17,736 Inventories . . . . . . . . . . . . . . . . . (5,793) (339) Prepaids. . . . . . . . . . . . . . . . . . . (462) 1,834 Net investment in leases. . . . . . . . . . . 254 (1,156) Accounts payable. . . . . . . . . . . . . . . 5,332 6,205 Deferred revenue. . . . . . . . . . . . . . . (908) 376 Income tax payable. . . . . . . . . . . . . . 290 - Other, net. . . . . . . . . . . . . . . . . . 847 23 ------------ ------------ Net operating activities . . . . . . . . . . . . 7,212 32,545 ------------ ------------ Cash flows from investing activities: Capital expenditures . . . . . . . . . . . . . . (1,062) (1,166) Proceeds from sale of fixed assets . . . . . . . 20 1 Acquisition of businesses, net of cash acquired . . . . . . . . . . . . . . . . (541) (3,499) ------------ ------------ Net investing activities . . . . . . . . . . . . (1,583) (4,664) ------------ ------------ Cash flows from financing activities: Payments of notes payable. . . . . . . . . . . . (663) - Proceeds from exercise of stock options and related tax benefit . . . . . . . . . . . 396 34 Purchase of treasury stock . . . . . . . . . . . (349) (2,686) Proceeds from employee stock purchase plan . . . 160 166 ------------ ------------ Net financing activities . . . . . . . . . . . . (456) (2,486) ------------ ------------ Increase in cash. . . . . . . . . . . . . . . . . . 5,173 25,395 Cash and cash equivalents Beginning of period. . . . . . . . . . . . . . . 40,200 32,505 ------------ ------------ End of period. . . . . . . . . . . . . . . . . . $ 45,373 $ 57,900 ============ ============

See notes to consolidated financial statements. 7 POMEROY IT SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements. Except as disclosed herein, there has been no material change in the information disclosed in the notes to consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended January 5, 2004. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the interim periods have been made. The results of operations for the six month period ended July 5, 2004 are not necessarily indicative of the results that may be expected for future interim periods or for the year ending January 5, 2005. 2. Recent Accounting Pronouncements In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." EITF No. 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple revenue generating activities. EITF No. 00-21 is effective for fiscal years beginning after June 15, 2003. Adoption of EITF No. 00-21 did not have any material impact on the Company's financial position or results of operations. In November 2002, the EITF reached a consensus on EITF 02-16, "Accounting by a Customer (including a reseller) for Certain Consideration Received from a Vendor." EITF 02-16 requires that cash payments, credits, or equity instruments received as consideration by a customer from a vendor should be presumed to be a reduction of cost of sales when recognized by the customer in the income statement. In certain situations, the presumption could be overcome and the consideration recognized either as revenue or a reduction of a specific cost incurred. The consensus should be applied prospectively to new or modified arrangements entered into after December 31, 2002. The Company had been participating in a vendor program that expired in November of 2003. Since this program was initiated prior to December 31, 2002, the Company has classified these vendor program payments as a reduction in selling, general and administrative expenses. Under new agreements, the Company has classified these vendor program payments under cost of sales in accordance with EITF 02-16. In January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation 46 (FIN 46), "Consolidation of Variable Interest Entities." FIN 46 clarifies the application of Accounting Research Bulletin 51, Consolidated Financial Statements, for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest ("variable interest entities"). Variable interest entities within the scope of FIN 46 are required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise 8 obtains an interest after that date. It applies in the first fiscal year or interim period beginning after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. Adoption of FIN 46 did not have any impact on the Company's financial condition or results of operations. In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" (SFAS 149). SFAS 149 amends and clarifies the financial accounting and reporting for derivative instruments, including certain derivatives instruments embedded in other contracts, and for hedging activities under SFAS 133. The Company has adopted the provisions of SFAS 149 and they had no material impact on our financial position or results of operations. In May 2003, the FASB issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" (SFAS 150). SFAS 150 clarifies the accounting for certain financial instruments that, under previous guidance, issuers could account for as either debt or equity. The new Statement requires that those financial instruments be classified as liabilities in statements of financial position. The Company has adopted the provisions of SFAS 150 and they had no material impact on our financial position or results of operations. 3. Cash and Bank Notes Payable On June 28, 2004, the Company finalized a new $165 million Syndicated Credit Facility Agreement with GE Commercial Distribution Finance ("GECDF"). The new credit facility has a three-year term and its components include a maximum of $75 million for inventory financing and a revolver, collateralized primarily by accounts receivable, of up to $110 million. Under the new agreement, the credit facility provides a letter of credit facility of $5 million. The Company maintains a sweep account with its bank whereby daily cash receipts are automatically transferred as payment towards the Company's credit facility. As of July 5, 2004 and January 5, 2004, the Company did not have a balance outstanding under the Company's credit facility. 4. Stock-Based Compensation The FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation", in the fall of 1995. The statement encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company elected to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of grant over the amount an employee must pay to acquire the stock. The Company adopted SFAS No. 123 for disclosure purposes and for non-employee stock options. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date consistent with the provisions of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below: 9

