XASE:SED Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

SQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2012

 

£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 0-16345

 

SED International Holdings, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

GEORGIA

(State or Other Jurisdiction

of Incorporation or Organization)

 

22-2715444

(I.R.S. Employer

Identification No.)

 

3505 NEWPOINT PLACE, SUITE 450, LAWRENCEVILLE, GEORGIA 30043

(Address, including zip code, of Principal Executive Offices)

 

(770) 491-8962

(Registrant’s telephone number, including area code)

 

NOT APPLICABLE

(Former name, former address and former fiscal year, if changed since last report)

 

 

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 S No £

  

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).  Yes S   No £

  

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated filer £

Non-accelerated filer £

 

Accelerated filer £

Smaller reporting company S

 

  

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):  Yes £ No S

  

The number of shares outstanding of the Registrant’s common stock, par value $.01 per share, at May 1, 2012 was 4,979,159 shares.

 



 

 

 

SED INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES

 

INDEX

 

 

PART I - FINANCIAL INFORMATION  
Item 1.  Financial Statements       Page
Condensed Consolidated Balance Sheets as of March 31, 2012 (Unaudited) and June 30, 2011      3
Condensed Consolidated Statements of Income for the three and nine months ended March 31, 2012 and 2011 (Unaudited)      4
Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2012 and 2011 (Unaudited)                 5
Notes to Condensed Consolidated Financial Statements (Unaudited)   6
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations   11
Item 3.     Quantitative and Qualitative Disclosures about Market Risk               18
Item 4.  Controls and Procedures 18
PART II - OTHER INFORMATION  
Item 1.   Legal Proceedings  19
Item 1A.   Risk Factors      19
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds  19
Item 6.   Exhibits   19
Signatures 20

 

  

FORWARD LOOKING STATEMENT INFORMATION

 

Certain statements made in this Quarterly Report on Form 10-Q are “forward-looking statements regarding the plans and objectives of management for future operations”. Such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Our plans and objectives are based, in part, on assumptions involving judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that our assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein particularly in view of the current state of our operations, the inclusion of such information should not be regarded as a statement by us or any other person that our objectives and plans will be achieved.

 

 

-2-
 

 

SED INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

 

   March 31, 2012  June 30, 2011
   (Unaudited)  (Note 1)
           
ASSETS          
Current assets:          
Cash and cash equivalents  $7,321   $4,751 
Trade accounts receivables, less allowance for doubtful accounts of $699 and $783, respectively   61,044    64,335 
Inventories   64,362    63,359 
Deferred tax assets, net   642    443 
Other current assets   7,737    6,617 
Total current assets   141,106    139,505 
Property and equipment, net   3,475    1,928 
Intangible assets, net   294    —   
Total assets  $144,875   $141,433 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
Current liabilities:          
Trade accounts payable  $70,267   $70,681 
Accrued and other current liabilities   9,191    9,581 
Revolving credit facilities   39,138    38,430 
Total current liabilities   118,596    118,692 
           
Commitments and contingencies          
           
Shareholders' equity:          
Preferred stock, $1.00 par value;129,500 shares authorized, none issued   —      —   
Common stock, $.01 par value; 100,000,000 shares authorized; 7,104,043 shares issued and 4,970,207 shares outstanding at March 31, 2012 and 6,979,161 shares issued and 4,867,697 shares outstanding at June 30, 2011   70    70 
Additional paid-in capital   70,945    70,648 
Accumulated deficit   (26,726)   (30,112)
Accumulated other comprehensive loss   (3,219)   (3,171)
Treasury stock 2,133,836 shares and 2,111,464 shares, at cost   (14,791)   (14,694)
Total shareholders' equity   26,279    22,741 
Total liabilities and shareholders' equity  $144,875   $141,433 

 

 

See notes to condensed consolidated financial statements.

-3-
 

 

SED INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except share and per share amounts)

(Unaudited)

 

 

   Three Months Ended  Nine Months Ended
   March 31,  March 31,
   2012  2011  2012  2011
             
Net sales  $138,675   $155,731   $445,440   $454,360 
Cost of sales   130,078    147,624    415,686    429,946 
Gross profit   8,597    8,107    29,754    24,414 
                     
Selling, general and administrative expense   7,910    6,521    24,720    20,111 
Depreciation and amortization expense   205    116    517    329 
Foreign currency transaction (gain) loss   (295)   (88)   638    33 
Acquisition-related costs   —      —      370    —   
      Total operating expenses   7,820    6,549    26,245    20,473 
Operating income    777    1,558    3,509    3,941 
                     
Interest income   (40)   (10)   (42)   (37)
Interest expense   299    232    984    727 
Gain on acquisition   (263)   —      (1,261)   —   
Income before income taxes   781    1,336    3,828    3,251 
Income tax expense   332    284    443    577 
Net income  $449   $1,052   $3,385   $2,674 
                     
Basic income per common share:  $.09   $.23   $.70   $.58 
Diluted income per common share:  $.09   $.21   $.69   $.54 
Weighted average number of common shares outstanding:                    
Basic   4,923,000    4,589,000    4,851,000    4,616,000 
Diluted   4,988,000    5,058,000    4,917,000    4,980,000 

 

 

See notes to condensed consolidated financial statements.

-4-
 

  

SED INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

   Nine Months Ended
March 31,
   2012  2011
Operating activities:          
Net income  $3,385   $2,674 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Depreciation and amortization   517    329 
Deferred tax assets   (199)   (67)
Stock compensation   297    268 
Gain on acquisition   (1,261)   —   
Provision for losses on trade accounts receivable   267    388 
Changes in operating assets and liabilities, net of assets acquired:          
Trade accounts receivable   2,761    (12,905)
Inventories   3,731    (8,915)
Other current assets   (1,150)   (3,190)
Trade accounts payable   (137)   5,195 
Accrued and other current liabilities   (205)   (643)
Net cash provided by (used in) operating activities   8,006    (16,866)
           
Investing activities:          
Purchases of equipment   (2,007)   (1,180)
Cash used in acquisition   (4,113)   —   
Net cash used in investing activities   (6,120)   (1,180)
           
Financing activities:          
Net borrowings under revolving credit facilities   708    20,843 
Purchases of Company common stock   (97)   (1,000)
Proceed from stock option exercises   —      169 
Net cash provided by financing activities   611    20,012 
Effect of exchange rate changes on cash and cash equivalents   73    37 
Net increase in cash and cash equivalents   2,570    2,003 
Cash and cash equivalents:
  Beginning of period
   4,751    7,445 
  End of period  $7,321   $9,448 
           

 

 

See notes to condensed consolidated financial statements.

-5-
 

 

SED INTERNATIONAL HOLDINGS, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Tabular amounts in thousands except share and per share amounts)

(Unaudited)

 

1.Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of SED International Holdings, Inc. and its wholly-owned subsidiaries, SED International, Inc. (“SED International”), SED International de Colombia S.A.S., and Intermaco S.R.L., (collectively, “SED” or the "Company") have been prepared in accordance with accounting principles generally accepted in the United States 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 accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and nine months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2012, or any other interim period. The June 30, 2011 condensed consolidated balance sheet has been derived from the audited consolidated financial statements included in SED’s Annual Report on Form 10-K for the fiscal year ended June 30, 2011.

