GLOBAL INDUSTRIAL Co - Quarter Report: 2007 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

 

COMMISSION FILE NUMBER 1-13792

Systemax Inc.

(Exact name of registrant as specified in its charter)

 

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 filing requirements for the past 90 days.

Yes  x    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer o  Accelerated filer o Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes  o    No  x

The number of shares outstanding of the registrant’s Common Stock as of May 1, 2007 was 35,980,476

TABLE OF CONTENTS

Available Information
Part I
Item 1.		Financial Statements
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures About Market Risk
Item 4.		Controls and Procedures
Part II
Item 6.		Exhibits
		Signatures

 

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Available Information

We maintain an internet web site at www.systemax.com. We file reports with the Securities and Exchange Commission (“SEC”) and make available free of charge on or through this web site our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, including all amendments to those reports.  These are available as soon as is reasonably practicable after they are filed with the SEC.  All reports mentioned above are also available from the SEC’s web site (www.sec.gov). The information on our web site is not part of this or any other report we file with, or furnish to, the SEC.

Our Board of Directors has adopted the following corporate governance documents with respect to the Company (the “Corporate Governance Documents”):

·                                          Corporate Ethics Policy for officers, directors and employees

·                                          Charter for the Audit Committee of the Board of Directors

·                                          Charter for the Compensation Committee of the Board of Directors

·                                          Charter for the Nominating/Corporate Governance Committee of the Board of Directors

·                                          Corporate Governance Guidelines and Principles

In accordance with the corporate governance rules of the New York Stock Exchange, each of the Corporate Governance Documents is available on our Company web site (www.systemax.com) or can be obtained by writing to Systemax Inc., Attention: Board of Directors (Corporate Governance), 11 Harbor Park Drive, Port Washington, NY 11050.

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PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

Systemax Inc.

Condensed Consolidated Balance Sheets

(In thousands)

 

		March 31,			December 31,
		2007			2006
		(Unaudited)
ASSETS:
Current assets:
Cash and cash equivalents		$	105,946		$	86,964
Accounts receivable, net		182,075			164,615
Inventories, net		247,007			233,136
Prepaid expenses and other current assets		19,024			26,919
Deferred income tax assets, net		8,120			7,727
Total current assets		562,172			519,361
Property, plant and equipment, net		47,831			48,586
Deferred income tax assets, net		12,939			14,041
Other assets		2,242			2,173
Total assets		$	625,184		$	584,161
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Current liabilities:
Short-term borrowings, including current portions of long-term debt		$	12,086		$	12,788
Accounts payable		222,806			201,486
Accrued expenses and other current liabilities		75,801			75,688
Dividends payable		36,588			—
Total current liabilities		347,281			289,962
Long-term debt		341			483
Other liabilities		5,729			4,226
Total liabilities		353,351			294,671
Commitments and contingencies		—			—
Shareholders’ Equity:
Preferred stock		—			—
Common stock		383			383
Additional paid-in capital		171,446			172,983
Accumulated other comprehensive income		7,674			7,181
Retained earnings		121,098			144,074
Treasury stock		(28,768		)	(35,131		)
Total shareholders’ equity		271,833			289,490
Total liabilities and shareholders’ equity		$	625,184		$	584,161

 

See notes to condensed consolidated financial statements.

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Systemax Inc.

Condensed Consolidated Statements of Operations (Unaudited)

(In thousands, except per share amounts)

		Three Months Ended
		March 31,
		2007			2006
Net sales		$	676,122		$	574,908
Cost of sales		579,448			484,145
Gross profit		96,674			90,763
Selling, general & administrative expenses		75,137			69,885
Operating income		21,537			20,878
Interest and other income, net		(742		)	(6,623		)
Income before income taxes		22,279			27,501
Provision for income taxes		8,384			9,944
Net income		$	13,895		$	17,557
Net income per common share:
Basic		$	.39		$	.51
Diluted		$	.37		$	.48
Weighted average shares outstanding:
Basic		35,718			34,762
Diluted		37,701			36,553
Dividends declared per common share		$	1.00		—

 

See notes to condensed consolidated financial statements.

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Systemax Inc.