(in thousands, except per Three Months Ended July 5, share amounts) 2004 2003 ------------- -------------- Net income - as reported $ 3,086 $ 2,013 Stock-based compensation expense-net of tax 261 253 ------------- -------------- Net income - pro forma $ 2,825 $ 1,760 ============= ============== Net income per common share - as reported Basic 0.25 $ 0.16 ============= ============== Diluted 0.25 $ 0.16 ============= ============== Net income per common share - pro forma Basic $ 0.23 $ 0.14 ============= ============== Diluted $ 0.23 $ 0.14 ============= ==============

(in thousands, except per Six Months Ended July 5, share amounts) 2004 2003 ----------- -------------- Net income - as reported $ 5,362 $ 3,520 Stock-based compensation expense-net of tax 800 805 ----------- -------------- Net income - pro forma $ 4,562 $ 2,715 =========== ============== Net income per common share - as reported Basic 0.44 $ 0.28 =========== ============== Diluted 0.43 $ 0.28 =========== ============== Net income per common share - pro forma Basic 0.37 $ 0.22 =========== ============== Diluted 0.37 $ 0.22 =========== ==============

5. Earnings per Common Share The following is a reconciliation of the number of shares used in the basic EPS and diluted EPS computations: (in thousands, except per share data) 10

Three Months Ended July 5, --------------------------------------- 2004 2003 ------------------- ------------------ Per Share Per Share Shares Amount Shares Amount ------ ----------- ------ ---------- Basic EPS 12,258 $ 0.25 12,346 $ 0.16 Effect of dilutive stock options 143 - 33 - ------ ----------- ------ ---------- Diluted EPS 12,401 $ 0.25 12,379 $ 0.16 ====== =========== ====== ========== Six Months Ended July 5, --------------------------------------- 2004 2003 ------------------- ------------------ Per Share Per Share Shares Amount Shares Amount ------ ----------- ------ ---------- Basic EPS 12,245 $ 0.44 12,399 $ 0.28 Effect of dilutive stock options 117 (0.01) 23 - ------ ----------- ------ ---------- Diluted EPS 12,362 $ 0.43 12,422 $ 0.28 ====== =========== ====== ==========

6. Goodwill and Long-Lived Assets Intangible assets with definite lives are amortized over their estimated useful lives. The following table provides a summary of the Company's intangible assets with definite lives as of April 5, 2004 and January 5, 2004:

(in thousands) Gross Net Gross Net Carrying Accumulated Carrying Carrying Accumulated Carrying Amount Amortization Amount Amount Amortization Amount 7/5/2004 7/5/2004 7/5/2004 1/5/2004 1/5/2004 1/5/2004 ----------------------------------- ----------------------------------- Amortized intangible assets: Covenants not-to-compete $ 1,894 $ 1,687 $ 207 $ 1,844 $ 1,650 $ 194 Customer lists 677 427 250 627 385 242 --------- ------------- --------- --------- ------------- --------- Total amortized intangibles $ 2,571 $ 2,114 $ 457 $ 2,471 $ 2,035 $ 436 ========= ============= ========= ========= ============= =========

Amortized intangible assets are being amortized over periods ranging from 3 to 15 years for covenants not-to-compete and 10 to 15 years for customer lists. The weighted average amortization period for all amortized intangible assets acquired in fiscal 2004 is 15 years. For the quarters ended July 5, 2004 and 2003, amortization expense related to intangible assets with definite lives was $39 and $73 thousand, respectively. For the six months ended July 5, 2004 and 2003, amortization expense related to intangible assets with definite lives was $79 and $296 thousand, respectively. 11 Projected future amortization expense related to intangible assets with definite lives are as follows:

(in thousands) Fiscal Years: 2004 $ 68 July 6, 2004 - January 5, 2005 2005 57 2006 26 2007 26 2008 26 2009 and thereafter 254 ------ Total $ 457 ======

The change in the net carrying amount of goodwill for the six months ended July 5, 2004 by segment are as follows:

(in thousands) Products Services Consolidated --------- --------- ------------- Net carrying amount as of 1/5/04 $ 35,862 $ 31,802 $ 67,664 Goodwill recorded during first quarter 130 116 246 --------- --------- ------------- Net carrying amount as of 4/5/04 35,992 31,918 67,910 Goodwill recorded during second quarter 66 59 125 --------- --------- ------------- Net carrying amount as of 7/5/04 $ 36,058 $ 31,977 $ 68,035 ========= ========= =============

7. Supplemental Cash Flow Disclosures Supplemental disclosures with respect to cash flow information and non-cash investing and financing activities are as follows: (in thousands)

Six Months Ended July 5, ---------------------------- 2004 2003 ----------- --------------- Interest paid $ 162 $ 211 =========== =============== Income taxes paid $ 2,364 $ 684 =========== =============== Adjustments to purchase price of acquisition assets and intangibles $ 70 $ 1,624 =========== =============== Business combinations accounted for as purchases: Assets acquired $ 541 $ 7,573 Liabilities assumed - (4,074) ---------------------------- Net cash paid $ 541 $ 3,499 ============================

8. Litigation There are various legal actions arising in the normal course of business that have been brought against the Company. Management believes these matters will not have a material adverse effect on the Company's financial position or results of operations. 12 9. Segment Information Summarized financial information concerning the Company's reportable segments is shown in the following table. (in thousands)

Three Months Ended July 5, 2004 ----------------------------------------------- Products Services Leasing Consolidated --------- --------- ---------- ------------- Revenues $ 143,703 $ 34,433 $ 19 $ 178,155 Income from operations 2,514 2,588 1 5,103 Total assets 175,926 96,586 7,016 279,528 Capital expenditures 423 388 - 811 Depreciation and amortization 546 519 1 1,066 Three Months Ended July 5, 2003 ----------------------------------------------- Products Services Leasing Consolidated --------- --------- ---------- ------------- Revenues $ 116,150 $ 31,157 $ 45 $ 147,352 Income from operations 2,008 1,180 39 3,227 Total assets 168,966 87,677 6,416 263,059 Capital expenditures 195 183 - 378 Depreciation and amortization 671 652 1,323

Six Months Ended July 5, 2004 ----------------------------------------------- Products Services Leasing Consolidated --------- --------- ---------- ------------- Revenues $ 268,289 $ 65,048 $ 32 $ 333,369 Income from operations 4,047 4,759 2 8,808 Total assets 175,926 96,586 7,016 279,528 Capital expenditures 560 502 - 1,062 Depreciation and amortization 1,051 942 2 1,995 Six Months Ended July 5, 2003 ----------------------------------------------- Products Services Leasing Consolidated --------- --------- ---------- ------------- Revenues $ 216,030 $ 61,149 $ 151 $ 277,330 Income from operations 3,278 2,323 140 5,741 Total assets 168,966 87,677 6,416 263,059 Capital expenditures 577 589 - 1,166 Depreciation and amortization 1,427 1,283 - 2,710

