GLOBAL INDUSTRIAL Co - Quarter Report: 2005 September (Form 10-Q)

Systemax Inc.
Condensed Consolidated Statement of Shareholders' Equity (Unaudited)
(In Thousands)

See notes to condensed consolidated financial statements.

Systemax Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In Thousands)

See notes to condensed consolidated financial statements.

Systemax Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Forward Looking Statements

This report contains forward looking statements within the meaning of that term in the Private Securities Litigation Reform Act of 1995 (Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). Additional written or oral forward looking statements may be made by the Company from time to time, in filings with the Securities and Exchange Commission or otherwise. Statements contained in this report that are not historical facts are forward looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward looking statements may include, but are not limited to, projections of revenue, income or loss and capital expenditures, statements regarding future operations, financing needs, compliance with financial covenants in loan agreements, plans for acquisition or sale of assets or businesses and consolidation of operations of newly acquired businesses, and plans relating to products or services of the Company, assessments of materiality, predictions of future events and the effects of pending and possible litigation, as well as assumptions relating to the foregoing. In addition, when used in this discussion, the words “anticipates”, “believes”, “estimates”, “expects”, “intends”, “plans” and variations thereof and similar expressions are intended to identify forward looking statements.

Forward-looking statements in this report are based on the Company’s beliefs and expectations as of the date of this report and are subject to risks and uncertainties which may have a significant impact on the Company’s business, operating results or financial condition. Investors are cautioned that these forward-looking statements are inherently uncertain. Should one or more of the risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described herein. Statements in this report, particularly in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Notes to Condensed Consolidated Financial Statements, describe certain factors, among others, that could contribute to or cause such differences.

Readers are cautioned not to place undue reliance on any forward looking statements contained in this report, which speak only as of the date of this report. We undertake no obligation to publicly release the result of any revisions to these forward looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unexpected events.

Overview

We are a direct marketer of brand name and private label products. Our operations are organized in two primary reportable segments – Computer Products and Industrial Products. Our Computer Products segment markets personal desktop computers, notebook computers and computer related products in North America and Europe. We assemble our own PCs and sell them under our own trademarks, which we believe gives us a competitive advantage. We also sell personal computers manufactured by other leading companies, such as Hewlett Packard, E-Machines and Sony. Our Industrial Products segment markets material handling equipment, storage equipment and consumable industrial items in North America. We offer more than 100,000 products and continuously update our product offerings to address the needs of our customers, which include large, mid-sized and small businesses, educational and government entities as well as individual consumers. We reach customers by multiple channels, utilizing relationship marketers, e-commerce web sites, mailed catalogues and retail outlet stores. We also participate in the emerging market for on-demand, web-based software applications through the marketing of our PCS Profitability Suite™ of hosted software, which we began during 2004, and in which we have not yet recognized any revenues and have incurred considerable losses to date. Computers and computer related products account for 92% of our net sales, and, as a result, we are dependent on the general demand for information technology products.

The market for computer products is subject to intense price competition and is characterized by narrow gross profit margins. The North American industrial products market is highly fragmented and we compete against multiple distribution channels. Distribution of information technology and our industrial products is working capital intensive, requiring us to incur significant costs associated with the warehousing of many products, including the costs of leasing warehouse space, maintaining inventory and inventory management systems, and employing personnel to perform the associated tasks. We supplement our on-hand product availability by maintaining relationships with major distributors and manufacturers, utilizing a combination of stocking and drop-shipment fulfillment.

The primary component of our operating expenses historically has been employee related costs, which includes items such as wages, commissions, bonuses, and employee benefits. We have made substantial reductions in our workforce and closed or consolidated several facilities over the past several years. In response to poor economic conditions in the United States, we implemented a plan in the first quarter of 2004 to streamline our United States computer business. This plan consolidated duplicative back office and warehouse operations, which resulted in annual savings of approximately $8 million excluding severance and other restructuring costs of approximately $3 million, which were recognized in fiscal 2004. With evidence of a prolonged economic downturn in Europe, we took measures to align our cost structure with expected potentially lower revenues and decreasing gross margins, initiating several cost reduction plans there during 2004 and 2005. Actions taken in 2005 to increase efficiency and profitability in our European operations resulted in the elimination of approximately 240 positions, and are expected to result in approximately $6.0 million in future annual savings excluding the severance and restructuring costs to be recognized in fiscal 2005. We will continue to monitor our costs and evaluate the need for additional actions.