 

For further information, refer to the consolidated financial statements and footnotes thereto, including Risk Factors, included in the SED’s Annual Report on Form 10-K for the year fiscal year ended June 30, 2011, filed with the Securities and Exchange Commission (“SEC”) on September 14, 2011.

 

2.Earnings per Common Share

 

Basic earnings per share are computed on the basis of the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Included in diluted earnings per share for the three and nine months ended March 31, 2012 are the dilutive effect of options to purchase 57,500 shares of common stock and the dilutive effect of 47,069 shares of non vested restricted stock. Included in the dilutive earnings per share for the three and nine months ended March 31, 2011 are the dilutive effect of options to purchase 257,500 shares of common stock and the dilutive effect of 338,334 shares on non vested restricted stock.

 

Components of basic and diluted earnings per share for the three and nine months ended March 31, 2012 and 2011 were as follows:

 

   Three Months Ended
March 31,
  Nine Months Ended
March 31,
   2012  2011  2012  2011
             
Net income  $449   $1,052   $3,385   $2,674 
                     
Weighted average number of common shares outstanding - Basic   4,923,000    4,589,000    4,851,000    4,616,000 
Effect of dilutive securities:                    
    Stock options   50,000    171,000    50,000    85,000 
    Non vested restricted stock   15,000    298,000    16,000    279,000 
Weighted average number of common shares outstanding - Diluted   4,988,000    5,058,000    4,917,000    4,980,000 
                     
Net income per share:                    
    Basic  $0.09   $0.23   $0.70   $0.58 
    Diluted  $0.09   $0.21   $0.69   $0.54 
                     

 

 

 

-6-
 

 

 

3.Acquisition

 

In August 2011, SED purchased certain assets including finished goods inventories, customer and supplier lists, and intellectual property of ArchBrook Laguna LLC (“ABL”), primarily those related to its subsidiary, Lehrhoff & Co., Inc. (“Lehrhoff”), a distributor of small appliances, housewares, personal care products, and consumer electronics. Under the terms of the agreement, SED acquired the net assets for a purchase price of approximately $4.1 million in cash. SED has also employed certain personnel of Lehrhoff.

 

In January 2012, SED received the final settlement related to the Lehrhoff acquisition and recorded an additional gain of $0.3 million on the transaction. The final settlement related to the reconciliation of inventory in transit at the time of the acquisition. The estimated fair value of the acquired assets of $5.4 million exceeded the $4.1 million paid by SED, resulting in a gain of $1.3 million for the nine months ended March 31, 2012.

 

SED conducted a review to value all the assets acquired and followed the required measurement procedures for the recognition of the fair value of net assets acquired. The review confirmed the calculation of the gain on acquisition.

 

The following table summarizes the estimated fair value of the assets acquired, gain on acquisition, and purchase price recognized on the acquisition date (in thousands):

 

Finished goods inventory  $5,022 
Intangible assets, including customer lists and intellectual property   352 
Assets acquired   5,374 
Gain on acquisition   1,261 
Total purchase price  $4,113 

 

The products acquired from ABL enhanced existing product lines and will be sold both from the new Northeast U.S. distribution center and SED’s other U.S distribution centers while being fully integrated within SED’s existing sales and distribution network. Due to this integration, SED does not operate Lehrhoff as a separate business unit and, as such, it is not practicable to report earnings separate from the consolidated financial statements of SED.

 

4.Comprehensive Income

 

Comprehensive income is defined as the change in equity (net assets) of a business enterprise during a period from transactions or other events and circumstances from non-owner sources, and is comprised of net income and other comprehensive income. SED’s other comprehensive income is comprised of changes in SED’s foreign currency translation adjustments and changes in fair value of an interest rate swap contract, including income taxes attributable to those changes.

 

Comprehensive income, net of income taxes, for the three and nine months ended March 31, 2012 and 2011, respectively, is as follows:

 

   Three Months Ended
March 31,
  Nine Months Ended
March 31,
   2012  2011  2012  2011
Net income  $449   $1,052   $3,385   $2,674 
Changes in foreign currency translation adjustments   731    119    (201)   27 
Changes in fair value of interest rate swap contract   37    55    153    26 
Comprehensive income  $1,217   $1,226   $3,337   $2,727 
                     

The deferred income tax asset related to the accumulated other comprehensive income was fully offset by a valuation allowance as of the beginning and end of the three and nine months ended March 31, 2012 and 2011 and, therefore, the comprehensive income for these periods had no income tax effect.

 

Accumulated other comprehensive income included in shareholders’ equity totaled $3.2 million at both March 31, 2012 and June 30, 2011 and consisted of foreign currency translation adjustments of $3 million and $2.8 million, respectively, and $0.2 million and $0.4 million related to the interest rate swap contract, respectively.

 

-7-
 

 

 

5.Segment Reporting

 

SED operates in one business segment as a wholesale distributor of microcomputer, consumer electronics, and small appliance products. SED operates in two geographic regions, the United States and Latin America/Caribbean (combined as one in the table below). Sales of products between SED's geographic regions are made at market prices and are eliminated in consolidation. All corporate overhead is included in the results of U.S. operations.

 

Financial information for continuing operations by geographic region is as follows:

 

   United States  Latin America  Eliminations  Consolidation
For the three months ended March 31, 2012                    
Net sales to unaffiliated customers  $102,606   $36,069   $—     $138,675 
Gross profit   6,130    2,467    —      8,597 
Foreign currency transaction (gain)   —      (295)   —      (295)
Operating income   102    675    —      777 
Interest expense, net   211    48    —      259 
Gain on acquisition   263    —      —      263 
Income tax expense   46    286    —      332 
Net income   108    341    —      449 
Total assets at March 31, 2012   113,578    44,095    (12,798)   144,875 
                     

 

   United States  Latin America  Eliminations  Consolidation
For the three months ended March 31, 2011                    
Net sales to unaffiliated customers  $119,663   $36,184   $(116)  $155,731 
Gross profit   5,488    2,619    —      8,107 
Foreign currency transaction (gain)   —      (88)   —      (88)
Operating income   912    646    —      1,558 
Interest expense, net   232    (10)   —      222 
Income tax expense   (5)   289    —      284 
Net income   685    367    —      1,052 
Total assets at March 31, 2011   115,170    39,714    (12,764)   142,120 

 

Net sales by product category is as follows:

 

For the three months ended March 31,  Microcomputer Products  Consumer
Electronics &
Small Appliance
Products
  Total
 2012   $120,050   $18,625   $138,675 
 2011   $139,652   $16,079   $155,731 

 

Approximately 44.3% ($25.4 million United States export and $36.1 million Latin America) and 38.8% ($24.2 million United States export, net of ($0.1) million elimination, and $36.2 million Latin America) for the three months ended March 31, 2012 and 2011, respectively, consisted of sales to customers for export principally into Latin America and the Caribbean area and direct sales to customers in Colombia and Argentina.