Condensed Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

		Three Months Ended
		March 31,
		2007			2006
Cash flows from operating activities:
Net income		$	13,895		$	17,557
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		2,132			2,011
Provision for deferred income taxes		715			1,460
Provision for returns and doubtful accounts		1,222			266
Compensation expense related to equity compensation plans		832			458
Gain on dispositions and abandonment		(3		)	(7,753		)
Changes in operating assets and liabilities:
Accounts receivable		(18,064		)	(7,880		)
Inventories		(13,784		)	(52,578		)
Prepaid expenses and other current assets		7,896			(990		)
Accounts payable, accrued expenses and other current liabilities		23,859			17,059
Net cash provided by (used in) operating activities		18,700			(30,390		)
Cash flows from investing activities:
Purchases of property, plant and equipment		(1,238		)	(1,699		)
Proceeds from disposals of property, plant and equipment		—			18,641
Net cash provided by (used in) investing activities		(1,238		)	16,942
Cash flows from financing activities:
Repayments of borrowings from banks		(742		)	(3,586		)
Repayments of long-term debt and capital lease obligations		(138		)	(7,911		)
Proceeds from issuance of common stock, net of repurchases		878			6
Excess tax benefit from exercises of stock options		1,579			5
Net cash provided by (used in) financing activities		1,577			(11,486		)
Effects of exchange rates on cash		(57		)	(164		)
Net increase (decrease) in cash and cash equivalents		18,982			(25,098		)
Cash and cash equivalents – beginning of period		86,964			63,291
Cash and cash equivalents – end of period		$	105,946		$	38,193
Supplemental disclosures of non-cash investing and financing activities:
Acquisitions of equipment through capital leases		$	—		$	257

 

See notes to condensed consolidated financial statements.

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Systemax Inc.

Condensed Consolidated Statement of Shareholders’ Equity (Unaudited)

(In thousands)

													Accumulated
		Common Stock											Other
		Number of					Additional						Comprehensive			Treasury
		Shares					Paid-in			Retained			Income,			Stock,			Comprehensive
		Outstanding		Amount			Capital			Earnings			Net of Tax			At Cost			Income
Balances, January 1, 2007		35,341		$	383		$	172,983		$	144,074		$	7,181		$	(35,131	)
Stock-based compensation expense							832
Issuance of restricted stock, net of repurchases		138					(1,915		)							1,557
Exercise of stock options		409					(2,751		)							4,806
Income tax benefit on stock-based compensation							2,297
Cumulative effect of adoption of FIN 48										(283		)
Change in cumulative translation adjustment, net													493						493
Dividends declared										(36,588		)
Net income										13,895									13,895
Total comprehensive income																			$	14,388
Balances, March 31, 2007		35,888		$	383		$	171,446		$	121,098		$	7,674		$	(28,768	)

 

See notes to condensed consolidated financial statements.

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Systemax Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)

1.                Basis of Presentation

The accompanying condensed consolidated financial statements of the Company and its wholly-owned subsidiaries are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America are not required in these interim financial statements and have been condensed or omitted. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to current year presentation.

In the opinion of management, the accompanying condensed consolidated financial statements contain all normal and recurring adjustments necessary to present fairly the financial position of the Company as of March 31, 2007 and the results of operations for the three month periods ended March 31, 2007 and 2006, cash flows for the three month periods ended March 31, 2007 and 2006 and changes in shareholders’ equity for the three month period ended March 31, 2007.  The December 31, 2006 condensed consolidated balance sheet has been derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements as of December 31, 2006 and for the year then ended included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.  The results for the three months ended March 31, 2007 are not necessarily indicative of the results for an entire year.

Adoption of New Accounting Standard

Effective January 1, 2007 the Company adopted the provisions of FASB Interpretation 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”).  FIN 48 clarifies the accounting and reporting for uncertainties in income tax law.  This interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. At January 1, 2007 the Company had a liability for unrecognized tax benefits of $3,378,500 (including interest and penalties of $731,000) of which $283,500 was charged to retained earnings at January 1, 2007. Of this total, $2,586,100 (net of the federal benefit on state issues) represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods.