The discussion of our results of operations and financial condition that follows will provide information that will assist in understanding our financial statements, the factors that we believe may affect our future results and financial condition as well as information about how certain accounting principles and estimates affect the consolidated financial statements. This discussion should be read in conjunction with the condensed consolidated financial statements included herein.

Results of Operations

Three Months Ended September 30, 2005 Compared to Three Months Ended September 30, 2004

Net sales for the three months ended September 30, 2005 increased 6.7% to $488.5 million compared to $458.0 million in the year-ago quarter. Net sales in the third quarter of 2005 included approximately $147.6 million of internet-related sales, a 21.9% increase from $121.1 million of internet-related sales in the prior year’s third quarter. North American sales were $327.3 million, an increase of 9.5% from $299.0 million in the prior year. European sales increased 1.4%, to $161.2 million (representing 32.3% of worldwide sales) compared to $159.0 million (34.7% of worldwide sales) in the year-ago quarter. Movements in foreign exchange rates unfavorably impacted the European sales comparison by approximately $0.5 million in the third quarter of 2005. Excluding the movements in foreign exchange rates, European sales would have increased 0.3% from the prior year. Sales as measured in local currencies, which had been declining in the first half of the year in each of the European markets we serve, began to show modest increases in some of these markets in the third quarter. The increase in our North American sales resulted from sales growth in both our computer and industrial products groups. Sales of computer products were $281.5 million, an 8.2% increase from $260.1 million of sales in the prior year and was primarily a result of our successful internet-based marketing focus. Sales of industrial products increased 17.9% to $45.8 million from $38.8 million in the prior year, continuing the trend in sales growth which began with the improved economic conditions in the United States last year.

Gross profit was $70.5 million compared to $71.2 million in the year-ago quarter, a decrease of $0.8 million. The gross profit margin was 14.4% in the current period, compared to 15.6% in the year-ago period. The decline in the gross profit margin was due to pricing pressures in the computer products business and increased warehouse costs for staff and supplies related to increased activity levels from a year ago.

Selling, general and administrative expenses for the quarter decreased $4.4 million, or 6.6%, to $62.0 million compared to $66.4 million in the third quarter of 2004. This decrease resulted primarily from a $1.4 million decrease in bad debt expense and a $2.0 million decrease in net advertising expense. Selling, general and administrative expenses as a percentage of net sales decreased to 12.7% compared to 14.5% in the year-ago quarter.

During the first quarter of 2005 we initiated plans to streamline and restructure the activities of our European computer businesses, resulting in the elimination of approximately 200 positions. We incurred $0.6 million of restructuring costs during the third quarter of 2005 associated with these actions for staff severance and benefits for terminated employees.

We had income from operations for the current quarter of $8.0 million compared to $3.8 million in the year-ago quarter. We had income from operations of $7.0 million in our North American operations in the current quarter compared to income from operations of $7.2 million last year. We had income from operations in Europe of $1.0 million in the third quarter of 2005, compared to a loss from operations of $3.4 million in the year-ago quarter.

Interest and other expense — net consists principally of interest expense. Interest expense was $0.6 million in the third quarter of 2005 and $0.9 million in 2004. Interest income on invested funds increased slightly in 2005 as a result of more cash available for investment.

Income tax expense was $2.9 million in the third quarter of 2005 and $1.8 million in the year-ago quarter. The effective income tax rate for the third quarter of 2005 was 42.5%, compared to 56.9% in the year ago period. The effective income tax rate was higher in 2004 as a result of increases in the projected losses in tax jurisdictions for which no benefit is currently recognized. Changes in the mix of U.S. and non-U.S. earnings over the balance of the year and changes in the valuation of deferred tax assets could have a significant impact on the effective tax rate for the year.

As a result of the above, net income for the third quarter was $3.9 million, or $.11 per basic and diluted share, compared to $1.3 million, or $.04 per basic and diluted share, in the third quarter of 2004.

Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2004

Net sales for the nine months ended September 30, 2005 increased 11.4% to $1.53 billion compared to $1.38 billion in the year-ago period. Net sales in the first nine months of 2005 included approximately 446.5 million of internet-related sales, a 24.6% increase from $358.3 million of internet-related sales in the prior year. North American sales were $1.01 billion, an increase of 16.5% from $871.0 million in the prior year. European sales increased 2.6%, to $517.9 million (representing 33.8% of worldwide sales) compared to $504.8 million (36.7% of worldwide sales) in the year-ago period. Movements in foreign exchange rates positively impacted the European sales comparison by approximately $17.5 million in 2005. Excluding the movements in foreign exchange rates, European sales would have decreased 3.5% from the prior year. Sales as measured in local currencies in each of the European markets we serve decreased in 2005 as a result of continuing weakness in demand for information technology products from business customers. The increase in our North American sales resulted from sales growth in both our computer and industrial products groups. Sales of computer products were $883.6 million, a 16.5% increase from $758.4 million of sales in the prior year and was primarily a result of our successful internet-based marketing focus. Sales of industrial products increased 16.4% to $131.1 million from $112.6 million in the prior year, continuing the trend in sales growth which began with the improved economic conditions in the United States last year.

