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 October 5, 2003 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 --- --- As of November 5, 2003, the number of shares of Common Stock issued was 12,933,245 and the number of Common Stock outstanding was 12,194,867. 1

POMEROY IT SOLUTIONS, INC. TABLE OF CONTENTS Part I. Financial Information Item 1. Financial Statements: Page ---- Consolidated Balance Sheets as of October 5, 2003 and January 5, 2003 3 Consolidated Statements of Income for the Three Months Ended October 5, 2003 and 2002 5 Consolidated Statements of Income for the Nine Months Ended October 5, 2003 and 2002 6 Consolidated Statements of Cash Flows for the Nine Months Ended October 5, 2003 and 2002 7 Notes to Consolidated Financial Statements 8 Management's Discussion and Analysis of Financial Condition and Results of Item 2. Operations 16 Quantitative and Qualitative Disclosure Item 3. about Market Risk 22 Item 4. Controls and Procedures 22 Part II. Other Information 23 SIGNATURES 24

2

POMEROY IT SOLUTIONS, INC. CONSOLIDATED BALANCE SHEETS (in thousands) October 5, January 5, 2003 2003 ----------- ----------- (unaudited) ASSETS Current Assets: Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40,264 $ 32,505 Accounts receivable: Trade, less allowance of $1,969 and $1,553 at October 5, 2003 and January 5, 2003, respectively. . . . . . . . . 107,422 95,859 Vendor receivables, less allowance of $3,334 at October 5, 2003 and January 5, 2003 . . . . . . . . . 3,820 10,297 Net investment in leases . . . . . . . . . . . . . . . . . 3,258 1,966 Other. . . . . . . . . . . . . . . . . . . . . . . . . . . 2,004 2,775 ----------- ----------- Total receivables. . . . . . . . . . . . . . . . . . 116,504 110,897 ----------- ----------- Inventories . . . . . . . . . . . . . . . . . . . . . . . . . 13,201 11,238 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,282 10,198 ----------- ----------- Total current assets . . . . . . . . . . . . . . . . 177,251 164,838 ----------- ----------- Equipment and leasehold improvements: Furniture, fixtures and equipment. . . . . . . . . . . . . 29,542 28,741 Leasehold Improvements . . . . . . . . . . . . . . . . . . 6,426 5,951 ----------- ----------- Total. . . . . . . . . . . . . . . . . . . . . . . . 35,968 34,692 Less accumulated depreciation. . . . . . . . . . . . . . . 18,672 15,393 ----------- ----------- Net equipment and leasehold improvements . . . . . . 17,296 19,299 ----------- ----------- Net investment in leases. . . . . . . . . . . . . . . . . . . 2,329 1,889 Goodwill. . . . . . . . . . . . . . . . . . . . . . . . . . . 66,493 60,635 Intangible assets . . . . . . . . . . . . . . . . . . . . . . 481 540 Other assets. . . . . . . . . . . . . . . . . . . . . . . . . 1,027 1,295 ----------- ----------- Total assets . . . . . . . . . . . . . . . . . . . . $ 264,877 $ 248,496 =========== ===========

See notes to consolidated financial statements. 3

POMEROY IT SOLUTIONS, INC. CONSOLIDATED BALANCE SHEETS (in thousands) October 5, January 5, 2003 2003 ----------- ----------- (unaudited) LIABILITIES AND EQUITY Current Liabilities: Accounts payable . . . . . . . . . . . . . . . . . . . . . . . $ 48,394 $ 31,165 Current portion of notes payable . . . . . . . . . . . . . . . 663 541 Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . 3,330 1,490 Other current liabilities. . . . . . . . . . . . . . . . . . . 10,692 8,308 ----------- ----------- Total current liabilities . . . . . . . . . . . . . . . 63,079 41,504 ----------- ----------- Notes payable. . . . . . . . . . . . . . . . . . . . . . . . . 663 - Deferred income taxes. . . . . . . . . . . . . . . . . . . . . 4,728 3,318 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, (12,927 and 12,869 shares issued at October 5, 2003 and January 5, 2003, respectively) . . . . . . . . . . . . . 129 129 Paid in capital . . . . . . . . . . . . . . . . . . . . . . 82,295 81,740 Retained earnings . . . . . . . . . . . . . . . . . . . . . 122,262 125,988 ----------- ----------- 204,686 207,857 Less treasury stock, at cost (738 and 355 shares at October 5, 2003 and January 5, 2003, respectively). . 8,279 4,183 ----------- ----------- Total equity. . . . . . . . . . . . . . . . . . . . . 196,407 203,674 ----------- ----------- Total liabilities and equity. . . . . . . . . . . . . $ 264,877 $ 248,496 =========== ===========