 

Financial information for continuing operations by geographic region is as follows:

 

   United States  Latin America 

 Eliminations

  Consolidation
For the nine months ended March 31, 2012                    
Net sales to unaffiliated customers  $341,406   $104,075   $(41)  $445,440 
Gross profit   22,029    7,725    —      29,754 
Foreign currency transaction loss   —      638    —      638 
Operating income   3,036    473    —      3,509 
Interest expense, net   840    102    —      942 
Gain on acquisition   1,261    —      —      1,261 
Income tax expense   96    347    —      443 
Net income   3,361    24    —      3,385 
Total assets at March 31, 2012   113,578    44,095    (12,798)   144,875 
                     

 

 

-8-
 

 

 

   United States  Latin America  Eliminations  Consolidation
For the nine months ended March 31, 2011                    
Net sales to unaffiliated customers  $351,613   $104,601   $(1,854)  $454,360 
Gross profit   16,945    7,469    —      24,414 
Foreign currency transaction loss   —      33    —      33 
Operating income   2,469    1,472    —      3,941 
Interest expense (income), net   703    (13)   —      690 
Income tax expense   15    562    —      577 
Net income   1,751    923    —      2,674 
Total assets at March 31, 2011   115,170    39,714    (12,764)   142,120 

 

Net sales by product category is as follows:

 

For the nine months ended March 31,  Micro-Computer Products  Consumer
Electronics & Small Appliance
Products
  Total
 2012   $385,946   $59,494   $445,440 
 2011   $401,304   $53,056   $454,360 

 

Approximately 39.5% ($71.7 million United States export and $104.1 million Latin America) and 37.5% ($65.6 million United States export, net of ($1.9) million elimination, and $104.6 million Latin America) for the nine months ended March 31, 2012 and 2011, respectively, consisted of sales to customers for export principally into Latin America and the Caribbean area and direct sales to customers in Colombia and Argentina.

 

6. Shareholders’ Equity

 

Incentive Compensation Plans — In December 2009, shareholders approved SED’s 2009 Incentive Compensation Plan (the “2009 Plan”). Under the 2009 Plan, 250,000 shares of Common Stock are available for awards. Awards under the 2009 Plan may take the form of stock options (either incentive stock options or non-qualified options), restricted stock, or restricted stock units. As of March 31, 2012, there were 151,651 shares of common stock available for future grants.

 

Stock Option Plans — At March 31, 2012, stock options for 57,500 shares were outstanding and were all exercisable with an aggregate intrinsic value of approximately $.2 million. During the nine months ended March 31, 2012, stock options for 102,500 shares were exercised on cash-less basis which resulted in the issuance of 40,302 shares of our common stock.

 

Restricted Stock — SED established the 2007 Restricted Stock Plan (the “2007 Plan”) during fiscal 2008. A total of 750,000 shares of SED’s authorized and unissued shares of common stock were reserved for grants under the 2007 Plan. Generally, the awards are subject to forfeiture prior to vesting and vest in equal amounts on the second, third and fourth anniversaries of the grant date; provided, however, that at the time of vesting the holder is an employee of SED. At March 31, 2012, all shares were vested under the 2007 Plan.

 

Effective January 2011, non-employee Director base compensation includes a per annum rate of $35,000 of restricted shares of common stock which shall be paid quarterly. The number of shares to be issued to the Directors will be determined on the last day of each quarter based upon the market price of SED’s common stock as of that date. The restricted shares of common stock vest on the date of issuance.

Non vested restricted stock activity is as follows:

 

   Nine Months Ended March 31,
   2012  Weighted Average Grant-Date Fair Value  2011  Weighted Average Grant-Date Fair Value
 Shares of non vested restricted stock-beginning of period    178,890   $1.61    423,987   $1.48 
 Issued    84,580   3.66    53,860   3.31 
 Vested    (214,039)  1.80    (132,847)  2.27 
 Forfeited    (2,362)  5.10    (6,666)  1.49 
 Shares of non vested restricted stock-end of period    47,069   $4.26    338,334   $1.46 

 

Share-based compensation expense recognized during each of the three months ended March 31, 2012 and 2011 totaled approximately $0.1 million. Share-based compensation expense recognized during each of the nine months ended March 31, 2012 and 2011 totaled $0.3 million. At March 31, 2012, there was $0.1 million of unrecognized compensation cost related to non-vested stock awards which SED expects to be recognized over the next twenty-seven months.

 

-9-
 

 

 

The value of restricted stock awards is determined using the market price of SED’s common stock on the grant date and amortized over a vesting period as stated in the restricted stock agreement.

 

Stock Repurchase Plan — For the nine months ended March 31, 2012, SED repurchased 20,010 shares of its common stock under its stock repurchase plan for an aggregate amount of $96,360. During the nine months ended March 31, 2011, SED repurchased 280,175 shares of its common stock under a stock repurchase plan for an aggregate amount of $1 million.

 

7.Credit Facility and Bank Debt

 

SED currently maintains two credit facilities, one with Wells Fargo Bank (USA) and the other with Helm Bank (Colombia). The Wells Fargo Agreement provides for borrowings based on SED’s eligible accounts receivable and inventories as defined in the Agreement. SED amended its credit facility with Wells Fargo on February 1, 2011 which increased the $50 million line of credit to $55 million and extended its term through January 1, 2015. On August 8, 2011, SED exercised its option to increase the credit facility to $60 million. The Wells Fargo line of credit may be increased to $75 million in $5 million increments at SED’s discretion, if certain criteria are met.

 

Borrowings under the Wells Fargo Agreement accrue interest based upon one of two interest rate options depending upon the computation of availability as defined in the Agreement. These interest rate options are (a) LIBOR, plus a margin ranging from 1.50% to 2.25%, or (b) the prime rate. SED is required to pay a commitment fee of .25% on the unused portion of the facility and interest is payable monthly. Borrowings under the Wells Fargo Agreement are collateralized by substantially all domestic assets of SED.

 

The Wells Fargo Agreement also contains certain covenants which, among other things, require that SED maintain unused availability of not less than $5 million during the term of the Agreement before SED is permitted to make advances to SED’s Latin American subsidiaries. SED’s advances to its Latin American subsidiaries are limited to $2 million under the Agreement. The Wells Fargo Agreement also requires that if SED’s unused availability is less than 10% of the formula borrowing base ($5.7 million at March 31, 2012) at any time during the extended term of the Agreement, then SED must maintain a minimum fixed charge coverage ratio. SED’s availability did not fall below this requirement during the three months ended March 31, 2012. Dividend payments are restricted to $0.5 million under the Agreement. As of March 31, 2012, SED determined that it was in compliance with the Wells Fargo Agreement. There is a $3 million stock buy-back limit permitted under the Wells Fargo Agreement and at March 31, 2012 SED has repurchased approximately $1.8 million worth of its stock and has approximately $1.2 remaining for future purchases.