Gross profit was $221.6 million compared to $215.2 million in the year-ago nine month period, an increase of $6.4 million. The gross profit margin was 14.5% in the current year, compared to 15.6% in the year-ago period. The decline in the gross profit margin was due to pricing pressures in the computer products business and increased warehouse costs for staff and supplies related to increased activity levels from a year ago.

Selling, general and administrative expenses for the nine months increased $5.7 million, or 2.9%, to $201.8 million compared to $196.1 million for the first nine months of 2004. This increase resulted primarily from more than $2.8 million of increased costs in Europe due to the effects of changes in foreign exchange rates and $2.8 million of higher credit card processing fees related to the higher sales volume in 2005. We also had increased consulting fees related to the restatement of our 2004 results which were offset by reductions in other operating expenses. Selling, general and administrative expenses as a percentage of net sales, however, decreased to 13.2% compared to 14.3% in the year-ago period.

During the first quarter of 2005 we initiated plans to streamline and restructure the activities of our European computer businesses. We incurred $3.5 million of restructuring costs associated with these actions in the first nine months of 2005 for staff severance and benefits for terminated employees.

We had income from operations for the first nine months of 2005 of $16.3 million compared to $13.1 million in the year-ago period. We had income from operations of $22.8 million in our North American operations in the current year compared to income from operations of $16.9 million last year. We had a loss from operations in Europe of $6.5 million in the first nine months of 2005, compared to a loss from operations of $3.8 million in the year-ago period.

Interest and other expense — net consists principally of interest expense. Interest expense was $1.4 million in the first nine months of 2005, which was unchanged from 2004. Interest income on invested funds increased slightly in 2005 as a result of less funds available for investment.

Income tax expense was $5.9 million for the first nine months of 2005 and $6.2 million in the year-ago period. The effective income tax rate for 2005 was 42.5%, compared to 55.0% in the year ago period. The effective income tax rate was higher in 2004 as a result of increases in the projected losses in tax jurisdictions for which no benefit is currently recognized. Changes in the mix of U.S. and non-U.S. earnings over the balance of the year and changes in the valuation of deferred tax assets could have a significant impact on the effective tax rate for the year.

As a result of the above, net income for the first nine months of 2005 was $8.0 million, or $.23 per basic and $.22 per diluted share, compared to $5.1 million, or $.15 per basic and $.14 per diluted share, in the first nine months of 2004.

Liquidity and Capital Resources

Our primary liquidity needs are to support working capital requirements in our business and to fund capital expenditures. We rely principally upon operating cash flow and borrowings under our credit facilities to meet these needs. We believe that cash flow available from these sources will be sufficient to meet our working capital requirements, projected capital expenditures and interest and debt repayments in the foreseeable future.

Our working capital was $155.9 million at September 30, 2005, an increase of $7.9 million from $148.0 million at the end of 2004. This was due principally to a $15.2 million increase in cash and a $21.8 million decrease in accounts payable and accrued expenses, offset by a $6.7 million decrease in accounts receivable, an $18.3 million decrease in inventories, a $3.0 million decrease in prepaid expenses and other current assets and a $1.1 million increase in short-term borrowings. Our inventories increased slightly from the end of the prior quarter, but were still considerably lower than at the beginning of the year. Inventory turnover decreased slightly from 10 to 9.7. Future accounts receivable and inventory balances will continue to fluctuate with changes in sales volume and the mix of our net sales between consumer and business customers.

Our cash balance increased to $51.5 million during the nine months ended September 30, 2005 from $36.3 million at the end of 2004. Net cash provided by operating activities was $15.3 million for the first nine months of 2005, compared to $29.8 million in the same period of 2004. The decrease in cash provided by operations in 2005 resulted from changes in our working capital accounts, which used $2.9 million in cash compared to providing $12.1 million of cash in 2004. The improvement resulted primarily from a $12.5 million decrease in accounts payable, accrued expenses and other current liabilities in the first nine months of 2005, compared to a $23.5 million increase for the same period of the prior year. Cash generated from net income adjusted by other non-cash items provided $18.1 million in 2005, compared to $17.7 million provided by these items in 2004.