See notes to consolidated financial statements. 4

POMEROY IT SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data) Three Months Ended -------------------------- October 5, October 5, 2003 2002 ------------ ------------ (unaudited) (unaudited) Net sales and revenues: Sales-equipment, supplies and leasing. . . . . . . . $ 125,698 $ 136,976 Service. . . . . . . . . . . . . . . . . . . . . . . 32,374 33,945 ------------ ------------ Total net sales and revenues. . . . . . . . . . . 158,072 170,921 ------------ ------------ Cost of sales and service: Sales-equipment, supplies and leasing. . . . . . . . 116,825 125,777 Service. . . . . . . . . . . . . . . . . . . . . . . 23,612 23,692 ------------ ------------ Total cost of sales and service . . . . . . . . . 140,437 149,469 ------------ ------------ Gross profit . . . . . . . . . . . . . . . . 17,635 21,452 ------------ ------------ Operating expenses: Selling, general and administrative. . . . . . . . 11,331 12,551 Rent expense . . . . . . . . . . . . . . . . . . . 802 786 Depreciation . . . . . . . . . . . . . . . . . . . 1,228 1,158 Amortization . . . . . . . . . . . . . . . . . . . 63 328 Provision for doubtful accounts. . . . . . . . . . - 400 Restructuring charge . . . . . . . . . . . . . . . - 227 Litigation settlement. . . . . . . . . . . . . . . - 300 ------------ ------------ Total operating expenses . . . . . . . . . . 13,424 15,750 ------------ ------------ Income before other expense (income) and income tax . 4,211 5,702 ------------ ------------ Other expense (income): Interest . . . . . . . . . . . . . . . . . . . . . (7) 112 Miscellaneous. . . . . . . . . . . . . . . . . . . 16 (45) ------------ ------------ Net other expense (income) . . . . . . . . . 9 67 ------------ ------------ Income before income tax. . . . . . . . . . . . . 4,202 5,635 Income tax expense . . . . . . . . . . . . . . . . 1,639 541 ------------ ------------ Net income . . . . . . . . . . . . . . . . . . . . $ 2,563 $ 5,094 ============ ============ Weighted average shares outstanding: Basic. . . . . . . . . . . . . . . . . . . . . . . 12,226 12,745 ============ ============ Diluted. . . . . . . . . . . . . . . . . . . . . . 12,369 12,772 ============ ============ Earnings per common share: Basic. . . . . . . . . . . . . . . . . . . . . . . $ 0.21 $ 0.40 ============ ============ Diluted. . . . . . . . . . . . . . . . . . . . . . $ 0.21 $ 0.40 ============ ============

See notes to consolidated financial statements. 5

POMEROY IT SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share data) Nine Months Ended -------------------------- October 5, October 5, 2003 2002 ------------ ------------ (unaudited) (unaudited) Net sales and revenues: Sales-equipment, supplies and leasing . . . . . . . $ 341,879 $ 453,352 Service . . . . . . . . . . . . . . . . . . . . . . 93,523 100,497 ------------ ------------ Total net sales and revenues . . . . . . . . . . 435,402 553,849 ------------ ------------ Cost of sales and service: Sales-equipment, supplies and leasing . . . . . . . 316,186 414,955 Service . . . . . . . . . . . . . . . . . . . . . . 67,887 69,520 ------------ ------------ Total cost of sales and service. . . . . . . . . 384,073 484,475 ------------ ------------ Gross profit. . . . . . . . . . . . . . . . 51,329 69,374 ------------ ------------ Operating expenses: Selling, general and administrative . . . . . . . 34,627 39,475 Rent expense. . . . . . . . . . . . . . . . . . . 2,397 2,550 Depreciation. . . . . . . . . . . . . . . . . . . 3,643 3,485 Amortization. . . . . . . . . . . . . . . . . . . 360 824 Provision for doubtful accounts . . . . . . . . . 200 900 Restructuring charge. . . . . . . . . . . . . . . - 714 Litigation settlement . . . . . . . . . . . . . . 150 300 ------------ ------------ Total operating expenses. . . . . . . . . . 41,377 48,248 ------------ ------------ Income before other expense (income) and income tax. 9,952 21,126 ------------ ------------ Other expense (income): Interest. . . . . . . . . . . . . . . . . . . . . (21) 437 Miscellaneous . . . . . . . . . . . . . . . . . . 1 (53) ------------ ------------ Net other expense (income). . . . . . . . . (20) 384 ------------ ------------ Income before income tax . . . . . . . . . . . . 9,972 20,742 Income tax expense. . . . . . . . . . . . . . . . 3,889 6,358 ------------ ------------ Net income. . . . . . . . . . . . . . . . . . . . $ 6,083 $ 14,384 ============ ============ Weighted average shares outstanding: Basic . . . . . . . . . . . . . . . . . . . . . . 12,340 12,729 ============ ============ Diluted . . . . . . . . . . . . . . . . . . . . . 12,390 12,799 ============ ============ Earnings per common share: Basic . . . . . . . . . . . . . . . . . . . . . . $ 0.49 $ 1.13 ============ ============ Diluted . . . . . . . . . . . . . . . . . . . . . $ 0.49 $ 1.12 ============ ============