 

The amount available for borrowings under the Wells Fargo Agreement at March 31, 2012 was $17.2 million, after deducting $1.4 million in reserves for outstanding letters of credit.

 

SED’s $5.1 million one year unsecured line of credit with Helm Bank bears interest at a fixed rate of 7.3% per annum and expires in May 2012. The amount available for borrowings under the line of credit at March 31, 2012 is $3.2 million after deducting $1.9 million for outstanding letters of credit.

 

The carrying value of all bank debt at March 31, 2012 and June 30, 2011 approximates its fair value based on the variable market rates of interest on such bank debt.

 

SED also maintains an interest rate swap contract to reduce the impact of the fluctuations in the interest rates on $15 million notional amount of the revolving credit facility under the Wells Fargo Agreement which expires on January 26, 2013. The contract effectively converted the variable rate to a fixed rate of 2.95%. The fixed rates cited do not include Wells Fargo's markup of 1.75% as of March 31, 2012. SED recognizes the interest rate swap contract as either assets or liabilities on its balance sheet and measures those instruments at fair value. SED has designated its interest rate swap agreement as a cash flow hedge. Accordingly, the gains and losses associated with changes in the fair value of the interest rate swap are reported in other comprehensive income (loss) as the hedge is highly effective in achieving offsetting changes in the fair value of cash flows of the asset or liability hedged. The fair value, not in SED’s favor, of the interest rate swap was $0.3 million at March 31, 2012 and $0.6 million at June 30, 2011 and is included in accrued and other current liabilities. SED does not hold or issue derivative financial instruments for trading purposes.

 

8.Fair Value Measurements

 

SED determines a fair value measurement based on the assumptions a market participant would use in pricing an asset or liability. The fair value measurement guidance established a three level hierarchy making a distinction between market participant assumptions based on (i) unadjusted quoted prices for identical assets or liabilities in an active market (Level 1), (ii) quoted prices in markets that are not active or inputs that are observable either directly or indirectly for substantially the full term of the asset or liability (Level 2), and (iii) prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement (Level 3).

 

 

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The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of the short maturity of these items. The carrying amount of debt outstanding pursuant to revolving debt and similar bank credit agreements approximates fair value as interest rates on these instruments approximate current market rates.

 

SED is exposed to market risks from changes in interest rates, which may affect its operating results and financial position. SED reduces its risks from interest rate fluctuations through the use of an interest rate swap contract (see Note 7). This derivative financial instrument is used to manage risk and is not used for trading or speculative purposes. SED endeavors to utilize the best available information in measuring the fair value of the interest rate swap. The interest rate swap is classified in its entirety based on the lowest level of input that is significant to the fair value measurement. SED has determined that its interest rate swap is a Level 2 liability in the fair value hierarchy as it is valued using a discounted cash flow valuation model which includes inputs other than quoted market prices that are both observable and unobservable.

 

 

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

SED International Holdings, Inc. (“SED”) distributes microcomputer and consumer electronic and small appliance products in the United States, Latin America and the Caribbean. SED purchases more than 17,000 products from approximately 170 vendors, including market leaders such as Acer, Asus, Canon, Cuisinart, Epson, Hewlett-Packard, Hitachi, Lenovo, Lexmark, Microsoft, Panasonic, Samsung, Sansui, Seagate and Western Digital. Product categories offered include mass storage, desktop, tablet, laptop, imaging, televisions, audio video equipment, cameras, and small appliances. SED sells its products through a dedicated sales force to reseller customers in retail, e-commerce, VAR, system builder, OEM, custom install and various other reseller channels. SED also offers custom-tailored supply chain management services ideally suited to meet the priorities and distribution requirements of the e-commerce, Business-to-Business and Business-to-Consumer markets. SED distributes its products in the United States, Latin America and the Caribbean region from its strategically located warehouses in Lawrenceville, Georgia; Miami, Florida; Keasbey, New Jersey; City of Industry, California; and Plano, Texas. SED services its customers in Latin America through its wholly-owned subsidiaries SED International de Colombia S.A.S. in Bogotá, Colombia and Intermaco S.R.L. in Buenos Aires, Argentina and from its warehouse in Miami, Florida. SED and its wholly-owned subsidiary, SED International, Inc. (“SED International”) are incorporated in Georgia. As hereinafter used in this document the terms “SED,” “Company,” “we,” “our” or “us” refer collectively to SED and its wholly-owned subsidiaries.

 

On August 15, 2011 we acquired, for approximately $4.1 million, certain assets including finished goods inventories, customer and supplier lists, and intellectual property of ArchBrook Laguna LLC (“ABL”), primarily those related to its subsidiary, Lehrhoff & Co., Inc. (“Lehrhoff”), a distributor of small appliances, housewares, personal care products, and consumer electronics (the “Lehrhoff Assets”). Lehrhoff had operated as a distributor of small appliances, housewares and personal care products for over 90 years, serving major retail chains and private retail establishments in the U.S. The products acquired from ABL enhanced existing product lines and will be sold both from a new Northeast U.S. distribution center and from SED’s other U.S distribution centers while being fully integrated within SED’s existing sales and distribution network.

 

The following discussion should be read in conjunction with the condensed consolidated financial statements of SED and the notes thereto included in this quarterly report. Historical operating results are not necessarily indicative of trends in operating results for any future period.

 

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Results of Operations

 

The following table sets forth, for the periods indicated, the amounts and percentage of net sales of certain line items from SED’s condensed consolidated statements of operations (dollar amounts in thousands):

 

   Three Months Ended March 31,
   2012  2011  $  %
    $    %    $    %    Change    Change 
                               
Net sales   138,675    100.00%   155,731    100.00%   (17,056)   (11.0)%
Cost of sales   130,078    93.80%   147,624    94.79%   (17,546)   (11.9)%
Gross profit   8,597    6.20%   8,107    5.21%   490    6.0%
                               
 Operating expenses:                              
Selling, general and administrative   7,910    5.70%   6,521    4.19%   1,389    21.3%
Depreciation and amortization   205    .15%   116    .07%   89    76.7%
Foreign currency transaction gain   (295)   (.21)%   (88)   (.05)%   (207)   235.2%
       Total operating expenses   7,820    5.64%   6,549    4.21%   1,271    19.4%
Operating income   777    .56%   1,558    1.00%   (781)   (50.1)%
Interest income   (40)   (.03)%   (10)   (.01)%   (30)   300.0%
Interest expense   299    .22%   232    .15%   67    28.9%
Gain on acquisition   (263)   (.19)%   —      —      (263)   —   
Income before income taxes   781    .56%   1,336    .86%   (555)   (41.5)%
Income tax expense   332    .24%   284    .18%   48    16.9%
Net income   449    .32%   1,052    .68%   (603)   (57.3)%

 

 