We maintain our cash and cash equivalents primarily in money market funds or their equivalent. As of June 30, 2005, all of our investments mature in less than three months. Accordingly, we do not believe that our investments have significant exposure to interest rate risk.

We used $4.2 million of cash in 2005 and $4.6 million in 2004 in investing activities, principally for the purchase of property, plant and equipment. Capital expenditures in both periods consisted primarily of upgrades and enhancements to our information and communications systems hardware and facilities costs for the opening of new retail outlet stores.

Net cash of $3.3 million was provided by financing activities in 2005. Cash of $3.0 million was provided by short-term borrowings under our European credit facilities. We used cash of $0.5 million for payments under long-term borrowing and capital lease agreements. Exercises of stock options provided $0.7 million of cash in 2005. Cash of $7.1 million was used in financing activities in 2004, including $6.1 million to repay borrowings under our European lines of credit and $1.3 million to repay long-term obligations. This was offset by $0.3 provided by exercises of stock options.

Under our United States secured revolving credit agreement, which then was $70 million and expired on September 30, 2006, availability as of September 30, 2005 was $62.8 million. There were outstanding letters of credit of $7.7 million and there were no outstanding advances as of June 30, 2005. The agreement was amended in October 2005 to increase the amount available to $120 million, extend the maturity date to October 2010 and provide for United States and United Kingdom borrowings. Under our £15 million ($26.5 million at the September 30, 2005 exchange rate) multi-currency United Kingdom credit facility, which was available to our United Kingdom subsidiaries, at September 30, 2005 there were £8.1 million ($14.3 million) of borrowings outstanding with interest payable at a rate of 5.87%. The facility did not have a termination date, but was cancelable by either party on six months notice. Borrowings under the facility were secured by certain assets of our United Kingdom subsidiaries. The United Kingdom facility was terminated in October 2005 and replaced by expanding the United States credit facility to $120 million.

Under our Netherlands €5 million ($6.0 million at the September 30, 2005 exchange rate) credit facility, at September 30, 2005 there were €2.5 million ($3.0 million) of borrowings outstanding under this line with interest payable at a rate of 5.0% per annum. This facility expires in November 2006.

We also have certain obligations with various parties that include commitments to make future payments. Our principal commitments at September 30, 2005 consisted of repayments of borrowings under our credit agreements and long-term borrowings and payments under operating leases for certain of our real property and equipment.

Off-balance Sheet Arrangements

The Company has not created, and is not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating the Company’s business. The Company does not have any arrangements or relationships with entities that are not consolidated into the financial statements that are reasonably likely to materially affect the Company’s liquidity or the availability of capital resources.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and revenues and expenses during the period. Significant accounting policies employed by the Company, including the use of estimates, were presented in the Notes to Consolidated Financial Statements of the Company’s amended 2004 Annual Report on Form 10-K/A.

Critical accounting policies are those that are most important to the presentation of our financial condition and results of operations, require management’s most difficult, subjective and complex judgments, and involve uncertainties. The accounting policies that have been identified as critical to our business operations and understanding the results of operations pertain to revenue recognition, net accounts receivable, inventories, long-lived assets, income taxes and restructuring charges and accruals. The application of each of these critical accounting policies and estimates was discussed in the Company’s amended Annual Report on Form 10-K/A for the year ended December 31, 2004. There have been no significant changes in the application of critical accounting policies or estimates during 2005. Management believes that full consideration has been given to all relevant circumstances that we may be subject to, and the condensed consolidated financial statements of the Company accurately reflect management’s best estimate of the consolidated results of operations, financial position and cash flows of the Company for the periods presented. Because of the uncertainty in these estimates, actual results could differ from estimates used in applying the critical accounting policies. We are not aware of any reasonably likely events or circumstances which would result in different amounts being reported that would materially affect its financial condition or results of operations.

Recent Accounting Developments

In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.” SFAS 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges. SFAS 151 also requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facility. The provisions of SFAS 151 will be effective for fiscal years beginning after June 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal 2006. The Company does not expect that the adoption will have a material impact on the Company’s consolidated financial position or results of operations.