The Company or one of its subsidiaries file U.S. federal income tax returns and in various state and foreign jurisdictions in Canada and Western Europe.  The Company’s U.S. federal income tax returns have been examined by the Treasury Department through 2001.  State and local tax returns have been examined through various dates from 2001 to 2005 with ongoing tax examinations pending in two states.  Included in the Company’s FIN 48 liability is a current liability of $2,264,000 for the expected taxes and interest relating to a pending state tax examination involving disputed allocation of income to that state; no issues have been raised to date with respect to the other pending state tax examinations. The Company has classified this as a current liability because payment of cash is anticipated within one year. The income tax returns of the Company’s principal foreign subsidiaries have been audited by local taxing authorities for years ended in 2001 through 2004.

With the exception of the current liability of $2,264,000, the Company’s remaining tax liabilities and interest with respect to unrecognized tax benefits have been reclassified to other non-current liabilities on the balance sheet because payment of cash is not anticipated within one year.  This amount at January 1, 2007 aggregates to approximately $1,114,500, including $304,500 for interest and penalties.  The Company’s continuing practice is to record interest and penalties related to tax positions in income tax expense in its consolidated statement of operations.

Other than the aforementioned FIN 48 adoption, since the date of the Company’s annual report on Form 10-K there have been no material changes to the Company’s significant accounting policies.

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2.     Stock-based Compensation Plans

Pre-tax stock-based employee compensation expense for the three months ended March 31, 2007 and 2006 was $689,000 and $241,000 respectively.

3.                Net Income per Common Share

Net income per common share - basic was calculated based upon the weighted average number of common shares outstanding during the respective periods presented.  Net income per common share - diluted was calculated based upon the weighted average number of common shares outstanding and included the equivalent shares for dilutive options outstanding during the respective periods. The dilutive effect of outstanding options issued by the Company is reflected in net income per share - diluted using the treasury stock method. Under the treasury stock method, options will only have a dilutive effect when the average market price of common stock during the period exceeds the exercise price of the options. The weighted average number of stock options outstanding excluded from the computation of diluted earnings per share was zero and 367,000 shares for the three months ended March 31, 2007 and 2006, respectively, due to their antidilutive effect.

4.                Comprehensive Income

Comprehensive income consists of net income and foreign currency translation adjustments, net of tax, and is included in the Condensed Consolidated Statement of Shareholders’ Equity. For the three month periods ended March 31, 2007 and 2006, comprehensive income was $14,388,000 and $18,980,000, respectively.

5.                Credit Facilities

The Company maintains a $120 million (which may be increased by up to $30 million, subject to certain conditions) secured revolving credit agreement with a group of financial institutions which provides for borrowings in the United States and United Kingdom. The borrowings are secured by all of the Company’s domestic and United Kingdom accounts receivable, the domestic inventories of the Company, general intangibles and the Company’s shares of stock in its domestic subsidiaries and the Company’s United Kingdom headquarters building. The credit facility expires and the outstanding borrowings thereunder are due on October 26, 2010. The revolving credit agreement contains certain financial and other covenants, including maintaining a minimum level of availability and restrictions on capital expenditures and payments of dividends. The Company was in compliance with all of the covenants as of March 31, 2007. As of March 31, 2007, eligible collateral under the agreement was $118.9 million and total availability was $100.2 million. There were outstanding letters of credit of $9.5 million and there were outstanding advances of $9.2 million (all in the United Kingdom) as of March 31, 2007.

The Company’s Netherlands subsidiary maintains a €5.0 million ($6.7 million at the March 31, 2007 exchange rate) credit facility with a local financial institution. At March 31, 2007 there were €1.7 million ($2.3 million) of borrowings outstanding with interest payable at a rate of 5.0%. Borrowings under the facility are secured by the subsidiary’s accounts receivable and are subject to a borrowing base limitation of 85% of the eligible accounts. The facility expires in August 2007.

6.                Accrued Restructuring Costs

The Company periodically assesses its operations to ensure that they are efficient, aligned with market conditions and responsive to customer needs. During the years ended December 31, 2005, 2004 and 2003, management approved and implemented restructuring actions which included workforce reductions and facility consolidations.

The following table summarizes the components of the accrued restructuring charges and the movements within these components during the three months ended March 31, 2007 (in thousands).