   Nine Months Ended March 31,
   2012  2011  $  %
    $    %    $    %    Change    Change 
                               
Net sales   445,440    100.00%   454,360    100.00%   (8,920)   (2.0)%
Cost of sales   415,686    93.32%   429,946    94.63%   (14,260)   (3.3)%
Gross profit   29,754    6.68%   24,414    5.37%   5,340    21.9%
                               
Operating expenses:                              
Selling, general and administrative   24,720    5.55%   20,111    4.42%   4,609    22.9%
Depreciation and amortization   517    .12%   329    .07%   188    57.1%
Foreign currency transaction loss   638    .14%   33    .01%   605    1,833.3%
Acquisition-related costs   370    .08%   —      —      370    —   
       Total operating expenses   26,245    5.89%   20,473    4.50%   5,772    28.2%
Operating income   3,509    .79%   3,941    .87%   (432)   (11.0)%
Interest income   (42)   (.01)%   (37)   (.01)%   (5)   13.5%
Interest expense   984    .22%   727    .16%   257    35.4%
Gain on acquisition   (1,261)   (.28)%   —      —      (1,261)   —   
Income before income taxes   3,828    .86%   3,251    .72%   577    17.7%
Income tax expense   443    .10%   577    .13%   (134)   (23.2)%
Net income   3,385    .76%   2,674    .59%   711    26.6%

 

Three Months Ended March 31, 2012 and 2011

 

Net sales. Net sales for the three months ended March 31, 2012 were $138.7 million, a decrease of $17 million or 11% compared with $155.7 million for the three months ended March 31, 2011. Sales in the quarter ended March 31, 2012 included U.S. sales of consumer electronics and small appliance products acquired from ABL.

 

Microcomputer product sales were $120.1 million for the three months ended March 31, 2012, a decrease of 14% over similar product sales of $139.7 million reported for the same period in 2011. The decrease in the microcomputer product sales were primarily attributable to the impact of the flooding in Thailand which interrupted hard drive production. We also had lower sales in the notebook products category. While the volume of hard drives and related products decreased during the third quarter, we saw an increase in margins in those products due to reduced product availability. Sales of microcomputer products represented approximately 86.6% of SED’s third quarter net sales compared to 89.7% for the comparable period in 2011.

 

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Consumer electronics and small appliance sales, all of which were in the U.S., for the three months ended March 31, 2012 were $18.6 million, an increase of 15.8% compared to $16.1 million for the comparable period in 2011. The increase was due primarily to the additional product categories acquired from ABL. Sales of consumer electronics products accounted for approximately 13.4% of SED’s third quarter net sales compared to 10.3% for the comparable period in 2011.

 

Comparative revenues by SED geography are summarized below (amounts in millions except for percentage amounts):

 

   Three Months Ended
March 31,
  Change
   2012  2011  Amount  Percent
United States                    
   Domestic  $77.2   $95.3   $(18.1)   (19.0)%
   Export (net of eliminations)   25.4    24.2    1.2    4.9%
Total U.S.   102.6    119.5    (16.9)   (14.2)%
Latin America   36.1    36.2    (0.1)   (0.3)%
Consolidated  $138.7   $155.7   $(17.0)   (10.9)%

 

U.S. domestic revenues were $77.2 million for the three months ended March 31, 2012 compared with $95.3 million for the same period in 2011. The decrease in 2012 was due to unit sale decreases in hard drives and notebooks as mentioned above. U.S. export revenues, net of eliminations, were $25.4 million and $24.2 for the three months ended March 31, 2012 and 2011, respectively. Latin America sales were $36.1 million and $36.2 million for the three months ended March 31, 2012 and 2011, respectively, a decrease of 0.3% (decrease of 1.6% currency adjusted).

 

Gross Profit Margins. Gross profit for the three months ended March 31, 2012 was $8.6 million, an increase of $0.5 million or 6% compared with $8.1 million for the same period in 2011. Gross margin improved, as a percentage of sales, to 6.2% for the quarter ended March 31, 2012 from 5.2% for the same period in 2011. The increased gross profit percent is attributable to higher than normal sales prices on hard drives due to inventory supply constraints resulting from interrupted production of hard drives in flooded areas in Thailand, and higher margins earned on small appliances.

 

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $7.9 million for the three months ended March 31, 2012, an increase of 21.3% compared with $6.5 million for the same period in 2011. The increase included $1.2 million related to the new SED New Jersey location to accommodate the sale of consumer electronics and small appliance products acquired from ABL, a reversal of a $0.3 million expense reserve for a contingent liability that was no longer deemed probable, increased salaries from selective headcount increases and increased commissions related to the increase in gross profit margins, and increased bad debt related expenses over prior year related to a large recovery on the prior year period.

 

Depreciation and Amortization. Depreciation and amortization was $0.2 million for the three months ended March 31, 2012 compared with $0.1 million for the same period last year.

 

Foreign Currency Transaction. SED has U.S. dollar denominated liabilities recorded in its subsidiaries in Argentina and Colombia to meet certain vendor payment requirements. The revaluation/devaluation of the peso in Colombia and Argentina versus the U.S. dollar resulted in a net foreign currency transaction gain totaling $0.3 million for the three months ended March 31, 2012 as compared to a net gain of $0.1 million for the three months ended March 31, 2011.

 

Operating Income. For the three months ended March 31, 2012, SED reported operating income of $0.8 million compared with operating income of $1.6 million for the comparable period in 2011. This decrease in operating income was primarily attributable to operating expenses for the New Jersey location which opened in fiscal 2012.

 

Interest Income. Interest income was $40,000 and $10,000 for the three months ended March 31, 2012 and 2011, respectively.

 

Interest Expense. Interest expense was $0.3 million and $0.2 million for the three months ended March 31, 2012 and 2011, respectively. This change resulted primarily from higher average loan balances and a 0.25% increase in the borrowing rate.

 

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Provision for Income Taxes. Income tax expense was $0.3 million for the three months ended March 31, 2012 and 2011. The provision is primarily related to income or losses generated by SED’s subsidiaries in Argentina and Colombia. The provision for income taxes differs from the amount which would result from applying the statutory federal income tax rate due to the taxes imposed on the foreign subsidiaries as well as the fact that SED provides a full valuation allowance against all deferred tax assets generated from its U.S. operations as there is no assurance that these assets will be realized.

 

 

Nine Months Ended March 31, 2012 and 2011

 

Net sales. Net sales for the nine months ended March 31, 2012 were $445.4 million, a decrease of $8.9 million or 2% compared with $454.4 million for the nine months ended March 31, 2011. Sales in the nine months ended March 31, 2012 included U.S. sales of consumer electronics and small appliance products acquired from ABL.

 

Microcomputer product sales for the nine months ended March 31, 2012 were $385.9 million a decrease of 3.8% compared with $401.3 million for the nine months ended March 31, 2011. Sales remained strong for certain computer products, consumables, and other computer product sales across all regions; however these increases were offset by the impact of the flooding in Thailand which interrupted the supply of hard drives. Sales of microcomputer products represented approximately 86.6% of SED’s net sales for the nine months ended March 31, 2011, compared to 88.3% for the comparable period in 2011.