In December 2004, the FASB issued SFAS 123 (revised 2004) (SFAS 123R), “Share-Based Payment.” SFAS 123R replaced SFAS 123, Accounting for Stock-Based Compensation, and superseded Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees. SFAS 123R requires the recognition of compensation cost relating to share-based payment transactions, including employee stock options, in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS 123R provides alternative methods of adoption which include prospective application and a modified retroactive application. SFAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow as prescribed under current accounting rules. The Company is required to adopt the provisions of SFAS 123R effective as of the beginning of its first quarter in 2006. The Company is evaluating the available alternatives of adoption of SFAS 123R. The Company currently accounts for share-based payments using APB Opinion 25‘s intrinsic value method and recognizes no compensation expense for employee stock options as permitted under SFAS 123. See “Stock-based Compensation” above for the effect on reported net income if we had accounted for our stock-based compensation plans using the fair value recognition provisions of SFAS 123. The actual effects of adopting SFAS 123R will depend on numerous factors, including the amounts of share-based payments granted in the future, the valuation model we use and estimated forfeiture rates. The Company has not made any modifications to its stock-based compensation plans as a result of the issuance of SFAS 123R. The Company believes the adoption of SFAS 123R will not have a material effect on its consolidated financial statements.

In March 2005, the Securities and Exchange Commission (“SEC”) released SEC Staff Accounting Bulletin (“SAB”) 107, “Share-Based Payment.” SAB 107 provides the SEC staff’s position regarding the application of SFAS No. 123R and certain SEC rules and regulations, and also provides the staff’s views regarding the valuation of share-based payments for public companies. The Company will adopt SAB 107 in connection with its adoption of SFAS 123R. The Company is currently reviewing the effects, if any, that the application of SAB 107 will have on the Company’s consolidated financial position and results of operations.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which replaces Accounting Principles Board Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements-An Amendment of APB Opinion No. 28.” SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition of a cumulative effect adjustment within net income of the period of the change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also applies to changes required by an accounting pronouncement in the rare case that the pronouncement does not contain specific transition provisions. This statement also carries forward the guidance from APB No. 20 regarding the correction of an error and changes in accounting estimates. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not believe the adoption of SFAS 154 will have a material effect on its consolidated financial position, results of operations or cash flows.

In June 2005, the FASB issued FSP FAS 143-1, “Accounting for Electronic Equipment Waste Obligations” (“FSP FAS 143-1”), to address the accounting for obligations associated with a European Union’s Directive on Waste Electrical and Electronic Equipment (the “Directive”). The Directive, enacted in 2003, requires EU-member countries to adopt legislation to regulate the collection, treatment, recovery and environmentally sound disposal of electrical and electronic waste equipment. The Directive distinguishes between products put on the market after August 13, 2005 (“new waste”) and products put on the market on or before that date (“historical waste”). FSP FAS 143-1 addresses the accounting for historical waste only and will be applied the later of the first reporting period ending after June 8, 2005 or the date of the adoption of the law by the applicable EU-member country. The adoption of FSP FAS 143-1 did not have a material impact on the Company’s consolidated financial position or results of operations for the EU-member countries which have adopted the law.

In October 2005, the FASB issued FSP FAS 13-1, “Accounting for Rental Costs Incurred During a Construction Period” (“FSP FAS 13-1”), which requires the expensing of rental costs associated with ground or building operating leases that are incurred during the construction period. FSP FAS 13-1 is effective in the first reporting period beginning after December 15, 2005. The Company does not expect that this pronouncement will have a material effect on its financial position or results of operations.

Item 3. Quantitative and Qualitative Disclosure About Market Risk.

We are exposed to market risks, which include changes in U.S. and international interest rates as well as changes in currency exchange rates (principally Pounds Sterling, Euros and Canadian dollars) as measured against the U.S. dollar and each other.

The translation of the financial statements of our operations outside of the United States is impacted by movements in foreign currency exchange rates. Changes in currency exchange rates as measured against the U.S. dollar may positively or negatively affect sales, gross margins, operating expenses and retained earnings as expressed in U.S. dollars. We have limited involvement with derivative financial instruments and do not use them for trading purposes. We may enter into foreign currency options or forward exchange contracts aimed at limiting in part the impact of certain currency fluctuations, but as of September 30, 2005 we had no outstanding forward exchange contracts.

Our exposure to market risk for changes in interest rates relates primarily to our variable rate debt. Our variable rate debt includes short-term borrowings under our European credit facilities and our United Kingdom term loan. As of September 30, 2005, the balance outstanding on our variable rate debt was approximately $25.5 million. Based on our market sensitive instruments as of September 30, 2005, a hypothetical change in average interest rates of one percentage point is not expected to have a material effect on our financial position, results of operations or cash flows for the fiscal year.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company establishes and maintains disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed by the Company in the reports it files under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls are also designed to provide reasonable assurance that such information is accumulated and reported to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosure.

Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in control systems, misstatements due to error or fraud may occur and not be detected. These limitations include the circumstances that breakdowns can occur as a result of error or mistake, the exercise of judgment by individuals or that controls can be circumvented by acts of misconduct. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and the operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934.

Based on their evaluation, as of September 30, 2005, the Chief Executive Officer and the Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were not effective to ensure that the information required to be disclosed by us in this quarterly report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. This conclusion is based on our identification of three material weaknesses in our internal controls over financial reporting as of September 30, 2005. The material weaknesses are:

As a result of this determination and as part of the work undertaken in connection with this report, we have applied compensating procedures and processes as necessary to ensure the reliability of our financial reporting. Accordingly, management believes, based on its knowledge, that (i) this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading with respect to the period covered by this report and (ii) the financial statements, and other financial information included in this report, fairly reflect the form and substance of transactions and fairly present in all material respects our financial condition, results of operations and cash flows as at, and for, the periods presented in this report.

Material Weaknesses Reported for the Years Ended December 31, 2004 and December 31, 2003

As reported in our amended Annual Reports on Form 10-K/A for the years ended December 31, 2004 and December 31, 2003, management was unable to conclude that the Company’s internal controls over financial reporting were then effective, as a result of material weaknesses resulting from the ineffectiveness of internal controls over inventory in our United Kingdom and Tiger Direct subsidiaries. We are continuing to evaluate and test the steps taken to improve the effectiveness of our internal controls over financial reporting and we implemented the following changes to further address our material weaknesses:

During 2005, beginning in the first quarter, we implemented a number of remediation measures to address the material weakness related to inventory at our United Kingdom subsidiary. These measures included:

During 2005, beginning in the third quarter, we also implemented remediation measures to address the material weakness related to inventory at our Tiger Direct subsidiary. These measures included:

While progress is being made to remediate the material weaknesses identified, we are continuing to monitor these processes to further improve our procedures as may be necessary.

Deloitte & Touche LLP, our former independent registered public accounting firm, issued a material weakness letter to the Company which addressed both the weaknesses at the Company’s United Kingdom subsidiary and inadequate oversight and control activities on the part of senior management of the Company over its remote subsidiaries. These matters were discussed in detail among management, the audit committee and Deloitte & Touche.

Section 404 of the Sarbanes-Oxley Act

We are not yet subject to the internal controls certification and attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 because we are not an accelerated filer. Based on SEC implementing regulations in effect as of June 30, 2006, at the end of fiscal year 2007 Section 404 of the Sarbanes-Oxley Act of 2002 will require that management provide an assessment of the effectiveness of the Company’s internal control over financial reporting and that the Company’s independent registered public accounting firm will be required to audit that assessment.

We are continuing to work to achieve compliance with the requirements of Section 404. We have dedicated substantial time and resources to documentation and review of our procedures, including the hiring of additional internal audit staff in both the United States and in Europe. We will also evaluate the need to engage outside consultants to assist us. We have not completed this process or its assessment, due to the complexities of our decentralized structure and the number of accounting systems in use. We have not completed our assessment of our internal control over financial reporting. In addition to the two material weaknesses as of March 31, 2005 discussed under the caption “Disclosure Controls and Procedures,” we have identified a number of internal control significant deficiencies, including controls in the information technology area, that may affect the timeliness and accuracy of recording transactions and which, individually or in the aggregate, could become material weaknesses in future periods if not remediated. While the Company does not believe that the following are currently material weaknesses, they are designated as significant deficiencies as of September 30, 2005:

We have a significant amount of work to do to remediate the items we have identified. In the course of completing our evaluation and testing we may identify further deficiencies and weaknesses that will need to be addressed and will require remediation. We may not be able to correct all such internal control deficiencies in a timely manner and may find that a material weakness or weaknesses continues to exist. As a result, management may not be able to issue an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007, if required.

Changes in Internal Controls Over Financial Reporting

Our management is not aware of any changes in internal control over financial reporting other than those described above that occurred during the quarter ended September 30, 2005 that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Item 6. Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: August 29, 2006

SYSTEMAX INC. By: /s/ RICHARD LEEDS Richard Leeds Chairman and Chief Executive Officer By: /s/ STEVEN GOLDSCHEIN Steven Goldschein Senior Vice President and Chief Financial Officer