		Other Exit Costs			Total
Accrued at December 31, 2006		$	89		$	89
Amounts utilized		(29		)	(29		)
Accrued at March 31, 2007		$	60		$	60

 

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7.                Product Warranties

Provisions for estimated future expenses relating to product warranties for the Company’s assembled PCs are recorded as cost of sales when revenue is recognized. Liability estimates are determined based on management judgment considering such factors as the number of units sold, historical and anticipated rates of warranty claims and the likely current cost of corrective action.  The changes in accrue product warranties were as follows:

		Three months ended March 31, 2007
Balance, beginning of year		1,061
Charged to expense		423
Deductions		(434		)
Balance, end of period		$	1,050

 

8.                Segment Information

The Company operates in one primary business as a reseller of business products to commercial and consumer users. The Company operates and is internally managed in three operating segments, Technology Products, Industrial Products and Hosted Software. Our Technology Products sales include computer, computer supplies and consumer electronics. We assemble our own PCs and sell them under the trademarks Systemax™ and Ultra™. In addition, we market and sell computers manufactured by other leading companies. Our Industrial Products segment sells a wide array of material handling equipment, storage equipment, and consumable industrial products. Our Hosted Software segment participates in the emerging market for on-demand, web-based business software applications through the marketing of our PCS ProfitCenter Software™ of hosted software.

The Company’s chief operating decision-maker is the Company’s Chief Executive Officer. The Company evaluates segment performance based on operating income, before net interest, foreign exchange gains and losses, restructuring and other charges and income taxes. Corporate costs not identified with the disclosed segments and restructuring and other charges are grouped as “Corporate and other expenses.” The chief operating decision-maker reviews assets and makes capital expenditure decisions for the Company on a consolidated basis only. The accounting policies of the segments are the same as those of the Company.

Financial information relating to the Company’s operations by reportable segment was as follows (in thousands):

		Three Months Ended
		March 31,
		2007			2006
Net sales:
Technology products		$	624,167		$	530,208
Industrial products		51,874			44,670
Hosted software		81			30
Consolidated		$	676,122		$	574,908
Operating income:
Technology products		$	21,407		$	21,759
Industrial products		4,592			1,339
Hosted Software		(2,669		)	(1,734		)
Corporate and other expenses		(1,793		)	(486		)
Consolidated		$	21,537		$	20,878

 

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Financial information relating to the Company’s operations by geographic area was as follows (in thousands):

		Three Months Ended
		March 31,
		2007			2006
Net sales:
United States:
Industrial products		$	51,874		$	44,670
Technology products		351,220			315,717
Hosted software		81			30
United States total		403,175			360,417
Other North America		37,214			30,547
North America total		440,389			390,964
Europe		235,733			183,944
Consolidated		$	676,122		$	574,908

 

Revenues are attributed to countries based on the location of the selling subsidiary.

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.

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 2006 Annual Report on Form 10-K.

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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, accounts receivable and allowance for doubtful accounts, inventories, long-lived assets, income taxes and restructuring charges and accruals. The application of each of these critical accounting policies and estimates was discussed in Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. There have been no significant changes in the application of critical accounting policies or estimates during 2007, with the exception of any tax estimates or adjustments related to the adoption of FIN 48. Management believes that full consideration has been given to all relevant circumstances that we may be subject to, and the condensed consolidated financial statements of the Company accurately reflect 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.

Overview

We are a direct marketer of brand name and private label products. Our operations are organized in three primary reportable segments – Technology Products, Industrial Products and Hosted Software. Our Technology Products segment markets personal desktop computers, notebook computers and computer related products in North America and Europe.  We assemble our own PCs and sell them under our own trademarks, which we believe gives us a competitive advantage. We also sell personal computers manufactured by other leading companies. Our Industrial Products segment markets material handling equipment, storage equipment and consumable industrial items in North America. We offer more than 100,000 products and continuously update our product offerings to address the needs of our customers, which include large, mid-sized and small businesses, educational and government entities as well as individual consumers. We reach customers by multiple channels, utilizing relationship marketers, e-commerce web sites, mailed catalogues and retail outlet stores. We also participate in the emerging market for on-demand, web-based software applications through the marketing of our PCS Profitability Suite™ of hosted software, which we began during 2004, and in which we have not yet recognized sizable revenues and have incurred considerable losses to date. Technology products account for 92% of our net sales, and, as a result, we are dependent on the general demand for such 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 is working capital intensive, requiring us to incur significant costs associated with the warehousing of many products, including the costs of leasing warehouse space, maintaining inventory and inventory management systems, and employing personnel to perform the associated tasks. We supplement our on-hand product availability by maintaining relationships with major distributors and manufacturers, utilizing a combination of stocking and drop-shipment fulfillment.