 

Consumer electronics sales and small appliances, all of which were in the U.S., were $59.5 million for the nine months ended March 31, 2012, an increase of 12.1% compared with $53.1 million for the nine months ended March 31, 2011. The increase was due primarily to the additional product categories acquired from ABL which were partially offset by a decrease in consumer electronics sales due to declines in market prices for television products and to declines in SED’s unit sales volumes in this product category. Sales of consumer electronics products accounted for approximately 13.4% of SED’s net sales for the nine months ended March 31, 2012, compared to 11.7% for the comparable period in 2011.

 

Comparative revenues by SED geography are summarized below (in millions except for percentage amounts):

 

   Nine Months Ended
March 31,
  Change
   2012  2011  Amount  Percent
United States                    
   Domestic  $269.6   $285.2   $(15.6)   (5.5)%
   Export (net of eliminations)   71.7    64.6    7.1    11.0%
Total U.S.   341.3    349.8    (8.5)   (2.4)%
Latin America   104.1    104.6    (0.5)   (0.5)%
Consolidated  $445.4   $454.4   $(9.0)   (2.0)%

 

Domestic revenues were $269.6 million and $285.2 million for the nine months ended March 31, 2012 and 2011, respectively. The net decrease in domestic revenue is attributable to additional revenues generated by sales of new products acquired from ABL, offset by decreases in sales of hard drives. Export revenues, net of eliminations, were $71.7 million and $64.6 million for the nine months ended March 31, 2012 and 2011, respectively. The increase resulted from additional sales of computer products, printers and consumable printer products. Latin America sales were $104.1 million and $104.6 million for the nine months ended March 31, 2012 and 2011, respectively, a decrease of 0.5%.

 

Gross Profit Margins. Gross profit increased $5.3 million to $29.8 million for the nine months ended March 31, 2012, compared to $24.4 million for the same period last year. Gross profit, as a percentage of net sales, was 6.7% for the nine months ended March 31, 2012 compared with 5.4% for the comparable period in 2011. The increased gross profit percentage is attributable to the higher margins in sales of hard drives due to inventory supply constraints resulting from interrupted production of hard drives in flooded areas in Thailand and higher margins earned on small appliances.

 

Selling, General and Administrative Expenses. Selling, general and administrative expenses, excluding acquisition-related costs, for the nine months ended March 31, 2012 were $24.7 million, an increase of 22.9%, compared with $20.1 million for the comparable period in 2011. The increase resulted from approximately $3.1 million attributable to the acquisition, integration, and selling of consumer electronics and small appliance products acquired from ABL, a reversal of a $0.3 million expense reserve for a contingent liability that was no longer deemed probable, increased salaries due to selective headcount additions and certain wage increases including statutorily mandated increases in Colombia and Argentina, an increase in commissions related to the increase gross margins, and management severance expenses in Argentina and the U.S.

 

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Depreciation and Amortization. Depreciation and amortization was $0.5 million for the nine months ended March 31, 2012 compared with $0.3 million for the comparable period last year.

 

Foreign Currency Transaction. SED has U.S. dollar denominated liabilities recorded in its subsidiaries in Argentina and Colombia to meet certain vendor payment requirements. The revaluation/devaluation of the peso in Colombia and Argentina versus the U.S. dollar resulted in a net foreign currency transaction loss totaling $0.6 million for the nine months ended March 31, 2012 as compared to a net loss of $33,000 for the nine months ended March 31, 2011.

 

Acquisition-related cost. Acquisition-related expenses associated with the acquisition of the Lehrhoff Assets during the nine months ended March 30, 2012 were approximately $0.4 million and consisted primarily of professional and legal fees associated with the transaction.

 

Operating Income. For the nine months ended March 31, 2012, SED reported operating income of $3.5 million compared with operating income of $3.9 million for the comparable period in 2011. The change is attributed to increased gross profit from the sale of higher margin small appliances and microcomputer product sales, including hard drives, partially offset by increased selling, general and administrative expense from the acquisition and integration of the Lehrhoff Assets, and personnel related enhancements.

 

Interest Income. Interest income was $42,000 and $37,000 for the nine months ended March 31, 2012 and 2011, respectively.

 

Interest Expense. Interest expense was $1 million and $0.7 million for the nine months ended March 31, 2012 and 2011, respectively. This change resulted primarily from higher average loan balances and a 0.25% increase in the borrowing rate.

 

Provision for Income Taxes. Income tax expense was $0.4 million for the nine months ended March 31, 2012 as compared to $0.6 million for the nine months ended March 31, 2011. The provision is primarily related to income generated by SED’s subsidiaries in Argentina and Colombia. The provision for income taxes differs from the amount which would result from applying the statutory Federal income tax rate due to the taxes imposed on the foreign subsidiaries as well as the fact that SED provides a full valuation allowance against all deferred tax assets generated from its U.S. operations as there is no assurance that these assets will be realized

 

Critical Accounting Policies and Estimates

 

Allowance for Doubtful Accounts

 

An allowance for doubtful accounts has been established based on collection experience and an assessment of the collectability of specific accounts. Management evaluates the collectability of accounts receivable based on a combination of factors. Initially, management estimates an allowance for doubtful accounts as a percentage of accounts receivable based on historical collections experience. This initial estimate is periodically adjusted when management becomes aware of a specific customer’s inability to meet its financial obligations (e.g., bankruptcy filing) or as a result of changes in the overall aging of accounts receivable. The overall determination of the allowance also considers credit insurance coverage and deductibles, which SED has maintained from time to time. SED maintains credit insurance, which protects us from credit losses exceeding certain deductibles for certain domestic sales and certain export shipments from the United States. SED maintains credit insurance in many Latin American countries (subject to certain terms and conditions).

 

Inventories — Slow Moving, Obsolescence, and Lower of Cost or Market

 

Certain SED vendors allow for either return of goods within a specified period (usually 45-90 days) or for credits related to price protection. However, for other vendor relationships and inventories, SED is not protected by vendors from the risk of inventory loss. Therefore, in determining the net realizable value of inventories, management identifies slow moving or obsolete inventories that (1) are not protected by vendor agreements from risk of loss, and (2) are not eligible for return under various vendor return programs. Based upon these factors, management estimates the net realizable value of inventories and records any necessary adjustments as a charge to cost of sales. If inventory return privileges were discontinued in the future, or if vendors were unable to honor the provisions of certain contracts, which protect SED from inventory losses, including price protections, the risk of loss associated with obsolete, slow moving or impaired inventories would increase.

 

Revenue Recognition

 

Revenue is recognized once four criteria are met: (1) SED must have persuasive evidence that an arrangement exists; (2) delivery must occur, which generally happens at the point of shipment (this includes the transfer of both title and risk of loss, provided that no significant obligations remain which is usually the case); (3) the price must be fixed or determinable; and (4) collectability must be reasonably assured. Shipping revenue is included in net sales while the related costs, including shipping and handling costs, are included in the cost of sales. SED allows its customers to return product for exchange or credit subject to certain limitations. A provision for such returns is recorded based upon historical experience.