See notes to consolidated financial statements. 6

POMEROY IT SOLUTIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Nine Months Ended -------------------------- October 5, October 5, 2003 2002 ------------ ------------ (unaudited) (unaudited) Cash flows from operating activities: Net income . . . . . . . . . . . . . . . . . . . $ 6,083 $ 14,384 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation . . . . . . . . . . . . . . . . . . 3,643 4,121 Amortization . . . . . . . . . . . . . . . . . . 360 824 Deferred income taxes. . . . . . . . . . . . . . 2,365 (1,251) Loss on sale of fixed assets . . . . . . . . . . 73 652 Changes in working capital accounts, net of effects of acquisitions: Receivables . . . . . . . . . . . . . . . . . (1,624) 36,224 Inventories . . . . . . . . . . . . . . . . . (1,851) 3,306 Prepaids. . . . . . . . . . . . . . . . . . . 3,057 (599) Net investment in leases. . . . . . . . . . . (561) 2,823 Accounts payable. . . . . . . . . . . . . . . 13,216 (42,902) Deferred revenue. . . . . . . . . . . . . . . 1,840 (472) Income tax payable. . . . . . . . . . . . . . - (2,866) Other, net. . . . . . . . . . . . . . . . . . 1,629 1,557 ------------ ------------ Net operating activities . . . . . . . . . . . . 28,230 15,801 ------------ ------------ Cash flows from investing activities: Capital expenditures . . . . . . . . . . . . . . (1,485) (7,113) Proceeds from sale of fixed assets . . . . . . . 1 469 Proceeds from sale of leasing segment. . . . . . - 24,374 Acquisition of subsidiary companies, net of cash acquired . . . . . . . . . . . . . . . . (5,097) (1,625) ------------ ------------ Net investing activities . . . . . . . . . . . . (6,581) 16,105 ------------ ------------ Cash flows from financing activities: Payments of notes payable. . . . . . . . . . . . (541) (10,053) Proceeds from notes payable. . . . . . . . . . . - 4,900 Net payments under bank notes payable. . . . . . - (12,118) Proceeds from exercise of stock options. . . . . 391 810 Payment for treasury stock purchase. . . . . . . (4,096) (889) Proceeds from employee stock purchase plan . . . 165 238 Cash dividend. . . . . . . . . . . . . . . . . . (9,809) - ------------ ------------ Net financing activities . . . . . . . . . . . . (13,890) (17,112) ------------ ------------ Increase in cash. . . . . . . . . . . . . . . . . . 7,759 14,794 Cash: Beginning of period. . . . . . . . . . . . . . . 32,505 2,875 ------------ ------------ End of period. . . . . . . . . . . . . . . . . . $ 40,264 $ 17,669 ============ ============

See notes to consolidated financial statements. 7 POMEROY IT SOLUTIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 2003. 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 nine month period ended October 5, 2003 are not necessarily indicative of the results that may be expected for future interim periods or for the year ending January 5, 2004. 2. Recent Accounting Pronouncements In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus opinion 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 has been participating in a vendor program that expires 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 a new agreement which the Company expects to be in place by the end of 2003, the Company will classify 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 will be 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 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. The Company is in the process of determining what impact, if any, the adoption of the provisions of FIN 46 will have upon its financial condition or results of operations. In April 2003, the FASB issued Statement No. 149, "Amendment of Statement Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and clarifies the accounting for 8 derivative instruments, including certain derivatives instruments embedded in other contracts, and for hedging activities under SFAS 133. 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 improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. The new Statement requires that those 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 its 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 October 5, 2003 and January 5, 2003, the Company did not have a balance outstanding under the Company's credit facility. This credit facility expires June 28, 2004. 4. Treasury Stock During the first nine months of fiscal 2003, the Company's Board of Directors authorized a program to repurchase up to 1.1 million shares of the Company's outstanding common stock at market price. During the first nine months of fiscal 2003, the Company repurchased 383,367 shares of its common stock at a cost of $4.1 million. 5. Dividends On August 7, 2003, the Company paid a one-time cash dividend of $9.8 million or $0.80 per share to shareholders of record as of July 28, 2003. 6. Stock-Based Compensation The Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation", in the fall of 1995. The statement encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value beginning in fiscal 1996. The Company elected to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of grant over the amount an employee must pay to acquire the stock. The Company adopted SFAS No. 123 for disclosure purposes and for non-employee stock options. 9 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 pro forma net income and earnings per share would have been as indicated below:

(in thousands, except per share amounts) Three Months Ended October 5, 2003 2002 ------------- ------------- Net income - as reported $ 2,563 $ 5,094 Less, stock-based compensation expense-net of tax 206 242 ------------- ------------- Net income - pro forma $ 2,357 $ 4,852 ============= ============= Net income per common share - as reported Basic $ 0.21 $ 0.40 ============= ============= Diluted $ 0.21 $ 0.40 ============= ============= Net income per common share - pro forma Basic $ 0.19 $ 0.38 ============= ============= Diluted $ 0.19 $ 0.38 ============= =============

(in thousands, except per share amounts) Nine Months Ended October 5, 2003 2002 -------------- -------------- Net income - as reported $ 6,083 $ 14,384 Less, stock-based compensation expense- net of tax 1,011 835 -------------- -------------- Net income - pro forma $ 5,072 $ 13,549 ============== ============== Net income per common share - as reported Basic $ 0.49 $ 1.13 ============== ============== Diluted $ 0.49 $ 1.12 ============== ============== Net income per common share - pro forma Basic $ 0.41 $ 1.06 ============== ============== Diluted $ 0.41 $ 1.06 ============== ==============

10 7. 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 October 5, -------------------------------------- 2003 2002 --------------------- --------------- Per Share Per Share Shares Amount Shares Amount --------- ---------- ------ ------- Basic EPS 12,226 $ 0.21 12,745 $ 0.40 Effect of dilutive Stock options 143 - 27 - --------- ---------- ------ ------- Diluted EPS 12,369 $ 0.21 12,772 $ 0.40 ========= ========== ====== =======

Nine Months Ended October 5, --------------------------------------- 2003 2002 --------------------- ---------------- Per Share Per Share Shares Amount Shares Amount --------- ---------- ------ -------- Basic EPS 12,340 $ 0.49 12,729 $ 1.13 Effect of dilutive Stock options 50 - 70 (0.01) --------- ---------- ------ -------- Diluted EPS 12,390 $ 0.49 12,799 $ 1.12 ========= ========== ====== ========

8. 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 October 5, 2003 and January 5, 2003: 11

(in thousands) Gross Net Gross Net Carrying Accumulated Carrying Carrying Accumulated Carrying Amount Amortization Amount Amount Amortization Amount 10/5/2003 10/5/2003 10/5/2003 1/5/2003 1/5/2003 1/5/2003 ---------- ------------- ---------- --------- ------------- --------- Amortized intangible assets: Covenants not to compete $ 1,845 $ 1,626 $ 219 $ 1,694 $ 1,324 $ 370 Customer lists 627 365 262 477 307 170 ---------- ------------- ---------- --------- ------------- --------- Total amortized intangibles $ 2,472 $ 1,991 $ 481 $ 2,171 $ 1,631 $ 540 ========== ============= ========== ========= ============= =========

Projected future amortization expense related to intangible assets with definite lives are as follows: (in thousands) Fiscal Years: 2003 $ 45 October 6, 2003 - January 5, 2004 2004 138 2005 53 2006 20 2007 20 2008 and thereafter 205 ------ Total $ 481 ====== 12 For the nine months ended October 5, 2003, there was no amortization expense related to goodwill. Amortization expense related to intangible assets was $63 thousand for the quarter ended October 5, 2003 and $360 thousand for the nine months ended October 5, 2003. For the nine months ended October 5, 2002, there was no amortization expense related to goodwill. For the quarter ended October 5, 2002, amortization expense related to intangible assets was $328 thousand. For the nine months ended October 5, 2002, amortization expense related to intangible assets was $741 thousand of which $71 thousand was reported under the captions "cost of sales" or "selling, general and administrative" expenses. Amortization expense associated with assets reported under the caption "other current assets" was $154 thousand. During the first quarter of fiscal 2003, the Company changed the allocation of goodwill by reporting unit. As a result of this evaluation process, the Company reallocated approximately $10.3 million of goodwill to the services reporting unit from the products reporting unit. This reallocation had no effect on the result of any previous period's impairment testing. The reallocation is also reflected in the segment information in Note 11. The reallocation of the net carrying amount of goodwill for the nine months ended October 5, 2003 by segment are as follows:

(in thousands) Products Services Consolidated ---------- --------- ------------- Net carrying amount as of 1/5/03 $ 42,357 $ 18,278 $ 60,635 Reallocation of goodwill (10,284) 10,284 - Goodwill recorded during first nine months 3,168 2,690 5,858 ---------- --------- ------------- Net carrying amount as of 10/5/03 $ 35,241 $ 31,252 $ 66,493 ========== ========= =============

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

Nine Months Ended October 5, ------------------------------ 2003 2002 -------------- -------------- Interest paid $ 310 $ 424 ============== ============== Income taxes paid $ 744 $ 10,474 ============== ============== Post acquisition adjustments to purchase price of acquired assets and intangibles $ 299 $ 1,936 ============== ============== Business combinations accounted for as purchases: Assets acquired $ 10,497 $ 2,069 Liabilities assumed 4,074 260 Notes payable 1,326 184 -------------- -------------- Net cash paid $ 5,097 $ 1,625 ============== ==============

13 10. Litigation During the first nine months of fiscal 2003, the Company recorded a litigation settlement of $0.2 million. The litigation settlement is related to a single bankruptcy preference claim. There are various other 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. 11. Segment Information During the first quarter of fiscal 2003, the Company revised its segment methodologies for allocating operating expenses between segments to reflect ongoing changes in the operating activities giving rise to such expenses. This change resulted in a decrease of approximately $1.4 million in the third quarter and $4.5 million year to date of allocated operating expenses to the product segment and a corresponding increase by the same amount to the services segment. In addition, the Company revised its allocation of assets between segments to reflect the use of assets in those segments. The assets affected were principally goodwill, tax-related assets and equipment and leasehold improvements. Summarized financial information concerning the Company's reportable segments is shown in the following table. (in thousands)

Three Months Ended October 5, 2003 --------------------------------------------- Products Services Leasing Consolidated --------- --------- -------- ------------- Revenues $ 125,685 $ 32,374 $ 13 $ 158,072 Income from operations 2,468 1,733 10 4,211 Total assets 169,879 86,849 8,149 264,877 Capital expenditures 160 159 - 319 Depreciation and amortization 644 647 - 1,291

Three Months Ended October 5, 2002 --------------------------------------------- Products Services Leasing Consolidated --------- --------- -------- ------------- Revenues $ 136,722 $ 33,945 $ 254 $ 170,921 Income from operations 1,921 3,570 211 5,702 Total assets 193,990 61,490 6,649 262,129 Capital expenditures 961 22 - 983 Depreciation and amortization 1,367 227 14 1,608

14

Nine Months Ended October 5, 2003 --------------------------------------------- Products Services Leasing Consolidated --------- --------- -------- ------------- Revenues $ 341,715 $ 93,523 $ 164 $ 435,402 Income from operations 5,746 4,056 150 9,952 Total assets 169,879 86,849 8,149 264,877 Capital expenditures 737 748 - 1,485 Depreciation and amortization 2,073 1,930 - 4,003

Nine Months Ended October 5, 2002 --------------------------------------------- Products Services Leasing Consolidated --------- --------- -------- ------------- Revenues $ 449,864 $ 100,497 $ 3,488 $ 553,849 Income from operations 7,655 11,945 1,526 21,126 Total assets 193,990 61,490 6,649 262,129 Capital expenditures 4,908 2,121 84 7,113 Depreciation and amortization 4,061 664 220 4,945

