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 April 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 April 30, 2004 was 12,257,752 1 POMEROY IT SOLUTIONS, INC. TABLE OF CONTENTS Part I. Financial Information Item 1. Financial Statements: Page ---- Consolidated Balance Sheets as of April 3 5, 2004 (Unaudited) and January 5, 2004 Consolidated Statements of Income for the Three Months Ended April 5, 2004 5 and 2003 (Unaudited) Consolidated Statements of Cash Flows 6 for the Three Months Ended April 5, 2004 and 2003 (Unaudited) Notes to Consolidated Financial 7 Statements (Unaudited) Item 2. Management's Discussion and Analysis of 12 Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosure 17 about Market Risk Item 4. Controls and Procedures 17 Part II. Other Information 18 SIGNATURES 20 2

POMEROY IT SOLUTIONS, INC. CONSOLIDATED BALANCE SHEETS (in thousands) April 5, January 5, 2004 2004 ------------ ----------- (unaudited) ASSETS Current Assets: Cash and cash equivalents. . . . . . . . . . . . . . . $ 48,633 $ 40,200 Accounts receivable: Trade, less allowance of $2,556 at April 5, 2004 and January 5, 2004. . . . . . . . . . . . . . 99,961 111,324 Vendor receivables, less allowance of $100 at April 5, 2004 and January 5, 2004. . . . . . . 4,032 7,226 Net investment in leases . . . . . . . . . . . . . 2,491 2,056 Other. . . . . . . . . . . . . . . . . . . . . . . 2,117 2,043 ------------ ----------- Total receivables . . . . . . . . . . . . . . 108,601 122,649 ------------ ----------- Inventories. . . . . . . . . . . . . . . . . . . . . . 22,158 12,453 Other. . . . . . . . . . . . . . . . . . . . . . . . . 4,968 5,193 ------------ ----------- Total current assets. . . . . . . . . . . . . 184,360 180,495 ------------ ----------- Equipment and leasehold improvements: Furniture, fixtures and equipment . . . . . . . . . 29,908 29,517 Leasehold Improvements. . . . . . . . . . . . . . . 6,332 6,438 ------------ ----------- Total . . . . . . . . . . . . . . . . . . . . 36,240 35,955 Less accumulated depreciation . . . . . . . . . . . 20,392 19,696 ------------ ----------- Net equipment and leasehold improvements. . . 15,848 16,259 ------------ ----------- Net investment in leases, net of current portion . . . 2,781 2,935 Goodwill . . . . . . . . . . . . . . . . . . . . . . . 67,910 67,664 Intangible assets, net . . . . . . . . . . . . . . . . 496 436 Other assets . . . . . . . . . . . . . . . . . . . . . 1,490 1,410 ------------ ----------- Total assets. . . . . . . . . . . . . . . . . $ 272,885 $ 269,199 ============ ===========

See notes to consolidated financial statements. 3

POMEROY IT SOLUTIONS, INC. CONSOLIDATED BALANCE SHEETS (in thousands) April 5, January 5, 2004 2004 ------------ ----------- (unaudited) LIABILITIES AND EQUITY Current Liabilities: Current portion of notes payable. . . . . . . . . . . . . . . . $ 913 $ 912 Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . 50,615 50,051 Deferred revenue. . . . . . . . . . . . . . . . . . . . . . . . 3,082 3,988 Other current liabilities . . . . . . . . . . . . . . . . . . . 10,814 8,758 ------------ ----------- Total current liabilities. . . . . . . . . . . . . . . . 65,424 63,709 ------------ ----------- Notes payable, less current portion . . . . . . . . . . . . . . 250 913 Deferred income taxes . . . . . . . . . . . . . . . . . . . . . 4,818 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, (12,990 and 12,943 shares issued at April 5, 2004 and January 5, 2004, respectively). . . . . . . . . . . . . . 130 130 Paid-in-capital. . . . . . . . . . . . . . . . . . . . . . . 83,016 82,696 Retained earnings. . . . . . . . . . . . . . . . . . . . . . 127,526 125,250 ------------ ----------- 210,672 208,076 Less treasury stock, at cost ( 738 shares at April 5, 2004 and January 5, 2004, respectively) . . . . . . . . . . . . 8,279 8,279 ------------ ----------- Total equity . . . . . . . . . . . . . . . . . . . . . 202,393 199,797 ------------ ----------- Total liabilities and equity . . . . . . . . . . . . . $ 272,885 $ 269,199 ============ =========== See notes to consolidated financial statements.