 

 

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Financial Instruments

 

SED’s principal financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable and revolving credit facilities. The carrying value of these financial instruments approximate fair value based upon the short-term nature of the instruments, and the variable rates on credit facilities.

 

The functional currency for SED’s international subsidiaries is the local currency of the country in which the subsidiaries own their primary assets. The translation of the applicable currencies into U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. Any related translation adjustments are recorded directly to stockholders’ equity as a component of accumulated other comprehensive income (loss). It is SED’s policy not to enter into derivative contracts for speculative trading purposes. SED conducts business in countries outside of the United States, which exposes SED to fluctuations in foreign currency exchange rates. SED may enter into short-term forward exchange or option contracts to reduce this risk. At March 31, 2012, SED held approximately $1.5 million of short-term forward exchange contracts, which mature in April 2012. The fair value of these contracts is recorded in accrued and other current liabilities.

 

SED’s revolving credit facility is currently a variable rate facility. SED has entered into an interest rate swap contract to reduce the impact of the fluctuations in the interest rate on $15 million notional amount of the obligation under its revolving credit facility with Wells Fargo, which expires on January 26, 2013.

 

Inflation and Price Levels

 

Inflation has not had a significant impact on SED’s overall business because of the typically decreasing costs of products sold by SED and the fact that we also receive price protection from vendors for a significant portion of our inventory. In the event a vendor or competitor reduces its prices for goods purchased by SED prior to SED’s sale of such goods, we generally have been able either to receive a credit from the vendor for the price differential or to return the goods to the vendor for credit.

 

Argentina and Colombia have experienced high rates of inflation and hyperinflation from time to time in the past. SED has experienced higher operating costs related to government mandated wage increases in those countries. At this time, management believes that inflation may have a material impact on SED’s Latin American business operations in the immediate future.

 

Net Operating Tax Loss Carry Forwards

 

SED has accumulated net operating loss carry forwards for Federal income tax purposes of approximately $60.5 million, which expire in fiscal years 2019 through 2029. These losses are available to offset taxable income generated through those dates. The ultimate realization of these deferred tax assets is dependent upon the generation of sufficient future taxable income during the periods in which these carryforwards may be utilized.

 

Liquidity and Capital Resources

 

Overview. At March 31, 2012, SED had cash and cash equivalents totaling $7.3 million and working capital of approximately $22.5 million. At March 31, 2012, SED’s availability under its credit facilities was approximately $20.4 million, after deducting $3.3 million in reserves for outstanding letters of credit. SED’s principal source of liquidity is its cash, cash equivalents, trade receivables, inventories and amounts available under its revolving credit facilities with Wells Fargo Bank (USA) and Helm Bank (Colombia). SED’s U.S. accounts receivable and inventories collateralize SED’s borrowings from Wells Fargo. SED amended its credit facility with Wells Fargo on February 1, 2011, to increase the $50 million line of credit to $55 million and extended its term through January 1, 2015. SED signed an amendment with Wells Fargo in August 2011 which increased borrowing availability from $55 million to $60 million as permitted in the February 2011 extension. The Wells Fargo line of credit may be further increased to $75 million in $5 million increments at SED’s discretion if certain criteria are met. Cash flows from the increase in the line of credit were used to fund the acquisition of Lehrhoff as described in Note 3 to the consolidated financial statements (“Acquisition”).

 

SED also maintains a $5.1 million unsecured one-year credit line with Helm Bank in Colombia that expires in May 2012. SED plans on renewing this line in May.

 

Historically, SED has financed its liquidity needs largely through internally generated funds, borrowings under the Wells Fargo credit facility, subsidiary bank credit agreements, and vendor lines of credit. As of March 31, 2012, SED was in compliance with the requirements of the Wells Fargo and Helm Bank credit facility agreements and has no reason to believe that it will not remain in compliance.

 

 

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While SED has historically derived a material portion of its operating income and cash flows from its foreign subsidiaries, management believes that if there were to be deteriorating economic conditions in Argentina or Colombia or a devaluation of the peso in either country it may have a negative effect on our foreign subsidiaries’ net income and the ability to generate cash flows from operations. Domestic banking agreements and international monetary restrictions may also limit SED’s ability to transfer cash between its foreign and domestic subsidiaries.

 

Operating Activities. Cash provided by operating activities was $8 million for the nine months ended March 31, 2012, an increase of $24.9 million as compared to approximately $16.9 million used in operating activities for the nine months ended March 31, 2011. The $24.9 million increase in operating activities is attributable to an increase in profitability combined with a decrease in inventories and trade receivables. Changes in operating assets and liabilities during the nine months ended March 31, 2012 are as follows:

 

Net trade receivables were $61.0 million at March 31, 2012 and $64.3 million at June 30, 2011. Average day’s sales outstanding for the quarter at March 31, 2012 and 2011 were approximately 39 and 37 days, respectively. Certain large retail customers acquired with the Lehrhoff Assets have extended terms which has led to the increase in days sales outstanding.

 

Inventories increased $1 million to $64.4 million at March 31, 2012 from $63.4 million at June 30, 2011. The increase can be attributed to lower inventory turns associated with the small appliance business. Inventory turns for the quarter at March 31, 2012 and 2011 were approximately 8.6 and 10.6, respectively.

 

Other current assets increased to $7.7 million at March 31, 2012 from $6.6 million at June 30, 2011. This was primarily due to increases in prepaid withholding taxes required in Argentina and Colombia, deposits, and miscellaneous receivables.

 

Trade accounts payable decreased by $0.4 million to $70.3 million at March 31, 2012 compared to $70.7 million at June 30, 2011.

 

Accrued and other current liabilities decreased to $9.2 million at March 31, 2012 from $9.6 million as of June 30, 2011.

 

SED’s cash flows are affected by the changes in exchange rates in Argentina and Colombia. The exchange rate changes had the effect of providing $73,000 in cash for the nine months ended March 31, 2012 as compared to providing $37,000 in cash for the nine months ended March 31, 2011.

 

Financing Activities. Net borrowings under the credit facilities increased by $0.7 million to $39.1 million at March 31, 2012 compared to $38.4 million at June 30, 2011.

 

Borrowings under the Wells Fargo Agreement accrue interest based upon one of two interest rate options depending upon the computation of availability as defined in the Agreement. Those options are (a) LIBOR plus a margin of 1.50% to 2.25%, or (b) the prime rate. SED is required to pay a commitment fee of .25% on the unused portion of the facility. Interest is payable monthly. Borrowings under the Wells Fargo Agreement are collateralized by substantially all domestic assets of SED.