12. Restructuring Charge During fiscal 2002, the Company approved a plan to consolidate and relocate operations in various geographical locations and to abandon certain assets associated with modification to strategic initiatives. The execution of the plan began and was completed during fiscal 2002. As of October 5, 2003, the Company had paid all of the remaining accrued and unpaid costs. 13. Acquisitions During fiscal 2003, the Company completed one acquisition through a stock purchase. The acquisition of Micrologic Business Systems of K.C., Inc. ("Micrologic"), a Kansas City based IT solutions and professional services provider was completed on February 21, 2003. For the twelve months ended December 31, 2002, Micrologic recorded revenues of $32.0 million. Their primary services include systems network integration, project management, and telephony integration. The Company recorded $3.2 million of goodwill related to the acquisition. The total consideration given consisted of $3.8 million in cash and subordinated notes of $1.3 million. Additionally, the purchase price will be adjusted for any potential earn outs. The Company shall pay fifty percent of the net profit before taxes ("NPBT") to the purchaser in excess of the NPBT threshold for the applicable year, subject to a cumulative limitation of $3.5 million during such aggregate period as earn outs. Interest on the subordinated notes is payable quarterly. Principal in the amount of $1.3 million is payable in two annual installments commencing on the first anniversary of closing. The acquisition was accounted for as a purchase, accordingly the purchase price was allocated to assets and liabilities based on their estimated value as of the date of acquisition. The results of operations of the acquisition are included in the consolidated statement of income from the date of acquisition. If the 2003 acquisition had occurred on January 6, 2003, the pro forma operations of the Company would not have been materially different than that reported in the accompanying consolidated statements of income. 15 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. 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 decreased $12.8 million, or 7.5%, to $158.1 million in the third quarter of fiscal 2003 from $170.9 million in the third quarter of fiscal 2002. This decrease was a result primarily of a continued industry-wide slowdown in technology spending due to the general weakness in the U.S. economy. Further, the Company sometimes elects to take a commission from the manufacturers for arranging sales transactions where it judges the gross profit to be inadequate for its participation in the sales transaction. During the third quarter of fiscal 2003, the Company elected to take such commissions on transactions whose sales would otherwise have been $2.6 million. Excluding acquisitions completed in fiscal year 2003, total net sales and revenues decreased 13.3%. Products and leasing sales decreased $11.3 million, or 8.2% to $125.7 million in the third quarter of fiscal 2003 from $137.0 million in the third quarter of fiscal 2002. Excluding acquisitions completed in fiscal year 2003, products and leasing sales decreased 15.0%. Service revenues decreased $1.5 million, or 4.4%, to $32.4 million in the third quarter of fiscal 2003 from $33.9 million in the third quarter of fiscal year 2002. Excluding acquisitions completed in fiscal year 2003, service revenues decreased 6.7%. Total net sales and revenues decreased $118.4 million, or 21.4%, to $435.4 million in the first nine months of fiscal 2003 from $553.8 million in the first nine months of fiscal 2002. This decrease was a result primarily of a continued industry-wide slowdown in technology spending due to the general weakness in the U.S. economy. Further, the Company sometimes elects to take a commission from the manufacturers for arranging sales transactions where it judges the gross profit to be inadequate for its participation in the sales transaction. During the first nine months of fiscal 2003, the Company elected to take such commissions on transactions whose sales would otherwise have been $7.9 million. Excluding acquisitions completed in fiscal year 2003, total net sales and revenues decreased 25.3%. Products and leasing sales decreased $111.5 million, or 24.6% to $341.9 million in the first nine months of fiscal 2003 from $453.4 million in the first nine months of fiscal 2002. Excluding acquisitions completed in fiscal year 2003, products and leasing sales decreased 29.0%. Service revenues decreased $7.0 million, or 7.0%, to $93.5 million in the first nine months of fiscal 2003 from $100.5 million in the first nine months of fiscal year 2002. Excluding acquisitions completed in fiscal year 2003, service revenues decreased 8.6%. 16 GROSS PROFIT. Gross profit decreased to 11.2% in the third quarter of fiscal 2003 as compared to 12.6% in the third quarter of fiscal 2002. This decrease in gross profit resulted primarily from the decrease in hardware and service margins, but was offset somewhat by the higher proportion of service gross margin to total gross margin. The decrease in hardware gross margin is primarily associated with the Company's strategic decision to aggressively price its hardware business in order to maintain and capture market share and to the weakened economic conditions of the IT industry. On a forward looking basis, the Company expects to continue its aggressive product pricing in order to gain existing market share which will have a continued impact on product gross margin. The competitive environment as well as less than maximum technical employee utilization rate has also resulted in downward pressure on service margins. 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. Service revenues increased to 20.5% of total net sales and revenues in the third quarter of fiscal 2003 compared to 19.9% of total net sales and revenues in the third quarter of fiscal 2002. Service gross margin increased to 49.7% of total gross margin in the third quarter of fiscal 2003 from 47.8% in the third quarter of fiscal 2002. 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 decreased to 11.8% in the first nine months of fiscal 2003 as compared to 12.5% in the first nine months of fiscal 2002. This decrease in gross profit resulted primarily from the decrease in hardware and service margins, but was offset somewhat by the higher proportion of service gross margin to total gross margin associated with the improved utilization of service personnel. The decrease in hardware gross margin is primarily associated with the Company's strategic decision to aggressively price its hardware business in order to maintain and capture market share and to the weakened economic conditions of the IT industry. On a forward looking basis, the Company expects to continue its aggressive product pricing in order to gain existing market share which will have a continued impact on product gross margin. The competitive environment as well as less than maximum technical employee utilization rate has also resulted in downward pressure on service margins. 