10. Merger On July 23, 2004, Pomeroy IT Solutions, Inc. ("Pomeroy") and Pomeroy Acquisition Sub, Inc. ("PAS"), a wholly owned subsidiary of Pomeroy, completed a merger with Alternative Resources Corporation ("ARC"). On May 11, 2004, the parties entered into a definitive merger agreement for PAS to acquire all of the issued and outstanding shares of capital stock of ARC. The merger was approved by ARC shareholders at a meeting held on July 22, 2004. As a result of the merger, ARC is now a wholly-owned subsidiary of Pomeroy. The cash consideration paid, including the cost of all stock, stock options and warrants purchased and the amount of ARC net debt retired, was approximately $46.1 million, which was funded from cash on hand and borrowings from Pomeroy's existing line of credit. 13 Item 2-Management's Discussion and Analysis of Financial Condition and Results of Operations Special Cautionary Notice Regarding Forward-Looking Statements -------------------------------------------------------------- Certain of the matters discussed under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" contain certain forward looking statements regarding future financial results of the Company. The words "expect," "estimate," "anticipate," "predict," and similar expressions are intended to identify forward-looking statements. Such statements are forward-looking statements for purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934, as amended, and as such may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Important factors that could cause the actual results, performance or achievements of the Company to differ materially from the Company's expectations are disclosed in this document including, without limitation, those statements made in conjunction with the forward-looking statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations". All written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by such factors. RESULTS OF OPERATIONS The following table sets forth for the periods presented information derived from our consolidated statements of income expressed as a percentage of net sales and revenues: 14

Percentage of net sales and revenues Financial Results Three months ended July 5, Six months ended ------------------------------------- July 5, July 5, ------------- -------------- ----------- ----------- 2004 2003 2004 2003 ------------- -------------- ----------- ----------- Net sales and revenues: Equipment, supplies and leasing 80.7% 78.9% 80.5% 78.0% Service 19.3% 21.1% 19.5% 22.0% ------------- -------------- ----------- ----------- Total net sales and revenues 100.0% 100.0% 100.0% 100.0% ============= ============== =========== =========== Cost of sales and servce: Equipment, supplies and leasing 74.9% 72.8% 74.4% 71.9% Service 14.0% 15.4% 14.2% 15.9% ------------- -------------- ----------- ----------- Total cost of sales and service 88.9% 88.2% 88.6% 87.8% ============= ============== =========== =========== Gross profit: Equipment, supplies and leasing 5.8% 6.1% 6.1% 6.1% Service 5.3% 5.7% 5.3% 6.1% ------------- -------------- ----------- ----------- Total gross profit 11.1% 11.8% 11.4% 12.2% ============= ============== =========== =========== Operating expenses: Selling, general and administrative 7.2% 8.1% 7.7% 8.4% Rent 0.4% 0.6% 0.5% 0.6% Depreciation 0.6% 0.9% 0.6% 0.9% Amortization 0.0% 0.0% 0.0% 0.1% Provision for doubtful accounts 0.0% 0.0% 0.0% 0.1% ------------- -------------- ----------- ----------- Total operating expenses 8.2% 9.6% 8.8% 10.1% ============= ============== =========== =========== Income from operations 2.9% 2.2% 2.6% 2.1% Net other expense 0.0% 0.0% 0.0% 0.0% Income before income tax 2.9% 2.2% 2.6% 2.1% Income tax expense 1.2% 0.8% 1.0% 0.8% ------------- -------------- ----------- ----------- Net income 1.7% 1.4% 1.6% 1.3% ============= ============== =========== ===========