 

The Wells Fargo Agreement contains certain covenants which, among other things, require that SED maintain unused availability of $5 million or more during the term of the Agreement before SED is permitted to make advances to SED’s Latin American subsidiaries. SED’s advances to its Latin American subsidiaries are limited to $2.0 million under the Agreement. The Wells Fargo Agreement also requires that if SED’s availability is less than 10% of the formula borrowing base ($5.7 million at March 31, 2012) at any time during the term of the Agreement, then maintenance of a minimum fixed charge coverage ratio, as defined, is required. SED’s availability did not fall below this requirement during the three months ended March 31, 2012. Dividends are limited to $0.5 million under the Agreement. As of March 31, 2012, SED determined that it was in compliance with the Wells Fargo Agreement. There is a $3 million stock buy-back limit permitted under the Wells Fargo Agreement and at March 31, 2012 SED has repurchased approximately $1.8 million worth of its stock and has approximately $1.2 remaining for future purchases.

 

SED’s $5.1 million one-year unsecured line of credit with Helm Bank bears interest at a fixed rate of 7.3% per annum and expires in May 2012.

 

Available borrowings under these credit facilities at March 31, 2012 were $17.2 million under the Wells Fargo Agreement, after deducting $1.4 million in reserves for its outstanding letters of credit, and $3.2 million under the Helm Bank line of credit after deducting $1.9 million in reserves for its outstanding letters of credit.

 

 

-17-
 

 

 

The carrying value of all bank debt at March 31, 2012 and June 30, 2011 approximates its fair value based on the variable market rates of interest on such bank debt.

 

SED also maintains an interest rate swap contract to reduce the impact of the fluctuations in the interest rates on $15 million notional amount of the revolving credit facility under the Wells Fargo Agreement which expires on January 26, 2013. The contract effectively converted the variable rate to a fixed rate of 2.95%. The fixed rates cited does not include Wells Fargo’s markup of 1.5% as of March 31, 2012. SED recognizes the interest rate swap contract derivatives as either assets or liabilities on its balance sheet and measures those instruments at fair value. SED has designated its interest rate swap agreement as a cash flow hedge. Accordingly, the gains and losses associated with changes in the fair value of the interest rate swap are reported in other comprehensive income (loss) as the hedge is highly effective in achieving offsetting changes in the fair value of cash flows of the asset or liability hedged. The fair value, not in SED’s favor, of the interest rate swap was $0.3 million and $0.6 million as of March 31, 2012 and 2011, respectively, and is included in accrued and other current liabilities. SED does not hold or issue derivative financial instruments for trading purposes.

 

The recent global economic downturn created several risks relating to SED’s financial results, operations and prospects. SED may experience a rapid decline in demand for the products it sells resulting in a more competitive environment and increased pressure to reduce the cost of operations. The benefits from cost reductions may take longer to fully realize and may not fully mitigate the impact of the reduced demand. The recent global economic downturn may also result in changes in vendor terms and conditions, such as rebates, cash discounts and cooperative marketing efforts, which may result in further downward pressure on SED’s gross margins. Deterioration in the financial and credit markets heightens the risk of customer bankruptcies and delays in payment. Deterioration in the credit markets in Argentina, Colombia and the United States have resulted in reduced availability of credit insurance to cover customer accounts. This may result in a reduction of the credit lines SED provides to its customers, thereby having a negative impact on its sales. Also, volatile foreign currency exchange rates increase SED’s risk related to products purchased in a currency other than the currency in which those products are sold. The realization of any or all of these risks could have a significant adverse effect on SED’s future financial results.

 

Historically, SED has financed its liquidity needs largely through internally generated funds, borrowings under the Wells Fargo credit facility, subsidiary bank credit agreements, and vendor lines of credit. There can be no assurance that any or all of the aforementioned sources of capital will be available to SED when needed. For example, SED’s creditors may tighten their lending standards and SED may find it necessary to tighten credit availability standards to its customers due to the general weakening of the economic environment. However, SED believes that funds generated from operations, together with its Wells Fargo credit facility, subsidiary bank credit agreements, vendor credit lines, and current cash and cash equivalents will be sufficient to support its working capital and liquidity requirements for at least the next 12 months.

  

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

As a smaller reporting company, SED is not required to provide the information required by this item.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a)Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, carried out an evaluation of the effectiveness of our “disclosure controls and procedures” (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this report (the “Evaluation Date”). Based upon that evaluation, our chief executive officer and chief financial officer concluded that as of the Evaluation Date, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (ii) is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

(b)Changes in Internal Control over Financial Reporting

 

There were no changes in our internal controls over financial reporting that occurred during the quarter ended March 31, 2012 that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

-18-
 

  

PART II – OTHER INFORMATION

 

ITEM 1. Legal Proceedings

 

None.

 

ITEM 1A. Risk Factors

 

As a smaller reporting company, SED is not required to provide the information required by this item.

 

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

On April 5, 2012, SED issued an aggregate of 8,952 shares of restricted common stock from its 2009 Incentive Compensation Plan, with a market value of approximately $68,000, to the four non-management members of its Board of Directors (the “Board”) under its director compensation plan for 2012 calendar year services. Shares are issued quarterly under the director compensation plan. The aforementioned shares of restricted common stock were issued in reliance upon the exemption from the registration requirements of the Securities Act of 1933, as amended (“Act”) pursuant to Sections 4(2) and 4(5) of the Act. Appropriate restrictive legends were imprinted on the back of each issued stock certificate.

 

Company Purchases of its Equity Securities

 

Since the adoption of our share repurchase plan in August 2009 continuing through March 31, 2012, we repurchased an aggregate of 481,925 shares of our common stock at an average cost of approximately $3.79 per share or $1.8 million in the aggregate. We did not repurchase shares of our common stock under our repurchase plan during the three months ended March 31, 2012.

 

ITEM 6. Exhibits

 

Exhibits Description

 

31.1   Rule 13a-14(a)/15d-14(a) Certification by Principal Executive Officer.*
31.2   Rule 13a-14(a)/15d-14(a) Certification by Principal Financial Officer.*
32.1   Section 1350 Certification by Principal Executive Officer.*
32.2   Section 1350 Certification by Principal Financial Officer.*
101.INS **   XBRL Instance Document
101.SCH**   XBRL Taxonomy Extension Schema Document
101.CAL**   XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB**   XBRL Taxonomy Extension Label Linkbase Document.
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF**    XBRL Taxonomy Extension Definition Linkbase Document.
________________
*Filed Herewith
**Filed herewith. In accordance with Rule 406T of Regulation S-T, the information in these exhibits shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.

 

 

 

-19-
 

 

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.

 

 

  SED International Holdings, Inc.
  (Registrant)

Date:  May 10, 2012 /s/ JONATHAN ELSTER
 

Jonathan Elster

Chief Executive Officer

(Principal Executive Officer)

 

Date:  May 10, 2012 /s/ LYLE DICKLER
 

Lyle Dickler

Chief Financial Officer

(Principal Financial and Accounting Officer)

 

-20-
 

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XASE:SED Quarterly Report 10-Q Filing - 3/31/2012
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