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. Service revenues increased to 21.5% of total net sales and revenues in the first nine months of fiscal 2003 compared to 18.1% of total net sales and revenues in the first nine months of fiscal 2002. Service gross margin increased to 49.9% of total gross margin in the first nine months of fiscal 2003 from 44.7% in the first nine months of fiscal 2002. 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 7.7% in the third quarter of fiscal 2003 from 8.0% in the third quarter of fiscal 2002. Total operating expenses expressed as a percentage of total net sales and revenues decreased to 8.5% in the third quarter of fiscal 2003 from 9.2% in the third quarter of fiscal 2002. This decrease is primarily due to the provision for doubtful accounts, litigation settlement and the restructuring charge recorded in the third quarter of fiscal 2002. Selling, general and administrative expenses (including rent expense and provision for doubtful accounts) expressed as a percentage of total net sales and revenues increased to 8.5% in the first nine months of fiscal 2003 from 7.8% in the first nine months of fiscal 2002. Total operating expenses expressed as a percentage of total net sales and revenues increased to 9.5% in the first nine months of fiscal 2003 from 8.7% in the first nine months of fiscal 2002. This increase is primarily the result of lower total net sales and revenues during the first nine months of fiscal 2003 as compared to the first nine months of fiscal 2002. 17 RESTRUCTURING CHARGE. In the second quarter of fiscal 2002, the Company approved a plan to consolidate and relocate operations in various geographical locations and to abandon certain assets associated with modification to strategic initiatives. The plan resulted in a pre-tax restructuring charge of $714 thousand ($438 thousand after tax) for the nine months ended October 5, 2002. The restructuring costs consist of $484 thousand in equipment and leasehold improvement dispositions, $126 thousand in involuntary employee severance costs, and $104 thousand in lease terminations. Under the plan, the Company eliminated approximately 40 employees. The execution of the plan began in the second quarter of fiscal 2002 and was completed in the third quarter of fiscal 2002. As of October 5, 2003, the Company had paid all of the remaining accrued and unpaid restructuring costs. LITIGATION SETTLEMENT. During the third quarter 2002, the Company recorded a litigation settlement of $0.3 million. The litigation settlement is related to a single bankruptcy preference claim. During the second quarter of 2003, the Company recorded a litigation settlement of $0.2 million. The litigation settlement is related to a single bankruptcy preference claim. INCOME FROM OPERATIONS. Income from operations decreased $1.5 million, or 26.3%, to $4.2 million in the third quarter of fiscal 2003 from $5.7 million in the third quarter of fiscal 2002. The Company's operating margin decreased to 2.7% in the third quarter of fiscal 2003 as compared to 3.3% in the third quarter of fiscal 2002. This decrease is primarily due to the decrease in the Company's gross margin. Income from operations decreased $11.1 million, or 52.6%, to $10.0 million in the first nine months of fiscal 2003 from $21.1 million in the first nine months of fiscal 2002. The Company's operating margin decreased to 2.3% in the first nine months of fiscal 2003 as compared to 3.8% in the first nine months of fiscal 2002. This decrease is primarily due to the increase in operating expenses as a percentage of total net sales and revenues and the decrease in the Company's gross margin. INTEREST INCOME/EXPENSE. Interest Income was $0.007 million in the third quarter of fiscal 2003 compared to interest expense of $0.1 million in the third quarter of fiscal 2002. This decrease was due to reduced borrowings as a result of improved cash flow and interest income earned on cash balances. Interest income was $0.02 million in the first nine months of fiscal 2003 compared to interest expense of $0.4 million in the first nine months of fiscal 2002. This decrease was due to reduced borrowings as a result of improved cash flow, the sale of certain T.I.F.S. assets and interest income on cash balances. INCOME TAXES. The Company's effective tax rate was 39.0% in the third quarter of fiscal 2003 compared to 9.6% in the third quarter of fiscal 2002. This increase was related to a tax benefit of $1.6 million associated with an increase in the tax basis of leased assets as a result of an accounting method change for tax purposes in the third quarter of fiscal 2002. The Company's effective tax rate was 39.0% in the first nine months of fiscal 2003 compared to 30.7% in the first nine months of fiscal 2002. This increase was related to a tax benefit of $1.6 million associated with an increase in the tax basis of leased assets as a result of an accounting method change for tax purposes in the third quarter of fiscal 2002. 18 NET INCOME. Net income decreased $2.5 million, or 49.7%, to $2.6 million in the third quarter of fiscal 2003 from $5.1 million in the third quarter of fiscal 2002 due to the factors described above. Net income decreased $8.3 million, or 57.6%, to $6.1 million in the first nine months of fiscal 2003 from $14.4 million in the first nine months of fiscal 2002 due to the factors described above. 19 LIQUIDITY AND CAPITAL RESOURCES Cash provided by operating activities was $28.2 million in the first nine months of fiscal 2003. Cash used in investing activities was $6.6 million, which included $5.1 million for an acquisition made in 2003 and prior year acquisitions and $1.5 million for capital expenditures. Cash used in financing activities was $13.9 million, which included $4.1 million for the purchase of treasury stock, $0.5 million in payments under notes payable, $9.8 million for a dividend payment and offset by $0.5 million in proceeds from the employee stock purchase plan and exercise of stock options. A significant part of the Company's inventories is financed by floor plan arrangements with third parties. At October 5, 2003, 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% per annum. 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. At October 5, 2003, 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. The Company anticipates that future acquisitions will be financed in a similar manner.