15 POMEROY IT SOLUTIONS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS TOTAL NET SALES AND REVENUES. Total net sales and revenues increased $30.8 million, or 20.9%, to $178.2 million in the second quarter of fiscal 2004 from $147.4 million in the second quarter of fiscal 2003. This increase was primarily a result of increased, industry-wide technology spending. Excluding acquisitions completed in fiscal year 2003, total net sales and revenues increased 18.2%. Products and leasing sales increased $27.5 million, or 23.7% to $143.7 million in the second quarter of fiscal 2004 from $116.2 million in the second quarter of fiscal 2003. Excluding acquisitions completed in fiscal year 2003, products and leasing sales in the second quarter of fiscal 2004 increased 21.6% over the products and leasing sales in the second quarter of fiscal 2003. Service revenues increased $3.2 million, or 10.5%, to $34.4 million in the second quarter of fiscal 2004 from $31.2 million in the second quarter of fiscal year 2003. Excluding acquisitions completed in fiscal year 2003, service revenues in the second quarter of fiscal 2004 increased 5.6% over service revenues in the second quarter of fiscal 2003. Total net sales and revenues increased $56.1 million, or 20.2%, to $333.4 million in the first six months of fiscal 2004 from $277.3 million in the first six months of fiscal 2003. Excluding acquisitions completed in fiscal year 2003, total net sales and revenues increased 18.3%. Products and leasing sales increased $52.1 million, or 24.1% to $268.3 million in the first six months of fiscal 2004 from $216.2 million in the first six months of fiscal 2003. Excluding acquisitions completed in fiscal year 2003, products and leasing sales in the first six months of fiscal 2004 increased 22.5% over products and leasing sales in the first six months of fiscal 2003. Service revenues increased $3.9 million, or 6.4%, to $65.0 million in the first six months of fiscal 2004 from $61.1 million in the first six months of fiscal year 2003. Excluding acquisitions completed in fiscal year 2003, service revenues in the first six months of fiscal 2004 increased 3.6% over service revenues in the first six months of fiscal 2003. GROSS PROFIT. Gross profit increased $2.4 million, or 13.9%, to $19.7 million in the second quarter of fiscal 2004 from $17.3 million in the second quarter of fiscal 2003. The increase was primarily due to increased total net sales and revenues offset somewhat by lower product gross profit margins in 2004. Gross profit, as a percentage of revenue, decreased to 11.1% in the second quarter of fiscal 2004 as compared to 11.8% in the second quarter of fiscal 2003. This decrease in gross margin resulted primarily from the decrease in product margins, decrease in service revenues as a percentage of total revenues and the decrease in service gross margin as a percentage of total gross margin. As a consequence of adopting EITF 02-16, the Company recorded approximately $208 thousand during the second quarter of fiscal 2004 of vendor considerations as a reduction of product cost of sales, which previously would have been recorded as a reduction of selling, general and administrative expenses. Excluding the impact of EITF 02-16, and therefore on a non-GAAP basis, the gross profit margin would have been 11.0% during the second quarter of fiscal 2004 compared to 11.8% during the second quarter of fiscal 2003. The non-GAAP gross profit margin is included in this discussion to provide meaningful comparison to prior periods. On a forward looking basis, the Company expects to be aggressive in product and service pricing in order to gain existing market share which may have a continued unfavorable impact on overall gross margin. Additionally, the Company expects to continue increasing the breadth and depth of its service offerings, which will have a continued impact on service gross margin. Factors that may have an impact on gross margin in the future include the continued changes in hardware margins, change in personnel utilization rates, the mix of products sold and services provided, a change in unit prices, the percentage of equipment or service sales with lower-margin customers, the ratio of service revenues to total net sales and revenues, and the Company's decision to aggressively price certain products and services. Gross profit increased $4.4 million, or 13.1%, to $38.1 million in the first six months of fiscal 2004 from $33.7 million in the first six months of fiscal 2003. The increase was primarily due to increased total net sales and revenues offset somewhat by lower product and service gross profit margins in 2004. Gross profit, as a percentage of revenue, decreased to 11.4% in the first six months of fiscal 2004 as compared to 12.2% in the first six months of fiscal 2003. This decrease in gross margin resulted primarily from the decrease in product and service gross profit margins, decrease in service revenues as a percentage of total revenues and decrease in service gross margin as a percentage of total gross margin. As a consequence of adopting EITF 02-16, the Company recorded approximately $473 thousand during the first six months of fiscal 2004 of vendor considerations as a reduction of product cost of sales, which previously would have been recorded as a 16 reduction of selling, general and administrative expenses. Excluding the impact of EITF 02-16, and therefore on a non-GAAP basis, the gross profit margin would have been 11.3% during the first six months of fiscal 2004 compared to 12.2% during the first six months of fiscal 2003. The non-GAAP gross profit margin is included in this discussion to provide meaningful comparison to prior periods. On a forward looking basis, the Company expects to be aggressive in product and service pricing in order to gain existing market share which may have a continued unfavorable impact on overall gross margin. OPERATING EXPENSES. Selling, general and administrative expenses (including rent expense and provision for doubtful accounts) expressed as a percentage of total net sales and revenues decreased to 7.6% in the second quarter of fiscal 2004 from 8.7% in the second quarter of fiscal 2003. Total operating expenses expressed as a percentage of total net sales and revenues decreased to 8.2% in the second quarter of fiscal 2004 from 9.6% in the second quarter of fiscal 2003. This decrease is primarily the result of higher net sales and revenues in the second quarter of fiscal 2004 as compared to the second quarter of fiscal 2003. As a result of adopting EITF 02-16, the Company reclassified approximately $208 thousand of vendor consideration to a reduction of cost of sales, which would previously have been recorded as a reduction of selling, general and administrative expenses. Excluding the impact of EITF 02-16, and therefore on a non-GAAP basis, operating expenses would have been 8.1% during the second quarter of fiscal 