The primary component of our operating expenses historically has been employee related costs, which includes items such as wages, commissions, bonuses, and employee benefits. We have made substantial reductions in our workforce and closed or consolidated several facilities over the past several years. Our restructuring actions and other cost savings measures implemented over the last several years resulted in reducing our consolidated selling, general and administrative expenses. We will continue to monitor our costs and evaluate the need for additional actions.

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

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Results of Operations

Three Months Ended March 31, 2007 compared to the Three Months Ended March 31, 2006

Key Performance Indicators (in thousands):

		2007			2006			% Change
Revenues by segment:
Technology Products		$	624,167		$	530,208		17.7	%
Industrial Products		51,874			44,670			16.1	%
Hosted Software		81			30			170.0	%
Total sales		$	676,122		$	574,908		17.6	%
Revenues by geography:
North American sales		$	440,389		$	390,964		12.6	%
European sales		235,733			183,944			28.2	%
Total sales		$	676,122		$	574,908		17.6	%
Internet sales		$	237,583		$	199,912		18.8	%
Gross margin		14.3		%	15.8		%
Selling, general and administrative costs		$	75,137		$	69,885		7.5	%
Selling, general and administrative as a % of net sales		11.1		%	12.2		%
Operating income		$	21,537		$	20,878		3.2	%
Operating margin		3.2		%	3.6		%
Effective income tax rate		37.6		%	36.2		%
Net income		$	13,895		$	17,557		(20.9	)%

 

The Technology Products sales increase was driven by increased internet sales, private label products and expanded product offerings. Industrial Products sales increase resulted from the Company increasing its market share through competitive pricing advantages and increased internet sales. Consolidated internet sales in the first quarter increased 18.8% compared to the year ago period, a greater rate than overall sales. Both North American sales and European sales increased quarter over quarter. Movements in foreign exchange rates positively impacted the European sales comparison by approximately $23 million in 2007. Excluding the movements in foreign exchange rates, European sales would have increased 15% from the prior year. Sales, as measured in local currencies, increased in all of the European markets we serve in the first three months of 2007 compared to the year ago period. The increase in our North American sales resulted from sales growth in both our computer and industrial products groups. This increase was primarily a result of our continuing internet initiatives and expansion of our product offerings. Gross margin decreased due primarily to competitive pricing pressures for technology products. Consolidated gross margin improved by over 140 basis points as compared to the fourth quarter of 2006 due primarily to less price discounting for technology products.

Selling, general and administrative expenses for the first three months increased 7.5%, primarily the result of $6.2 million of increased salaries and $0.9 million of increased credit card fees, offset by settlement proceeds of approximately $2.4 million from a lawsuit that was settled favorably in the first quarter. Selling, general and administrative expenses decreased as a percentage of sales both in North America and Europe compared to the year ago quarter. Included in selling, general and administrative expenses for the first quarter of 2007 is a gain of approximately $2.4 million from a lawsuit settled in the Company’s favor.

Operating income decreased $1.8 million in North America and increased $2.4 million in Europe. This decrease in North America was mainly due to a lower gross margin as compared to the prior year.

During the first quarter of 2006 we sold a warehouse facility and recognized a gain of approximately $6.7 million net of a prepayment penalty incurred upon the repayment of the underlying mortgage loan, which is included in “Other non-operating (income) expense, net.” The facility was replaced by a larger, leased building.

The Company’s estimated effective tax rate was 37.6% in the first quarter of 2007, an increase over 2006 primarily the result of increased pre-tax income in the US and other locations with high tax rates.