4

POMEROY IT SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands, except earnings per share data) Three Months Ended -------------------------- April 5, April 5, 2004 2003 ------------ ------------ (unaudited) (unaudited) Net sales and revenues: Sales-equipment, supplies and leasing . . . . $ 124,599 $ 99,986 Service . . . . . . . . . . . . . . . . . . . 30,615 29,992 ------------ ------------ Total net sales and revenues . . . . . . . 155,214 129,978 ------------ ------------ Cost of sales and service: Sales-equipment, supplies and leasing . . . . 114,573 92,070 Service . . . . . . . . . . . . . . . . . . . 22,272 21,531 ------------ ------------ Total cost of sales and service. . . . . . 136,845 113,601 ------------ ------------ Gross profit. . . . . . . . . . . . . 18,369 16,377 ------------ ------------ Operating expenses: Selling, general and administrative . . . . 12,967 11,687 Rent expense. . . . . . . . . . . . . . . . 768 787 Depreciation. . . . . . . . . . . . . . . . 889 1,165 Amortization. . . . . . . . . . . . . . . . 40 224 ------------ ------------ Total operating expenses. . . . . . . 14,664 13,863 ------------ ------------ Income from operations . . . . . . . . . . . . 3,705 2,514 ------------ ------------ Other expense (income): Interest, net . . . . . . . . . . . . . . . (12) 67 Other . . . . . . . . . . . . . . . . . . . 2 (22) ------------ ------------ Total other expense (income). . . . . (10) 45 ------------ ------------ Income before income tax . . . . . . . . . 3,715 2,469 Income tax expense . . . . . . . . . . . . . . 1,439 963 ------------ ------------ Net income. . . . . . . . . . . . . . . . . $ 2,276 $ 1,506 ============ ============ Weighted average shares outstanding: Basic . . . . . . . . . . . . . . . . . . . 12,231 12,451 ============ ============ Diluted . . . . . . . . . . . . . . . . . . 12,401 12,465 ============ ============ Earnings per common share: Basic . . . . . . . . . . . . . . . . . . . $ 0.19 $ 0.12 ============ ============ Diluted . . . . . . . . . . . . . . . . . . $ 0.18 $ 0.12 ============ ============

See notes to consolidated financial statements. 5

POMEROY IT SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Three Months Ended -------------------------- April 5, April 5, 2004 2003 ------------ ------------ (unaudited) (unaudited) Cash Flows from operating activities: Net income. . . . . . . . . . . . . . . . . . . $ 2,276 $ 1,506 Adjustments to reconcile net income to net cash from operating activities: Depreciation. . . . . . . . . . . . . . . . . . 889 1,163 Amortization. . . . . . . . . . . . . . . . . . 40 224 Deferred income taxes . . . . . . . . . . . . . 197 (672) Loss on sale of fixed assets. . . . . . . . . . 3 - Changes in working capital accounts, net of effects of acquisitions: Accounts receivable. . . . . . . . . . . . . 14,480 20,345 Inventories. . . . . . . . . . . . . . . . . (9,932) 1,419 Prepaids . . . . . . . . . . . . . . . . . . 225 4,887 Net investment in leases . . . . . . . . . . (281) 427 Accounts payable . . . . . . . . . . . . . . 564 612 Deferred revenue . . . . . . . . . . . . . . (906) 66 Income tax payable . . . . . . . . . . . . . 363 - Other, net . . . . . . . . . . . . . . . . . 1,546 808 ------------ ------------ Net operating activities. . . . . . . . . . . . 9,464 30,785 ------------ ------------ Cash Flows from investing activities: Capital expenditures. . . . . . . . . . . . . . (251) (788) Proceeds from sale of fixed assets. . . . . . . - 1 Acquisition of businesses, net of cash acquired. . . . . . . . . . . . . . . . (438) (3,184) ------------ ------------ Net investing activities. . . . . . . . . . . . (689) (3,971) ------------ ------------ Cash Flows from financing activities: Payments of notes payable . . . . . . . . . . . (662) - Proceeds from exercise of stock options and related tax benefit . . . . . . . . . . . 320 34 Purchase of treasury stock. . . . . . . . . . . - (770) ------------ ------------ Net financing activities. . . . . . . . . . . . (342) (736) ------------ ------------ Increase in cash . . . . . . . . . . . . . . . . . 8,433 26,078 Cash and cash equivalents Beginning of period . . . . . . . . . . . . . . 40,200 32,505 ------------ ------------ End of period . . . . . . . . . . . . . . . . . $ 48,633 $ 58,583 ============ ============