2004 as compared to 9.6% during the second quarter of fiscal 2003. This non-GAAP measurement is included to provide a more meaningful comparison to prior periods. Selling, general and administrative expenses (including rent expense and provision for doubtful accounts) expressed as a percentage of total net sales and revenues decreased to 8.2% in the first six months of fiscal 2004 from 9.1% in the first six months of fiscal 2003. Total operating expenses expressed as a percentage of total net sales and revenues decreased to 8.8% in the first six months of fiscal 2004 from 10.1% in the first six months of fiscal 2003. This decrease is primarily the result of higher net sales and revenues in the first six months of fiscal 2004 as compared to the first six months of fiscal 2003. As a result of adopting EITF 02-16, the Company reclassified approximately $473 thousand of vendor consideration to a reduction of cost of sales, which would previously have been recorded as a reduction of selling, general and administrative expenses. Excluding the impact of EITF 02-16, and therefore on a non-GAAP basis, operating expenses would have been 8.6% during the first six months of fiscal 2004 as compared to 10.1% during the first six months of fiscal 2003. This non-GAAP measurement is included to provide a more meaningful comparison to prior periods. INCOME FROM OPERATIONS. Income from operations increased $1.9 million, or 58.1%, to $5.1 million in the second quarter of fiscal 2004 from $3.2 million in the second quarter of fiscal 2003. The Company's operating margin increased to 2.9% in the second quarter of fiscal 2004 as compared to 2.2% in the second quarter of fiscal 2003. This increase is primarily due to higher net sales and revenues and decreased operating expenses as a percentage of total net sales and revenues. Income from operations increased $3.1 million, or 53.4%, to $8.8 million in the first six months of fiscal 2004 from $5.7 million in the first six months of fiscal 2003. The Company's operating margin increased to 2.6% in the first six months of fiscal 2004 as compared to 2.1% in the first six months of fiscal 2003. This increase is primarily due to higher net sales and revenues and decreased operating expenses as a percentage of total net sales and revenues. NET INTEREST INCOME. Net interest income was $19 thousand during the second quarter of fiscal 2004 as compared to $81 thousand during the second quarter of fiscal 2003. This was a result of reduced cash available to invest. Interest income was $31 thousand in the first six months of fiscal 2004 compared to $15 thousand in the first six months of fiscal 2003. This increase in interest income was a result of improved net cash flow and interest income earned on cash balances. INCOME TAXES. The Company's effective tax rate was 39.5% in the second quarter of fiscal 2004 compared to 39.0% in the second quarter of fiscal 2003. 17 The Company's effective tax rate was 39.2% in the first six months of fiscal 2004 compared to 39.0% in the first six months of fiscal 2003. NET INCOME. Net income increased $1.1 million, or 53.3%, to $3.1 million in the second quarter of fiscal 2004 from $2.0 million in the second quarter of fiscal 2003 due to the factors described above. Net income increased $1.9 million, or 52.3%, to $5.4 million in the first six months of fiscal 2004 from $3.5 million in the first six months of fiscal 2003 due to the factors described above. LIQUIDITY AND CAPITAL RESOURCES Cash provided by operating activities was $7.2 million in the first six months of fiscal 2004. Cash used in investing activities was $1.6 million, which included payments of $0.5 million for prior year acquisitions and $1.1 million for capital expenditures. Cash used in financing activities was $0.5 million, which included $0.7 million for payments of notes payable and $0.3 million for the purchase of treasury stock offset by $0.4 million of proceeds from exercise of stock options and $0.2 million of proceeds from employee stock plan purchases. A significant part of the Company's inventories is financed by floor plan arrangements with third parties. At July 5, 2004, these lines of credit totaled $87.0 million, including $75.0 million with GE Commercial Distribution Finance ("GECDF") and $12.0 million with IBM Credit Corporation ("ICC"). Borrowings under the GECDF floor plan arrangements are made on thirty-day notes. Borrowings under the ICC floor plan arrangements are made on either thirty-day or sixty-day notes. All such borrowings are secured by the related inventory. Financing on substantially all of the arrangements is interest free due to subsidies by manufacturers. Overall, the average rate on these arrangements is less than 1.0%. The Company classifies amounts outstanding under the floor plan arrangements as accounts payable. The Company's financing of receivables is provided through a portion of its credit facility with GECDF. On June 28, 2004, the Company finalized a new $165 million syndicated credit facility with GECDF. This new $165 million syndicated credit facility has a three-year term and supersedes the $240.0 million credit facility that was in effect with GECDF prior to the closing of this transaction. The new credit facility components include a maximum of $75 million for inventory financing and a revolver, collateralized primarily by accounts receivable, of up to $110 million. Under the new agreement, the credit facility provides a letter of credit facility of $5 million. The accounts receivable portion of the credit facility carries a variable interest rate based on the London InterBank Offering Rate ("LIBOR") and a pricing grid. At July 5, 2004, the Company did not have a balance outstanding under the working capital component of this facility. The credit facility is collateralized by substantially all of the assets of the Company, except those assets that collateralize certain other financing arrangements. Under the terms of the credit facility, the Company is subject to various financial covenants. Currently, the Company is in compliance with all financial covenants. The Company believes that the anticipated cash flow from operations and current financing arrangements will be sufficient to satisfy the Company's capital requirements for the next twelve months. Historically, the Company has financed acquisitions using a combination of cash, earn outs, shares of its Common Stock and seller financing. The merger of Alternative Resources Corporation with and into Pomeroy Acquisition Sub, Inc., a wholly owned subsidiary of the Company, completed on July 23, 2004 was financed using cash on hand and borrowings from Pomeroy's existing line of credit. The Company anticipates that future acquisitions will be financed in a similar manner. Aggregated information about the Company's contractual obligations and other off balance sheet commitments as of July 5, 2004 are presented in the following table: 18