Aggregated information about the Company's contractual obligations and other commitments as of October 5, 2003 is presented in the following table: MORE THAN (in thousands) TOTAL YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 5 YEARS ------- ------- ------- ------- ------- ------- ---------- Acquisition note $ 1,326 $ 663 $ 663 $ - $ - $ - $ - Operating leases 15,696 4,055 3,487 2,468 1,787 1,489 2,410 ------- ------- ------- ------- ------- ------- ---------- Total contractual cash obligations $17,022 $ 4,718 $ 4,150 $ 2,468 $ 1,787 $ 1,489 $ 2,410 ======= ======= ======= ======= ======= ======= ==========

20 On January 29, 2003, the Company's Board of Directors authorized a program to repurchase up to an additional 100,000 shares of the Company's outstanding common stock, which represents less than 1.0% of its outstanding common stock, in open market purchases made from time to time at the discretion of the Company's management. On May 13, 2003, the Company announced that its Board of Directors authorized the repurchase of an additional 1,000,000 shares through its stock repurchase program. The additional shares to be repurchased represent approximately 8.0% of the Company's outstanding common stock and will be purchased in open market purchases made from time to time at the discretion of the Company's management. The time and extent of the repurchases will depend on market conditions. The acquired shares will be held in treasury or cancelled. The Company anticipates financing the stock redemption program out of working capital and the redemption program will be effectuated over the next 12 months. On February 21, 2003, the Company announced the completion of the acquisition of Micrologic Business Systems of K.C., Iin. ("Micrologic"), a Kansas City based IT solutions and professional services provider. For the twelve months ended December 31, 2002, Micrologic recorded revenues of $32.0 million. Their primary services include systems network integration, project management, and telephony integration. On July 18, 2003, the Company announced that it would pay a one-time dividend of approximately $10 million or $.80 per share to shareholders of record as of July 28, 2003. The cash dividend of $9.8 million was paid on August 7, 2003. 21 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 nine months of fiscal 2003. 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 October 5, 2003, 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 October 5, 2003, 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. 22 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 23 Item 6-Exhibits and Reports on Form 8-K (a) Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . On October 7, 2003, the Company reported the dismissal of Grant Thornton LLP as the Company's independent accountants effective October 3, 2003. Additionally, the Company reported the engagement of Crowe Chizek and Company LLC as its new independent accountants effective October 3, 2003. On November 11, 2003, the Company announced the results for the third quarter and the nine months ended October 5, 2003. (b) Exhibits 10 Material Agreements 10 (iii) Material Employee Benefit and Other Agreements (j)(7) Amended and restated employment agreement by and between Pomeroy IT Solutions, Inc. fka Pomeroy Computer Resources, Inc. and Stephen E. Pomeroy, dated November 3, 2003 11 Computation of earnings per share 31(a) Section 302 CEO Certification 31(b) Section 302 CFO Certification 32(a) Section 906 CEO Certification 32(b) Section 906 CFO Certification SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. POMEROY IT SOLUTIONS, INC. -------------------------- (Registrant) Date: November 19, 2003 By: /s/ Michael E. Rohrkemper ----------------------------- Michael E. Rohrkemper Chief Financial Officer and Chief Accounting Officer 24