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Financial Condition, Liquidity and Capital Resources

Our primary liquidity needs are to support working capital requirements in our business, to fund capital expenditures, minimal acquisitions and the special dividend declared by our Board in March 2007. We rely principally upon operating cash flow and borrowings under our credit facilities to meet these needs. We believe that cash flow available from these sources will be sufficient to meet our working capital requirements as well as any interest and debt repayments in the next twelve months.

Selected liquidity data (in thousands):

		March 31, 2007			December 31, 2006			$ Change
Cash and cash equivalents		$	105,946		$	86,964		$	18,982
Accounts receivable, net		$	182,075		$	164,615		$	17,460
Inventories		$	247,007		$	233,136		$	13,871
Prepaid expenses and other current		$	19,024		$	26,919		$	(7,895	)
Accounts payable		$	222,806		$	201,486		$	21,320
Accrued expenses		$	75,801		$	75,688		$	113
Dividends payable		$	36,588		—			$	36,588
Short term debt		$	12,086		$	12,788		$	(702	)
Working capital		$	214,891		$	229,399		$	(14,508	)

 

Our working capital decreased in the first quarter primarily the result of an increase in dividends payable related to the special dividend declared, as well as an increase in accounts payable. This was offset by an increase in cash in North America, an increase in accounts receivable in Europe and increases in inventory in both Europe and North America. Our inventory turnover remained constant at 10 times. Our accounts receivable increase in Europe was due to the increase in sales in the first quarter of 2007 compared to the fourth quarter of 2006. 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 balances increased in the first quarter of 2007. The increase in cash provided by operations in 2007 resulted from changes in our working capital accounts, which used $.1 million in cash compared to $44.4 million of cash used in 2006, primarily from increases in inventory purchases. Cash generated from net income adjusted by other non-cash items provided $18.8 million for the three months ended March 31, 2007 compared to $14.0 million provided by these items for the three months ended March 31, 2006, primarily as a result of net proceeds of $7.8 million from the sale of a warehouse facility in the first quarter of 2006, offset by a decrease in our net income in the first quarter of 2007.

Last year we had $18.6 million of proceeds from the sale of a warehouse facility. Capital expenditures in 2007 and 2006 consisted primarily of upgrades and enhancements to our information and communications systems hardware and facilities costs for the opening of new retail outlet stores.

Net cash of $1.6 million was provided by financing activities for the three months ended March 31, 2007. We repaid $.7 million in short-term loans in Europe. Proceeds from stock option exercises net of repurchases and excess tax benefits from stock option exercises provided approximately $2.5 million of cash. In the first three months of 2006, we used cash of $7.9 million to repay long-term debt obligations, primarily for the mortgage on a warehouse facility, and we used $3.6 million to repay short-term borrowings in Europe.

Under our $120 million (which may be increased by up to $30 million, subject to certain conditions) secured revolving credit agreement for borrowings in the United States and United Kingdom, as of March 31, 2007, eligible collateral was $118.9 million and total availability was $100.2 million. There were outstanding letters of credit of $9.5 million and there were outstanding advances of $9.2 million (all in the United Kingdom) as of March 31, 2007. The borrowings are secured by all of the domestic and United Kingdom accounts receivable, the domestic inventories of the Company, general intangibles and the Company’s shares of stock in its domestic subsidiaries and the Company’s United Kingdom headquarters building. The credit facility expires and the outstanding borrowings thereunder are due on October 26, 2010. The revolving credit agreement contains certain financial and other covenants, including maintaining a minimum level of availability and restrictions on capital expenditures and payments of dividends. We were in compliance with all of the covenants under this facility as of March 31, 2007.

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Under our Netherlands €5 million ($6.7 million at the March 31, 2007 exchange rate) credit facility, at March 31, 2007 there were €1.7 million ($2.3 million) of borrowings outstanding under this line with interest payable at a rate of 5.0% per annum. This facility expires in August 2007.

We also have certain obligations with various parties that include commitments to make future payments. Our principal commitments at March 31, 2007 consisted of repayments of borrowings under our credit agreements, payments under operating leases for certain of our real property and equipment and payments under employment and other service agreements. In connection with the adoption of FIN 48, the Company has a $3.4 million liability related to uncertain tax positions of which $2.2 million is anticipated to be payable within one year. No other material changes occurred in the Company’s contractual obligations during the three months ended March 31, 2007.