MORE THAN TOTAL YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 5 YEARS --------------------------------------------------------------- Acquisition notes $ 1,162 $ 912 $ 250 $ - $ - $ - $ - Operating leases 13,136 3,869 2,901 1,883 1,646 1,383 1,454 --------------------------------------------------------------- Total contractual cash obligations $14,298 $ 4,781 $ 3,151 $ 1,883 $ 1,646 $ 1,383 $ 1,454 ===============================================================

The operating leases, shown above, are not recorded on the consolidated balance sheet. Operating leases are utilized in the normal course of business. Item 3-Quantitative and Qualitative Disclosures about Market Risk. The Company is exposed to interest rate risk primarily through its credit facility with GECDF. Due to the Company's current cash position, the Company did not experience a material impact from interest rate risk for the second quarter of fiscal 2004. Currently, the Company does not have any significant financial investments for trading or other speculative purposes or to manage interest rate exposure. Item 4-Controls and Procedures As of July 5, 2004, an evaluation was carried out under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are, to the best of their knowledge, effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to July 5, 2004, our Chief Executive Officer and Chief Financial Officer have concluded that there were no significant changes in the Company's internal controls or in other factors that could significantly affect our internal controls. 19 PART II - OTHER INFORMATION Item 1-Legal Proceedings There are various legal actions arising in the normal course of business that have been brought against the Company. Management believes these matters will not have a material adverse effect on the Company's financial position or results of operations. Item 2-Changes in Securities and Use of Proceeds Issuer Purchases of Equity Securities

(c) Total number (d) Maximum of shares number of shares (a) Total number (b) Average purchased as that may yet be of shares price paid part of publicly purchased under Period purchased per share announced plan the plan 4/6/04 - 5/5/04 - 5/6/04 - 6/5/04 - 6/6/04 - 7/5/04 30,000 $ 11.64 413,367 586,633 ------------------------------------------------------------------ Total 30,000 $ 11.64 413,367 586,633 ==================================================================

Item 3-Defaults Upon Senior Securities NONE Item 4-Submission of Matters to a Vote of Security Holders On June 10, 2004, the Company held its annual meeting of stockholders for the following purposes: 1. To elect nine directors; and 2. To approve the amendment to the Company's 1998 Employee Stock Purchase Plan; and 3. To approve the amendments to the Company's 2002 Outside Director's Stock option Plan; and 4. To approve the Company's 2002 Amended and Restated Stock Incentive Plan. The voting on the above matters by the stockholders was as follows:

Matter ------ Election of Directors: For Withheld ---------------------- ---------- --------- David B. Pomeroy, II 6,937,918 4,941,894 James H. Smith III 6,867,790 5,012,022 Michael E. Rohrkemper 6,908,252 4,971,560 Stephen E. Pomeroy 6,924,375 4,955,437 William H. Lomicka 10,529,259 1,350,553 Vincent D. Rinaldi 6,988,240 4,891,572 Debra E. Tibey 10,217,221 1,662,591 Edward E. Faber 10,268,514 1,611,298 Kenneth R. Waters 10,581,026 1,298,786

20 Approve the Amendment to the Company's 1998 Employee Stock Purchase ---------------------------------------------------------------------- Plan ---- 10,178,853 shares were voted in favor of the forgoing proposal and 295,019 shares were voted against the forgoing proposal. Stockholders holding 49,785 shares abstained from voting in this proposal. The number of shares voted in favor of the proposal was sufficient for its passage. Approve the Amendment to the Company's 2002 Outside Director's Stock ---------------------------------------------------------------------- Option Plan ------------ 8,377,604 shares were voted in favor of the forgoing proposal and 2,095,098 shares were voted against the forgoing proposal. Stockholders holding 50,955 shares abstained from voting in this proposal. The number of shares voted in favor of the proposal was sufficient for its passage. Approve the Company's 2002 Amended and Restated Stock Incentive Plan ---------------------------------------------------------------------- 6,380,860 shares were voted in favor of the forgoing proposal and 4,091,537 shares were voted against the forgoing proposal. Stockholders holding 51,260 shares abstained from voting in this proposal. The number of shares voted in favor of the proposal was sufficient for its passage. Item 5-Other Information NONE Item 6-Exhibits and Reports on Form 8-K (a) Reports on Form 8-K On May 11, 2004, Pomeroy IT Solutions, Inc. announced that Pomeroy Acquisition Sub, Inc. ("PAS"), a wholly owned subsidiary of Pomeroy and Alternative Resources Corporation ("ARC") entered into an Agreement and Plan of Merger pursuant to which PAS will be merged with and into ARC. On July 23, 2004, Pomeroy IT Solutions, Inc. ("Pomeroy") announced that Pomeroy and PAS completed the merger with Alternative Resources Corporation ("ARC"). On May 11, 2004, the parties entered into a definitive merger agreement for PAS to acquire ARC. The merger was approved by ARC shareholders at a meeting held on July 22, 2004. (b) Exhibits 10 (I) Material Agreements (mm)(1) The Credit Facilities Agreement dated June 28, 2004 by, between, and among Pomeroy IT Solutions, Inc. (formerly known as, Pomeroy Computer Resources, Inc.), Pomeroy Select Integration Solutions, Inc., Pomeroy Select Advisory Services, LLC (formerly, prior to conversion, Pomeroy Select Advisory Services, Inc.), Pomeroy IT Solutions Sales Company, Inc. (formerly known as, Pomeroy Computer Resources Sales Company, Inc.), Pomeroy Computer Resources Holding Company, Inc., Pomeroy Computer Resources Operations, LLP, PCR Holdings, Inc. (formerly known as, Technology Integration Financial Services, Inc.), PCR Properties, LLC (formerly, prior to conversion, PCR Properties, Inc., and prior to such conversion, formerly known as, T.I.F.S. Advisory Services, Inc.), TheLinc, LLC, Val Tech Computer Systems, Inc., Micrologic Business Systems of K.C., LLC, Pomeroy Acquisition Sub, Inc. (collectively, and separately referred to as, "Borrower"), and GE Commercial Distribution Finance Corporation ("GECDF"), as Administrative Agent, and GECDF and the other lenders listed on Exhibit 3 of the Agreement and the signature pages hereto (and their respective successors and permitted assigns), as "Lenders". 21 31.1 Section 302 CEO Certification 31.2 Section 302 CFO Certification 32.1 Section 906 CEO Certification 32.2 Section 906 CFO Certification SIGNATURE 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. POMEROY IT SOLUTIONS, INC. -------------------------- (Registrant) Date: August 16, 2004 By: /s/ Michael E. Rohrkemper ---------------------------------------- Michael E. Rohrkemper Chief Financial Officer and Chief Accounting Officer 22