See notes to consolidated financial statements. 6 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 three month period ended April 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 7 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 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 April 5, 2004 and January 5, 2004, the Company did not have a balance outstanding under the Company's credit facility. This credit facility expires June 28, 2004. The Company is currently negotiating a new credit facility with terms sufficient for its financing needs and does not anticipate any problems securing a new credit facility before June 28, 2004. 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: 8 (in thousands, except per Three Months Ended April 5, share amounts) 2004 2003 ------------- --------------- Net income - as reported $ 2,276 $ 1,506 Stock-based compensation expense-net of tax 539 552 ------------- --------------- Net income - pro forma $ 1,737 $ 954 ============= =============== Net income per common share - as reported Basic $ 0.19 $ 0.12 ============= =============== Diluted $ 0.18 $ 0.12 ============= =============== Net income per common share - pro forma Basic $ 0.14 $ 0.08 ============= =============== Diluted $ 0.14 $ 0.08 ============= =============== 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) Three Months Ended April 5, --------------------------------------------------------- 2004 2003 ------------------------- ------------------------ Per Share Per Share Shares Amount Shares Amount ------ ----------- ------ ---------- Basic EPS 12,231 $ 0.19 12,451 $ 0.12 Effect of dilutive Stock options 170 (0.01) 14 - ------ ----------- ------ ---------- Diluted EPS 12,401 $ 0.18 12,465 $ 0.12 ====== =========== ====== ========== 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 4/5/2004 4/5/2004 4/5/2004 1/5/2004 1/5/2004 1/5/2004 ----------------------------------- ----------------------------------- Amortized intangible assets: Covenants not-to-compete $ 1,894 $ 1,669 $ 225 $ 1,844 $ 1,650 $ 194 Customer lists 677 406 271 627 385 242 Total amortized intangibles $ 2,571 $ 2,075 $ 496 $ 2,471 $ 2,035 $ 436 ========= ============= ========= ========= ============= =========

9 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 April 5, 2004 and 2003, amortization expense related to intangible assets with definite lives was $40 and $224 thousand, respectively. Projected future amortization expense related to intangible assets with definite lives are as follows: (in thousands) Fiscal Years: 2004 $106 April 6, 2004 - January 5, 2005 2005 58 2006 27 2007 27 2008 27 2009 and thereafter 251 ---- Total $496 ==== The change of the net carrying amount of goodwill for the three months ended April 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 ========= ========= =============

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)

Three Months Ended April 5, ------------------------------- 2004 2003 ------------- ---------------- Interest paid $ 88 $ 70 ============= ================ Income taxes paid $ 978 $ 350 ============= ================ Adjustments to purchase price of acquisition assets and intangibles $ 92 $ 1,624 ============= ================ Business combinations accounted for as purchases: Assets acquired $ 438 $ 7,258 Liabilities assumed - (4,074) ------------------------------- Net cash paid $ 438 $ 3,184 ===============================

10 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. 9. Segment Information Summarized financial information concerning the Company's reportable segments is shown in the following table. (in thousands)

Three Months Ended April 5, 2004 ---------------------------------------------- Products Services Leasing Consolidated --------- --------- --------- ------------- Revenues $ 124,586 $ 30,615 $ 13 $ 155,214 Income from operations 1,533 2,171 1 3,705 Total assets 173,475 91,665 7,745 272,885 Capital expenditures 137 114 - 251 Depreciation and amortization 505 423 1 929 Three Months Ended April 5, 2003 ---------------------------------------------- Products Services Leasing Consolidated --------- --------- --------- ------------- Revenues $ 99,880 $ 29,992 $ 106 $ 129,978 Income from operations 1,270 1,143 101 2,514 Total assets 165,584 83,522 6,515 255,621 Capital expenditures 382 406 - 788 Depreciation and amortization 756 631 - 1,387

10. Merger On May 11, 2004, Pomeroy IT Solutions, Inc. announced that Pomeroy Acquisition Sub, Inc., a wholly owned subsidiary of Pomeroy ("PAS"), and Alternative Resources Corporation (OTCBB: ALRC) ("ARC") entered into an Agreement and Plan of Merger ("Agreement") pursuant to which PAS will be merged with and into ARC. The signing of the Agreement was announced in a joint news release by the parties on May 11, 2004. 11 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. 12 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:

Percentage of Net Sales and Revenues Financial Results Three months ended April 5, ------------------------------------- ------------------------------------ 2004 2003 ---------------- ------------------ Net sales and revenues: Equipment, supplies and leasing 80.3% 76.9% Service 19.7% 23.1% ---------------- ------------------ Total net sales and revenues 100.0% 100.0% ================ ================== Cost of sales and servce: Equipment, supplies and leasing 73.8% 70.8% Service 14.3% 16.6% ---------------- ------------------ Total cost of sales and service 88.1% 87.4% ================ ================== Gross profit: Equipment, supplies and leasing 6.5% 6.1% Service 5.4% 6.5% ---------------- ------------------ Total gross profit 11.9% 12.6% ================ ================== Operating expenses: Selling, general and administrative 8.4% 9.0% Rent 0.5% 0.6% Depreciation 0.6% 0.9% Amortization 0.0% 0.2% ---------------- ------------------ Total operating expenses 9.5% 10.7% ================ ================== Income from operations 2.4% 1.9% Net other expense 0.0% 0.0% Income before income tax 2.4% 1.9% Income tax expense 0.9% 0.7% ---------------- ------------------ Net income 1.5% 1.2% ================ ==================

13 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 $25.2 million, or 19.4%, to $155.2 million in the first quarter of fiscal 2004 from $130.0 million in the first 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 12.4%. Products and leasing sales increased $24.6 million, or 24.6% to $124.6 million in the first quarter of fiscal 2004 from $100.0 million in the first quarter of fiscal 2003. Excluding acquisitions completed in fiscal year 2003, products and leasing sales increased 16.1%. Service revenues increased $0.6 million, or 2.1%, to $30.6 million in the first quarter of fiscal 2004 from $30.0 million in the first quarter of fiscal year 2003. Excluding acquisitions completed in fiscal year 2003, service revenues increased 0.04%. GROSS PROFIT. Gross profit increased $2.0 million, or 12.2%, to $18.4 million in the first quarter of fiscal 2004 from $16.4 million in the first quarter of fiscal 2003. The increase was primarily due to increased product sales offset somewhat by lower service gross profit margins in 2004. Gross profit, as a percentage of revenue, decreased to 11.9% in the first quarter of fiscal 2004 as compared to 12.6% in the first quarter of fiscal 2003. This decrease in gross margin resulted primarily from the decrease in service 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. The decrease in service margins was offset by an increase in product margins enhanced somewhat by the adoption of EITF 02-16. As a consequence of adopting EITF 02-16, the Company recorded approximately $265 thousand during the first quarter of fiscal 2004 of vendor considerations as a reduction of product cost of sales, which would previously have been recorded as a reduction of selling, general and administrative expenses. Excluding the impact of EITF 02-16, and therefore on a non-GAAP basis, the gross profit margin would have been 11.7% during the first quarter of fiscal 2004 compared to 12.6% during the first 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 will 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. 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 8.9% in the first quarter of fiscal 2004 from 9.6% in the first quarter of fiscal 2003. This decrease is primarily a result of higher net sales and revenues. Total operating expenses expressed as a percentage of total net sales and revenues decreased to 9.5% in the first quarter of fiscal 2004 from 10.7% in the first quarter of fiscal 2003. This decrease is primarily the result of higher net sales and revenues. As a result of adopting EITF 02-16, the Company reclassified approximately $265 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 9.6% during the first quarter of fiscal 2004 as compared to 10.7% during the first quarter 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 $1.2 million, or 47.4%, to $3.7 million in the first quarter of fiscal 2004 from $2.5 million in the first quarter of fiscal 2003. The Company's operating margin increased to 2.4% in the first quarter of fiscal 2004 as compared to 1.9% in the first quarter of fiscal 2003. This increase is primarily due to higher net sales and revenues. 14 INTEREST INCOME/EXPENSE. Net interest income was $0.012 million during first quarter of fiscal 2004 as compared to net interest expense of $0.07 million during first quarter of fiscal 2003. This decrease in interest expense was a result of improved net cash flow and interest income earned on cash balances. INCOME TAXES. The Company's effective tax rate was 38.7% in the first quarter of fiscal 2004 compared to 39.0% in the first quarter of fiscal 2003. NET INCOME. Net income increased $0.8 million, or 51.1%, to $2.3 million in the first three months of fiscal 2004 from $1.5 million in the first three months of fiscal 2003 due to the factors described above. LIQUIDITY AND CAPITAL RESOURCES Cash provided by operating activities was $9.5 million in the first three months of fiscal 2004. Cash used in investing activities was $0.7 million, which included $0.4 million for prior year acquisitions and $0.3 million for capital expenditures. Cash used in financing activities was $0.4 million, which included $0.7 million for payments of notes payable offset by $0.3 million of proceeds from exercise of stock options. A significant part of the Company's inventories is financed by floor plan arrangements with third parties. At April 5, 2004, these lines of credit totaled $84.0 million, including $72.0 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. The Company's $240.0 million credit facility with GECDF has a three-year term and includes $72.0 million for inventory financing as described above, $144.0 million for working capital which is based upon accounts receivable financing, and a cash-flow component in the form of a $24.0 million term loan, which is not restricted to a borrowing base. The accounts receivable and term loan portion of the credit facility carry a variable interest rate based on the London InterBank Offering Rate ("LIBOR") and a pricing grid. This credit facility expires June 28, 2004. The Company is currently negotiating a new credit facility with terms sufficient for its financing needs and does not anticipate any problems securing a new credit facility before June 28, 2004. At April 5, 2004, the Company did not have a balance outstanding under the working capital and cash flow components under 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. Other than the merger of Alternative Resources Corporation with an into Pomeroy Acquisition Sub, Inc., a wholly owned subsidiary of the Company, as announced on May 11, 2004 which the Company anticipates will be finance using cash only, the Company anticipates that future acquisitions will be financed in a similar manner. 15 Aggregated information about the Company's contractual obligations and other off balance sheet commitments as of April 5, 2004 are presented in the following table:

MORE THAN TOTAL YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 5 YEARS ------- ------- ------- ------- ------- ------- --------- Acquisition notes $ 1,163 $ 913 $ 250 $ - $ - $ - $ - Operating leases 14,348 3,009 3,634 2,302 1,709 1,520 2,174 ------- ------- ------- ------- ------- ------- --------- Total contractual cash obligations $15,511 $ 3,922 $ 3,884 $ 2,302 $ 1,709 $ 1,520 $ 2,174 ======= ======= ======= ======= ======= ======= =========

The operating leases, shown above, are not recorded on the consolidated balance sheet. Operating leases are utilized in the normal course of business. 16 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 first 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 April 5, 2004, an evaluation was carried out under the supervision and with the participation of the Company's management, including our 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 April 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. 17 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. . . . . . . . . . . None Item 3-Defaults Upon Senior Securities. . . . . . . . . . . . . . . . None Item 4-Submission of Matters to a Vote of Security Holders. . . . . . None Item 5-Other Information. . . . . . . . . . . . . . . . . . . . . . . None Item 6-Exhibits and Reports on Form 8-K (a) Reports on Form 8-K On February 23, 2004, Pomeroy IT Solutions, Inc. announced that it was recognized by Cisco Systems, Inc., during the Cisco annual Partner Summit, in Honolulu, Hawaii, as the Direct Value Added Reseller (DVAR) of the Year in the Southeast Region. The Cisco DVAR Awards are conferred to partners who meet and score the highest on a specific set of requirements that are designed to identify the best channel partners. These include customer satisfaction, year over year growth of Cisco sales and Advanced Technologies sales as a percentage of overall bookings and compliance with the Cisco Channel Partner Program. On May 11, 2004, Pomeroy IT Solutions, Inc. announced that Pomeroy Acquisition Sub, Inc., a wholly owned subsidiary of Pomeroy ("PAS"), and Alternative Resources Corporation ("ARC") entered into an Agreement and Plan of Merger pursuant to which PAS will be merged with and into ARC. (b) Exhibits 10(I) Agreement and Plan of Merger by and between Pomeroy Acquisition Sub, Inc., a wholly owned subsidiary of Pomeroy, and Alternative Resources Corporation, dated May 11, 2004. 10(ii) Lockup and Purchase Agreement by and between Pomeroy IT Solutions, Inc., a Delaware corporation ("Parent"), and Wynnchurch Capital Partners, L.P. ("Wynnchurch US"), a Delaware limited partnership, Wynnchurch Capital Partners Canada, L.P. ("Wynnchurch Canada"), an Alberta, Canada limited partnership and Wynnchurch Capital, Ltd., a Delaware corporation (Wynnchurch US, Wynnchurch Canada and Wynnchurch Capital, Ltd. are collectively "Wynnchurch"), dated May 11, 2004. 10 (iii) Material Employee Benefit and Other Agreements 18 (j)(8) Amended and restated employment agreement by and between Pomeroy IT Solutions, Inc. and David B. Pomeroy, II, dated January 6, 2004. (j)(9) Amended and restated employment agreement by and between Pomeroy IT Solutions, Inc. and Stephen E. Pomeroy, dated January 6, 2004. 31.1 Section 302 CEO Certification 31.2 Section 302 CFO Certification 32.1 Section 906 CEO Certification 32.2 Section 906 CFO Certification 19 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: May 17, 2004 By:/s/ Michael E. Rohrkemper -------------------------------------- Michael E. Rohrkemper Chief Financial Officer and Chief Accounting Officer 20