Our current and anticipated needs for cash include funding growth in working capital and capital expenditures necessary for future growth in sales, potential expansion through acquisitions and payment of the special dividend. We believe that our cash balances and our availability under credit facilities will be sufficient to fund our working capital and other cash requirements for the next twelve months.

We maintain our cash and cash equivalents primarily in money market funds or their equivalent. As of March 31, 2007, all of our investments had maturities of less than three months.  Accordingly, we do not believe that our investments have significant exposure to interest rate risk.

Off-balance Sheet Arrangements

The Company currently leases its facility in Port Washington, NY from Addwin Realty Associates, an entity owned by Richard Leeds, Bruce Leeds, and Robert Leeds, Directors of the Company and the Company’s three senior executive officers and principal stockholders.

The Company has not created, and is not party to, except as described above, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating the 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.

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 March 31, 2007 we had no outstanding forward exchange contracts.

Our exposure to market risk for changes in interest rates relates primarily to our variable rate debt. Our variable rate debt includes short-term borrowings in Europe under our credit facilities. As of March 31, 2007, the balance outstanding on our variable rate debt was approximately $9.2 million. Based on our market sensitive instruments as of March 31, 2007, a hypothetical change in average interest rates of one percentage point is not expected to have a material effect on our financial position, results of operations or cash flows for the fiscal year.

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Item 4.   Controls and Procedures

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

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

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and the operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934. As part of this evaluation we identified certain significant deficiencies in our internal controls over financial reporting as of March 31, 2007. These significant deficiencies are:

·                  The Company has internal control deficiencies in its information technology area including the lack of adequate general controls. The Company lacks program change and project management controls, has inadequate segregation of duties between information technology department development and production functions, needs formal information technology strategic planning, needs formal documentation of information security procedures, needs security around user rights to certain application systems and needs to implement formal help desk procedures.

·                  The Company has disparate operating and financial information systems at certain of the Company’s locations that have inherent limitations resulting in a control environment heavily reliant upon manual review procedures and adjustments. These deficiencies include inadequate or lack of systems interfaces and the preparation of numerous manual journal entries. In addition, there are additional adjustments entered into the general ledger from subsidiaries after submission by the subsidiary.

·                  The Company has not developed adequate estimation processes to appropriately calculate fairly stated vendor drop shipments, sales returns and allowances, cooperative advertising and customer rebate reserves, and other vendor and employee related costs.

·                  The Company has a manual process for estimating certain amounts for inventory in transit. There is inadequate review of the manual process to determine if the amounts are complete and properly valued.

·                  The Company needs to increase headcount of adequately trained financial personnel to assist in executing timely financial closings, addressing non-routine accounting issues that arise in the normal course of business and ensure timely and accurate preparation of interim and annual financial statements.

·                  The Company needs to increase headcount of adequately trained personnel to ensure the accurate and timely recording of deferred tax assets and liabilities and income tax provisions.

Although these significant deficiencies do not, in our judgment, rise to the level of a material weakness in internal controls over financial reporting, the Chief Executive Officer and the Chief Financial Officer have concluded, based on our evaluation as of March 31, 2007, that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were 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.

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

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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.

Section 404 of the Sarbanes-Oxley Act

For the year ended December 31, 2006 and the quarter ended March 31,2007, we were not subject to the internal controls certification and attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 because we were not an accelerated filer as defined by the SEC. For the year ending December 31, 2007, we expect to be subject to the requirements of Section 404 that management provide an assessment of the effectiveness of the Company’s internal control over financial reporting and the Company’s independent registered public accounting firm will be required to audit that assessment.

We are working to achieve compliance with the requirements of Section 404. We have begun to be dedicate substantial time and resources to documentation and review of our procedures in 2007. We will also 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, the number of accounting systems in use and the lack of qualified personnel to devote to the process. In addition to the weaknesses reported as of March 31, 2007 discussed under the caption “Disclosure Controls and Procedures,” we have identified numerous other internal control deficiencies 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.

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

Changes in Internal Control 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 March 31, 2007 that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 6.		Exhibits
		31		Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
		32		Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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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.

 

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